What are directly attributable costs?
When you acquire a long-term asset, you can include directly attributable costs to the initial measurement of its cost.
Although IFRS define directly attributable expenses quite clearly and provide a few examples, there are many different items we are not sure about.
In this article, I decided to look at directly attributable expenses with a magnifier and to give you some guidance for your future use.
I’d like to focus on acquisition of tangible assets under IAS 16 Property, Plant and Equipment, but the same principles apply for intangibles and other assets, too.
What do the rules say?
IAS 16 says that we can capitalize any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management (IAS 16.16(b)).
In the paragraph 17 of IAS 16 there are the examples of what expenses are considered to be directly attributable and therefore, can be capitalized (or included in the cost of an asset):
- Costs of employee benefits (IAS 19 Employee benefits) arising directly from the construction or the acquisition of the item of PPE,
- Costs of site preparation,
- Initial delivery and handling costs,
- Installation and assembly costs,
- Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition, and
- Professional fees.
As opposed to that, the paragraph 19 of IAS 16 lists examples of costs that are not costs of an item of PPE and therefore, cannot be capitalized:
- Costs of opening a new facility
- Costs of introducing a new product or service
- Costs of conducting a business in a new location or with a new class of customer, and
- Administration and other general overhead costs.
On top of that, IAS 16 clarifies in the paragraph 20 that costs of operation below full capacity, initial operating losses and relocating or reorganizing entity’s operations are not to be capitalized.
Yet in practice, there are many items that require our careful judgment and we are not sure whether to include them in the cost of an asset or not. These doubts arise especially when your company constructs a big asset, such as a plant or a mine.
Let’s break it down.
Cost of employee benefitsAs written above, you can capitalize only those employee benefits that arise from the construction or the acquisition of the asset.
Here, two principal questions arise:
- Which employee categories arise from the construction or the acquisition of the asset?
The answer is no admin, no general functions, no research activities, no marketing & advertising, no training employees.
It means that:
- You can capitalize the employee benefits provided to site workers, in-house architects and surveyors or production supervisors. To some extent, you can also capitalize quality controls and testing (if these activities are inevitable in order to put an asset into use).
- You cannot capitalize any portion of employees benefits paid to general managers, accountants taking care solely about ship’s accounting, etc.
- Which expenses related to these employees can be capitalized?
The answer is all employee benefits under IAS 19 and that is:
- Short-term employee benefits (salaries, wages, paid vacation…)
- Post-employment benefits
- Other long-term benefits and
- Termination benefits.
The following types of expenses are NOT employee benefits under IAS 19 and therefore, they shall be considered separately:
- Travel expenses of your employees,
- Training of your employees,
How should you include the expenses for the employee benefits into the cost of your asset?
The answer is based on some reasonable allocation method.
For example, you build a ship. Based on timesheet reports you find out that in 20X1 John worked:
- 1 500 hours on the ship construction,
- 300 hours on other projects or work, and
- he took 100 hours of paid vacation.
Your company incurred the following expenses for employee benefits in relation to John’s work:
- Salary: CU 18 000
- Compensation for paid vacation (in line with law): CU 1 000
- Expense for contribution into a pension fund (defined contribution plan): CU 2 000
How much of these benefits can you include into a cost of a ship?
You can include all of these expenses for employee benefits allocated on a reasonable basis.
In this case, we can allocate it based on time spent on a ship construction (1 500 hours) and total time worked (1 500+300=1 800 hours).
Here, we do not take the paid vacation time into account for allocation purposes. It means that a compensation for paid vacation will be allocated to the cost of a ship. The reason is that a company is obliged to provide this vacation to its employees and a vacation is simply another cost of worked hours.
- Allocation of salary: CU 18 000*1 500/1 800 = CU 15 000
- Compensation for paid vacation: CU 1 000*1 500/1 800 = CU 833
- Contribution to a pension fund: CU 2 000*1 500/ 1 800 = CU 1 667
- TOTAL: CU 17 500
Note: you include only current year’s expenses; or the expenses incurred during ship’s construction.
Cost of relocating the asset to the new locationLet’s say you construct a new plant and you decided to relocate some machines from an older plant to the new premises. As machines are quite heavy, you paid CU 1 000 to relocate them.
Can you capitalize these expenses to the cost of a machine?
In short, no – this is a relocation cost and IAS 16 specifically says it cannot be capitalized, but expensed as incurred.
Insurance of an assetInsurance premiums paid to the insurance companies cannot be capitalized, but expensed in profit or loss in line with an insurance policy terms.
The reason is that these costs are not inevitable to bring the assets to the condition and location to operate as desired by the management.
In fact, these costs are incurred to protect an asset against some risks during some period and therefore, it would not be correct to take these costs to the cost of an asset and put them in profit or loss via depreciation over asset’s useful life.
Some time ago, one CFO raised a point to this matter. He said:
“We take a loan to finance the acquisition of a plant, but our bank insists on insurance policy for this plant. Otherwise we won’t get a loan. Without an insurance policy we cannot acquire a plant, therefore I think the insurance cost can be capitalized as it’s inevitable”.
Hmmm, a good argument, but the truth is that the CFO needed an insurance policy to get a loan and not to acquire an asset. In other words, that company could have acquired a plant without a loan, with a cash payment and in such a case, no insurance policy would be necessary.
Operating lease expenses for landYou can incur some lease expenses during construction of your asset. For example, you can pay rentals for the land you build your plant on.
Can you capitalize these expenses?
This question is quite controversial and really, an answer depends on how well you can justify your own view in front of your auditors.
I’d like to give you arguments for YES and NO here:
Operating lease charges can be considered directly attributable costs and included into cost of an item of PPE, if these lease costs are necessary to bring the asset to the desired condition and location. Therefore, rentals paid for land under operating lease on which you build a building can be capitalized into a cost of a building during a construction stage.
NO, don’t capitalize:
I am more in favor of no capitalization, but recognizing these expenses in profit or loss.
The reason is that it produces quite inconsistent impact on profit or loss. If you include just rentals during the construction period into the cost of PPE and you expense the subsequent rentals as they incur, then the first rentals will be expensed via depreciation over asset’s useful life, and the remaining rentals will be expensed immediately. This means that matching principle is shattered.
Also, I always see a land as a separate asset, because its useful life is different from the life of a building on it. The rental payments relate to the “acquisition of a land”, not to a building itself.
Anyway, this is one of the reasons why I like the new IFRS 16 Leases. Under the new standard, you will have to recognize a right-to-use asset instead of dealing with operating lease payments and therefore, this dilemma will not exist anymore.
Travel expendituresCan you capitalize travel expenses (hotel, transport) when a trip happened to acquire an item of PPE?
Or, can you capitalize travel expenses of a consultant who came to your site to perform professional work related to PPE?
Unless you have a great argumentation ready for your auditor, then no, you should not do it.
The reason is that these expenses relate more to personal services than to bring an asset to the desired location and condition. At least, that’s what I experienced in the practice.
However, this area is quite unclear and you might be successful to provide good arguments to your auditor for capitalizing.
If you hire a consultant and you agree to pay travel cost for him, you should try to negotiate the higher price for his services with inclusion of all his expenses (to hide his travel expenses into the cost of service) – just to be on a safe side.
Other expenses you CAN capitalize
- Fees for environmental permits, certifications whether an asset works properly
- Expenses for necessary repairs during the construction phase
- Expenses for removing hurdles on the site (e.g. demolition of old building)
Do not capitalize:
- Training expenses (never!)
- Expenses for searching an appropriate site, evaluation of a site, feasibility study
- Advertising and marketing expenses
- Expenses to hire employees
OK, guys, I’ve just tried to bring more light to the most common types of expenses and feel free to ask in the comments if you need help with something else. I might update this article and add some more explanations!
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Training cost of employee cannot be capitalized. How about monthly training allowance or dependent training allowance that are paid as part of employee benefit? Can these allowances be capitalized with the rest of salaries and wages?
we are planning to replace KEY Asset in 2023 and Installation shall take 6-8 weeks as confirmed by supplier and consultants which indicates Production and planning team to manufacture FG in advance to avoid loss of sales during installation period.
Supply chain is exploring all the options to accommodate the demand and advancing Production by 2-3 months till new Asset commence commercial productions which requires additional storage space beyond existing capacity and can cost us $ XXX (Apprx)
IAS 16- PPE allows us to capitalize all Direct Attributable Cost which is not incremental in nature and forcing by Installation and Commissioning of New Assets.
We believe that Accounting Standard supports capitalization of WH Rent and accordingly we should budget our CAPEX for 2023.
What is your Opinion about it?
Paragraph 20(c) of IAS16 states that the costs of conducting business in a new location are not costs of an item of PPE.
Does this include the costs associated with temporary location?
For example, if an organisation is undergoing a capital upgrade of its office building and staff are temporarily located in another building owned by a third party, can the cost of rent and electricity of the other building be included as part of the capital upgrade of the organisations building?
I would say no, because these costs relate to the services consumed in that particular year. If the staff would have been located elsewhere in the own building, you would still expense related electricity and depreciation charges in profit or loss as they reflect the consumption of that building and electricity in that year. The different thing would for example be if you rented a warehouse to store building materials – that rental is directly attributable cost and also, incremental, too, because these expenses would not have been incurred at all without building a building. But not the rental of offices. You would incur these or similar expenses for staff location in any case.
Thanks for the prompt reply.
In this example the rental and electricity costs ARE incremental, they are still being incurred in the building being upgraded, even though that space is not occupied by staff. The additional electricity and rental has only occured because of the capital work.
Well, a good auditor would tell you that these costs were incurred because you need staff to operate the business 🙂 I am not going to argue here with you 🙂
Hi, what about transit voyage cost : voyage from Shipyard (newly build vessel) to the first point of operation start- can this cost be capitalized as well under IAS 16 considering that the transit voyage is necessary to “bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management”
For security officer cost can be capitalised part of the asset?
In general no.
Can we capitalise the “loss of parts during testing and training”
Hi. do we capitalise costs of rehabilitating the site after refurbishment of an asset? i.e removing tar road and reconstructing it?
Is depreciation of computer equipment purchased for generating intangibles internally can be capitalize?
Yes, as soon as these intangibles meet the criteria for capitalizing and you are able to attribute computer’s depreciation to the development on some reasonable basis.
For an intercompany(IC) recharges, the bought and sold normally should be book IC with affiliates in the bought and sold accounts. If we agree to capitalize the costs, locally capitalizing the bought cost as fixed assets and amortizing down along 12 months, how can we done with keeping the IC bought in place to reflect the IC recharges?
Taking insurance is compulsory for construction project and I would like to ask from you whether we can capitalize these insurance cost.
Hi, I think the article above gives quite a good answer. S.
Hi Good Morning Ma’am, the company is under sole proprietorship and just started to construct a resort, how am I going to account the cost of plants and flowers acquired for it? Will it be considered part of the cost of the structure?
Thank you Silvia.
How about a expenses on a major renovation work on building that will enhance the building and provide a longer useful life. can such expenses be capitalised.
Hi Lamin, it depends on the specific expenses, but in general yes, because extending the useful life means improved performance and increased capacity of that asset.
Asset Department employees who are their main duty is to select appropriate assets and ensure that each assets will reach in the site in proper time.
In other word, they are directly attributed to bring the assets.
Now, the benefits paid to them can be capitalized?
Yes, salaries of the employees working directly on bringing the assets to the desired location and condition are directly attributable cost, however make sure they are reasonably apportioned and allocated. I am speaking in general now.
Thank you so much Silvia.
How about payments by the bldg owner to tenants (such as squatters) of an old bldg to induce them to vacate, because the owner of the old bldg will demolish the old bldg and will construct a new one.
I need clarification on why employee/staff training in the use of the acquired asset should not be treated under cost. Also will the following fall under cost :
i. purchase of a maintenance contract
ii. consultants used for advice on the acquisition of an asset
iii. interest charges paid to supplier of the asset for deferred credit
Hi John, training shall not be capitalized because you do not have control of your employees. As for your items, ii in general can be capitalized, iii – not unless it is qualifying asset under IAS 23, i – not sure what the maintenance is for.
Dear Silvia, thanks for the valuable sharing.
I wish to ask is the deposit paid for acquisition of building can be reclassified under Capital Work In Progress (PPE) or have to be parked under Deposit (Current Asset)?
Another question I would like to ask is whether the legal fee for banking facility and stamp duty incurred on charge can be capitalised to land and building?
Hi Ying, the classification of the deposit depends on the contractual provisions (refundable/non-refundable, etc.), so there is no definitive answer based on this short description. Legal fee for banking facility – I guess for loan taken to finance the acquisition – cannot be directly capitalized, only within the capitalized borrowing cost under IAS 23 if you treat this fee as a part of interest cost by the effective interest method. Stamp duty – again, this depends what it relates to, e.g. if it relates to the acquisition of some parts of the building and only to the acquisition (it is not paid annually), then yes.
Thank you for the useful information. I know you repeated yourself many times saying that Training costs are not to be capitalised, however my situation is a bit different.
Our company has an intangible assets: some internally developed standards and they create a number of items to people to understand how and when to use them. So, let say we developed user guides and videos. Do we capitalise these costs as a separate asset with the benefit being reduced training costs , which will be obtained for the period over 12 months, or do we expense them ?
Hi Bill, I would say yes, because this asset seems to meet separability/identifiability criteria, plus unlike with trained employees you have control of this asset. Also, that’s not a training cost. Learn more here 🙂
Thank you Silvia for your valuable article. My question related to
Commettees meeting costs of LNG project construction. Huge amounts paid to several Commettees of the project ,dutring construction of LNG trains and pipeline, such as finance committee costs, Audit commettee costs, custom’s and clearance commettee costs etc.
Can such commrttees expenditures be capitalized as part of project PPE?
Anouther question, The construction of this LNG project financed 99% by loans which generates loan intrest, Can such loan intrest be capitalized as part of project PPE?
i received one question from our IT department and it is how to threat project manager hours spent on project. Project manager work tasks are coordinating the project, defining work procedures, processes, rules, documentation, leading meetings, following up on due dates. Under which stage in development process can we categorize project manager working hours and can we capitalize it?
as soon as your project meets 6 criteria (PIRATE) to capitalize, you can capitalize directly attributable costs along with “major” IT developers’ costs. Please read that article I linked here for more info. S.
thanks for the excellent article. It answered all my questions and gave me insight in matter of labor costs capitalisation.
Keep up the good work!
J Abraham Cherian June 9, 2020 at 3:08 pm
In case of a new project under CWIP, the company purchased some vehicles for the same. Is the depreciation for the vehicle to be transferred to CWIP or should be expended in the current year itself
A company employs another construction company to build its building. During the construction period there is a legal dispute which ends up in paying substantial arbitration and legal costs to defend the suit by the builder. Is this part of the building cost to be capitalized ?
Hi Silvia, thanks for an informative article on PPE
need your help please regarding survey costs incurred in later years, are they capitalized? or only when a survey cost is incurred in preparation for selling land? say if they were to be capitalized separately from land, would they (survey costs) be subject to depreciation? (I might be lost in my own understanding lol) help plse
Please can you advise,
In regards to the development/ establishment costs in a farm which can be capitalized are you allowed to capitalize the depreciation of the equipment being tractors, ploughing equipment etc to get the farm set up?
Hi Slyvia, what about unusual costs incurred because of the COVID-19 pandemic, because of restrictions we had to change the approach in constructing a plant and in this way incurred much more cost because at that time this was the only options available. Could we capitalise these even though this is not the normal way that these plants would have been constructed?
I want to ask about capitalizing VAT for constructed projects. when I sign a contract with a company to perform some construction activity for me amounting to 105000 USD including vat 5%. at the end of the work when I want to capitalize the assets should I capitalize the full amount included in the contract 105000 or should I exclude the VAT 5% amounting 5000 and capitalize 100,000 only and record the 5000 as expense. if you can mention the reference, please
I would like to know the capitalization criteria for biological assets particularly employee benefits. To what extent are we allowed to capitalise admin costs when the biological asset is still undergoing development?
Thanks for your article.
Considering that, there is a new entity established specially to construct the new facility for manufacturing.
it is allowable that every cost incurred in that entity during the construction to be capitalized (salary, traveling cost, even bank administration cost like as issuance LC cost and interest cost)?
let say, this entity has not started their operation until the facility is ready to produce their product on the 5th year.
No, only those that can be directly attributed to the specific item of PPE.
Thanks for your important topic as IAS-16
Can you give few examples of overheads allocated by a business in respect of Plant installation but can not be capitalised as per IAS 16
Salaries of workers who work both on installation of the plant and repairs/maintenance of other facilities.
I have an inquiry about the demobilization (decommissioning) cost which already added to assets (Rigs)I have asked CFO to share the base of calculations, shall I get the third party opinion to assess the calculation or accept the technical engineers and maintenance manger in the company?
Well, I can’t really say. Of course, the third-party opinion and valuation is a great input, better than just internal valuation, but if your auditor accepts your own technical expertise, then it is fine.
In case of a new project under CWIP, the company purchased some vehicles for the same. Is the depreciation for the vehicle to be transferred to CWIP or should be expended in the current year itself.
Need your guidance on these 3 costs if they can capitalized in relation to the construction of a building:
1. Legal fees- for the review of the construction contracts
2. Documentary stamp tax- for the loan from parent company to finance the construction of the building
3. Documentary stamp tax – for the bank loan for the construction of the building
Can you give some example of “initial operating losses, such as those incurred while demand for the item’s output builds up” as given in Para 20.
Initial operating losses are not eligible for capitalisation, because they are considered costs incurred subsequent to the asset first date available for use. I use the example of a restaurant. The restaurant may have an occupancy permit and may be full operational, with all the necessary components to operate in the manner intended, but it probably wont be open for several months while staff is being trained, supplies are acquired in the ramp up to opening day. All those subsequent costs incurred are operational losses.
Hi, i just opened a new branch and took a place on rent for leasehold improvements, the initial operations started 2 years later then the site is rented and i have to pay rent for 2 years which approx 1,4 million. Can i capitalize these expenses once the branch is fully functional.
Can you capitalise procurement costs e.g. tendering for a plant item through an OJEU or similar process. The asset will be used once procured so could the costs of the running the procurement exercise be capitalised?
Well put thanks
Hi, my company just incurred takeover cost for the fixed assets inside office on Feb 2020 (to be rent on Mar 2020), can i capitalized the takeover cost?