IAS 16 22 sets out the core principle for determining the cost of a self-constructed asset.
The cost of a self-constructed asset is determined using the same principles as applicable to an purchased asset. If an entity makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale. Any internal profits are eliminated in arriving at such costs. Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset.
Elements of cost for a purchased asset and self-constructed asset are the same. For internally generated input , no profit is included.
Example Cost of self-constructed asset
Entity E incurred the following expenses on account of construction of its office building :
- Material purchased CU 10 million
- Labour CU 5 million
- Other expenses CU 2 million
- Advance to material suppliers CU 2 million
- Material on hand CU 1 million
- Loans taken for construction CU 10 million @ 14%. Loan to date 12 months.
Record the above-mentioned expenses in the appropriate asset-class.
Amounts in CU
Office under construction
Loans and advances
Capitalisation of interest
Advance to material suppliers
Commencement date of self-construction of an asset is critical as that signifies the commencement of capitalisation of expenses incurred for the self-constructed asset. Costs incurred prior to that shall be expensed.
Commencement of capitalisation of expenses relating to self-constructed assets
The Board of X Ltd. discussed on 1 January 2012 based on a note prepared by the project team to construct a plant for manufacturing certain chemicals. This note was prepared based on a discussion in an earlier Board meeting in which the Board wished that the project department should put forth some expansion proposals. Accordingly, it has asked the project department to carry out a preliminary survey about the feasibility of the proposal which should be the basis for further discussion.
Based on the preliminary survey (report dated 30 June 2012) , the Board subsequently decided to go ahead with a full fledged Feasibility Study and appointed a consultancy firm to carry out market survey as well. The scope of feasibility report included the selection of location.
The feasibility report was satisfactory (report date 30 September 2012) . The Board decided ( meeting date 31 October 2012) to go ahead with the project but there was no unanimity as regards project location. Another team was appointed to decide upon the location. Location was decided in another Board meeting dated 31 January 2013. The company then took necessary step to complete the formalities relating to project development in the earmarked location and construction work started on due course.
Expenses incurred for various activities are as follows:
(Amounts in CU)
Expenses for preliminary survey
Expenses for feasibility report
Expenses for site selection
Expenses for preliminary survey ,feasibility report, site selection include allocated overhead costs of the project department.
Allocated overhead represents office expenses and depreciation. Cost of self-constructed assets
Items to solve:
- Shall these expenses be capitalised in accordance with IAS 16? If not, what shall be the point of commencement of capitalisation?
- Which of the above-stated expenses can be capitalised? Is it permissible to capitalise allocated overhead?
- Can the company capitalise allocated overhead on the basis of normal capacity of the project department? It may appear that indirect cost of the Project Department will unnecessarily inflate the project cost and thus the cost of various assets under construction. The company has recorded cost of project excluding overhead of project department.
This case shall be addressed with reference to recognition principle set out in IAS 16 7: Cost of self-constructed assets
“The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: Cost of self-constructed assets
- it is probable that future economic benefits associated with the item will flow to the entity; and Cost of self-constructed assets
- the cost of the item can be measured reliably.” Cost of self-constructed assets
In the given case, cost of all items could be reliably measured. But the point of time since when ‘it is probable that future economic benefits associated with the item will flow to the entity’ becomes critical for the purpose of capitalization of expenses.
All project ideas are not translated into a successful project. Rejection rate may be pretty high. So commencement of developing initial project ideas through preliminary survey or feasibility report does not signify the point of time when it becomes ‘probable that future economic benefits associated with the item will flow to the entity’.
The probability can be significant when the Board approves the project report and decided to implement the project. In case the site selection is post –project approval process then related expenses can be capitalized.
Allocation of overhead of the project department: Administration and other general overhead costs are not included in the cost of asset. A portion of the overhead may be directly linked to the project. Other portion are office expenses by nature like expenses for electricity and facilities, depreciation of office equipment. Such indirect expenses are not allocated to project(s).
Expenses for site selection
Directly attributable costs are capitalised as asset under construction but administrative and general overheads shall be excluded. However, project office expenses are directly attributable expenses but it is linked to capacity of the project office. If the capacity of the project office remains under-utilised, then full allocation of cost would result in overloading the asset. Therefore, it is appropriate to allocate project office expenses on normal capacity basis.
Incidental Income and Expenses – An entity may carry out certain incidental operations which are linked to construction of assets but not necessary to ‘bring the item to the location and condition necessary for it to be capable of operating in the manner intended by management’. These incidental operations , of course, give rise to expense and income. For example, income may be earned through using a building site as a car park until construction starts. Cost of self-constructed assets
These incidental operations may occur before or during the construction or development activities. Cost of self-constructed assets
Because incidental operations are not necessary to bring an item of asset ‘to the location and condition necessary for it to be capable of operating in the manner intended by management’, the income and related expenses of incidental operations are recognised in profit or loss and included in their respective classifications of income and expense.