Last update: March 2023

“We run the school and we plan to build the new school building on the leased land. We leased a land from the government for 40 years with an option to renew for another period. The rentals are at market conditions.

The construction is going to take about 3 years. Can we capitalize the rental payments during construction into the cost of the new school building?

Another question is that a part of the older school building undergoes major refurbishment and we had to lease a building to continue with classes. Can we capitalize these rentals into the cost of the new building?”

Answer: Not really.

The short answer is – NO, I would not do it, in both cases.

Let me explain you why.

Capitalization of land rental expenses

I know that many companies do capitalize the rental expenses in pre-opening period or during the construction because they consider it as expenses directly attributable to bringing the asset to the location and condition to operate as intended by the management.

But, let me tell you that the rental expenses in this case are NOT attributable to the construction itself, but they are attributable to the leased property – land.

The paragraph 58 of IAS 16 specifically says that the land and buildings are separable assets and are accounted for separately when they are acquired together.

So, yes, it is true that without this rental expense the school would not be able to construct the new school building, but under IAS 16, the company still must distinguish the land and building.

In this case, the rental expense relates to the land, not the building – so no capitalization.

Also, let me point you to the paragraph 19 of IAS 16.

It deals with expenses during the pre-opening period – it’s clearly said that no, you cannot capitalize the similar expenses.

What to do instead?

Well, we are in 2023 and since 2019, the new lease standard IFRS 16 is in place. That solves a few things, because under IFRS 16, you are effectively capitalizing the operating lease of land anyway, in the form of right-of-use asset.

Capitalization of rental expenses to continue business

The school refurbishes the old building and moves classes to another leased building while the new one is constructed or the older one is refurbished.

Can the school capitalize the rental expenses of the alternative building?

No, it cannot.

The reason is that these expenses are not directly attributable to the construction of the new building or to the refurbishment of the old one – I think that the school can do both without renting out the alternative building.

These expenses are attributable to continuing the business, they are simply related to the revenue-generating activities and thus they need to be expensed.

Of course, here’s IFRS 16, so if you apply this standard and the lease is for more than 12 months, then you would probably need to account for certain right-of-use asset, too.

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