019: Can you capitalize rental expenses of land?
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IFRS Question 019: Capitalization of the rental expenses
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?
IFRS Answer 019
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 2018 and currently, there are two lease standards: IAS 17 and IFRS 16.
I’m sure you are aware of the main difference:
- Under older IAS 17, the school would have to book the rental expenses for the land in profit or loss because it’s clearly operating lease. IAS 17 says that the land of the lease is operating.
- Under the new IFRS 16, you need to book the right-of-use asset resulting from the operating lease.
It means that you need to discount all the future rentals by the interest rate implicit in the lease to the present value and this would be your right-of-use asset.
That’s the debit side, and the credit is the lease liability.
So, under IFRS 16, you are effectively capitalizing the operating lease of land anyway, in the form of right-of-use asset.
And, as it is 2018, I strongly recommend applying IFRS 16 now and not wait, because it is applicable since 1 January 2019, the next year and you would have to do that anyway, just later.
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.
Any questions or comments? Please share them below. Thank you!
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23 Comments
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Hi Silvia,
In fact very fruit full, my question is how about travelling expenses related to an Under Construction Building which is located in another City.
No, normally you should not capitalize them, because they don’t relate directly to bringing the building to the desired condition and location. More about it here.
Hi Eman,
You can not capitalize it as Sylvia said. The core reason is that travelling cost is inevitable. You can employ other employees without paying travelling expenses.
Therefore it is not directly attributable to the cost of construction.
Hope this will help
Regards,
Mushvig
Hi silvia
Recently i had the same issue, We leased a land and paid in advance, later on we decided to buy the land on 1 July. The cost of the land was 250000 USD, however we have paid a rent expense at the beginning of the year 24000 USD on 1 January.
how do we treat?
Hi Mohamed, the cost of rent is simply expensed in profit or loss, because it relates to the service of renting, not to the acquisition of the land itself.
hi silvia , and thank you
my question is when we will record ROU for the land .. if we have contract before 1/1/2018 and we applied full method !
its seems to me that we will applied ROU prospective ..
because IAS 17 do not allowed that before ?!
Thank you for the best explanation.
But the problem here is, As you mentioned that we could capitalise the land rental as ROU.
Is it allowed to depreciate the land over 40 year under the IFRS 16
Hi Silvia,
Could you please help me on ; the nature/criteria to capitalise the pre opening expenses ?
Regards,
Priya
Hi Silvia,
My question is our university entered into one lease contract which have approximately 37 Buildings, and some of the Buildings will have options to be renewed in 2022. The issue we are facing is will there be one lease or Do we identify each building separately on our Balance Sheet.?
Many thanks
Sorry but I do not fully agree with you view. The rental cost of a land incurred during the construction periods need to be capitalisased as part of the cost of the building when these costs are directly attributable to bringing the asset to location and condition necessary for it to be capable of operating in the manner intended by mamagement (IAS 16-16B)
I disagree and the reasons are explained in the article. Rental of land relates to the land itself, not to the building on it.
The land was taken on lease specifically for constructing the building so these 2 assets are linked with each other. Thus, lease rent of land should be capitalised using IFRS 16 and should be amortised from start of lease. However, amortisation of right of use asset should be capitalised to the cost of the building as it was the expense which was necessary to bring the building asset into existence under IAS 16 and finance cost on lease liability should be capitalised to cost of building using IAS 23 principles. Please refer Extract, IFRS® Discussion Group Report on the Meeting – September 25, 2019 affirming my view.
Oh, but you are not referring to the official IASB source. You are referring to the discussion group in Canada and this is NOT authoritative material. As I read it, it just gives you their views, not authoritative guidance. I do agree that you should account for ROU asset related to the land – that’s clear and that’s what I wrote above. However I do NOT agree with capitalizing amortization of ROU asset into the cost of the building. The reason is that paragraph 58 of IAS 16 explicitly states that the land shall be accounted separately from the building, even if these two elements were acquired together. And, it does not matter whether the land was acquired by regular purchase under IAS 16 or by lease under IFRS 16, because “substance over form” principle applies throughout all IFRS. Hence if you treat these 2 elements separately, you CANNOT capitalize amortization of ROU asset into the cost of a facility of that land. What I was very surprised is the fact that this Discussion Group completely omitted paragraph 58 of IAS 16 from its analysis. Therefore I simply stand firmly behind my opinion. Anyway, thank you for bringing this up.
Hi Silvia, we leased a land from the neighbourhood democratic council and we erected a building on that land. Can we capitalize this building? If so, how do I go about doing so?
Yes of course. I assume you can use this building for more than one year, right? It meets the definition of PPE, so go ahead and capitalize.
Hi Silvia
We have an agreement with Landlord for 25 years for construction of building and we will pay rental on yearly basis for his land. But Landlord also invest in our project (30% investment will be of landlord). So during the construction period will be capitalize rental cost or not ? because Landlord is joint owner of the project as well and we have joint venture agreement of investment in project by 30% (Landlord) and 70% (Us).
Thanks. This has helped me.
Hi Silvia. Please assist me. We have leased a land for 33 years for construction of storage facility. The cost of lease is USD 43,000. payable twice ( @usd 21,500 ) in December 2020 and June 2021. I am working on 2020 Accounts. How do i record this transaction in 2020 and in 2021. Do i need to discount this 43,000 to present value ?
Hi Silvia,
I would like to ask on the capitalization requirements on a specific case for further clarification:
1. Say we have got a building for hospital use and started paying rent expense of the building, and thats a major amount.
2. Then we buy assets ( medical equipment, furniture fixtures etc, some work in progress fir installation works etc , salaries of some workers for work directly associate (not admin related)).
3. We pay some cost to the government as well for legal matters for building fitness certificates etc
In the above case still more to come on the initial setup expenses and revenues can;t be generated unless incurred the above expenses so can we classify all this as a part of CWIP and the capitalize or some cost typical for P&L like rent, direct salaries etc need to be chareged off in P&L
Hi Silvia
In my opinion rentals need to be capitalized.
EXAMPLE 1B – DIRECTLY ATTRIBUTABLE EXPENDITURE – OPERATING LEASE COSTS
3.2.30.85 Company B enters into an operating lease of land on which there are several buildings in shell form – i.e. the interior and
infrastructure is yet to be completed. The lease term is for a period of 20 years and management’s intention is to use the premises
as its corporate headquarters.
3.2.30.86 Because the buildings are in shell form, significant leasehold improvements are required before the premises will be
ready for their intended use. Over a 10-month period, B constructs the interior of the buildings including ceilings and frames,
electricity, lighting, air conditioning and work stations.
3.2.30.87 In this example, we believe that the construction of the leasehold improvements is similar to the construction of a
building; therefore, the operating lease costs incurred during the construction period should be capitalised because they are
directly attributable to bringing the premises to the condition necessary to be capable of operating in the manner intended by
management – i.e. as its corporate headquarters.
Please give me the reference where this is coming from, because I am failing to find this in the official IFRS texts. Anyway, the rental expenses of land now fall under the standard IFRS 16 applicable from 1 January 2019 and it means that you should think of ROU asset related to the land instead of capitalizing its expenses. The above article was written earlier, back in 2018, when two lease standards applied: IAS 17 and IFRS 16; but it is mentioned above.
Hi Silvia
If we bought a tractor to provide it on a financial lease next year, how should it be reflected in the financial statements: as inventory or fixed assets?
Interesting question. I would say that since you are not going to use it in your business but effectively resell it (finance lease is a sort of resale), then I would recognize it as inventories in this particular situation.