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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Thanks for very informative explanation. When constructing a power plan, can we capitalise depreciation of equipment used in the construction of the plant? Is it directly attributable cost?
Great job you are doing.
Please how do I treat an expense incurred on a building acquired under a finance lease e.g An expense of CU1million incurred on tiling, electricity and others on a building under Finance lease.
Thanks , it is very informative and helpful 🙂
I appreciate your articles and very useful .
could please mention more details about the professional fees or examples.
I am wondering if it is possible to capitalize recruitment and training cost as part of the mobilization cost under a contract (i.e. all activities and associated costs related to contractors organization, who is responsible for the operation of the asset).
More specifically, the asset in question may only operate by granted approval by the authorities – this approval is dependent on the contractor’s ability to provide a “safety organization” in accordance with local regulation.. the contract specifies that “at Hand over, the providers organization shall be fully employed, trained and approved by the authorities..”.
Does the recruitment and training of this safety organization qualify as a directly attributable cost, since the asset may not operate otherwise?
Hi Simon, no, sorry. The training cost is never capitalized, because it is tied to employee rather than asset itself and you have no control of the employee (he/she can leave anytime basically and you will have to train the new one). S.
raw and packaging materials used during test run can be capitalised?
Hi Silvia, our company just bought a land to build an expansion of our offices. We have paid Land survey fees and land clearing and landfill deposits, I am wondering if under IFRS can we include those fees as part of the land cost?
Hi Silvia thanks for your very informative article. Would you be able to clarify a couple of queries?
1. If an employee is 100% funded from a capital grant and he is only working on one capital scheme, does this mean that 100% of his salary can be capitalised or just the non-admin costs?
2. Internal staff time taken on negotiating funding for a specific scheme – is this capital or revenue?
We have acquired an asset in the beginning of year through a mortgage bond, later in the year we decided to move the bond from one bank to another, therefore we incurred legal fees. Should I expense or capitalise these legal fees?
Expense, because they are not the initial transaction cost.
we are moving a machine from one plant we closed to another plant which still operates. I am unsure if some of the cost can be capitalized:
– dismantling and transportation cost at the closed plant
– dismantling cost of old machine at the new site where the transdered machine has to be set-up
– some repairs to make the machine work properly
Thanks for your advise.
how about transportation costs?
Hi Sella, if they are initial transportation costs (from the supplier to the place of operation), then yes, you can capitalize. S.
Hi Silvia, could you advise on the following. Should we capitalize to the cost of assets dedicated general and administration ( salary of site supervisors, engineers) which are not directly by hand doing construction works but supervising/managing on site these construction works on field or from the office. Construction works mainly done by Contractors. Also should we capitalize Service ( running ) costs, which include for example spent hours of helicopters flying to the sites/fields that support Operation of the company. thank you
why are Expenses for searching an appropriate site, evaluation of a site, feasibility study cannot be capitalised ?
Because they do not relate to bringing the asset in the desired condition and location. These expenses are like research activities.
Thank you silvia,
well , but is it possible to bring the asset in a desired location without consider selection of an appropriate site ? if so those costs are inevitable to bring the asset into condition and location intended by management. so why we cannot capitalised those cost?
This is a very common argument, but it is not generally accepted. As I told you – the selection of the site cannot be attached to the specific asset. S.
We have hired consultant for installation of machines. Can we capitalise his travelling cost i.e. air tickets, conveyance from hotel to factory and his daily allowance?
Can profit bonuses paid out for prior year company or employee performance be capitalised if those employees are working 100% on developing the new software?
I’m thinking more on huge legal costs resulting from compensation to a company that was contracted to construct investment properties but did not do a good job but the court was in favour of that company and we paid compensation. The case was for a capital project. Should the cost be capitalised?
Just want to ask if you can capitalize consultancy fees in relation to a project?
For example: We are currently developing a billing system and we hired outside consultants to provide insight on the best practices, validate gaps,provide solution options, and provide recommendations on the process model to use which will become basis of the development of the billing system which will be created.
Hi Riel, as soon as you are creating a PPE or an intangible asset, then yes, you can capitalize consultancy fees. If the billing system meets the definition of PPE, then yes, you can capitalize these fees. S.
i would like to know that if you are expected to relocate a school that is on the property you have purchased and will allow for the PPE item that you will construct after demolishing the school to have the most effecient path should it be capitalised or expensed ?
Thanks for such a valuable article.
With regards to relocation costs, if for instance we are constructing a pipeline and in order for the pipeline to merely have the most efficient path, a community will be required to be relocated. this relocation only takes place two months into the project and takes one month to complete.
would this relocation cost still be an expense?
this is not a relocation of an asset itself. This is a removal of obstacles and the related expenditures can be capitalized. S.
Consultancy service expenses for customer service enhancement can be capitalized ? as it has future benefit and the amount is material.
unless you can attribute these expenses to specific asset (tangible or intangible), or you are able to attribute these expenses to the specific contract with your customer, then in general no.
If cost such as legal costs, employee salaries incurred to rezone a property and the value subsequently have risen as a result, should we be able to capitalise rezoning costs or expense?
Hi Alex, no, relocation expenditures must be expensed in profit or loss, that’s specifically said in IAS 16.
Thank you Silvia, however I was not able to find anything on rezoning in IAS16.
Alex, IAS 16 par. 20 (c) – it speaks about relocating the operations or their part and IASB team once answered the question similar to yours that this paragraph covers also relocating the asset (as it’s a part of business’ operations).
Oh, but now I noted that you asked about “rezoning property” – so in fact, you are asking not about physical relocation of an asset (not possible in this case), but about mere change of property’s classification.
In this case yes, you can capitalize because all these expenses will definitely increase the future economic benefits from that asset. Sorry for the confusion.
Hi Silvia, my question is regarding IAS 38. Employees of the entity are engaged in development of software. Can the rent of the premise and laptop depreciation which can be allocated to these employees be considered directly attributable and hence capitalise?
did you rent the premises especially for this project? If not, then it’s general admin and cannot be capitalised. Laptops – if they are used solely for software development, you could probably justify that they are production overheads and could be allocated. S.
My question is. Insurance expenses paid during the project period against the loss of fire, theft, and etc., can be capitalized as part of the cost of asset. As these are necessary to protect the asset with out which we can not complete the project. the base for my view to capitalise this cost is 1) Even I outsource to the contractor for lumsum price. contractor will include the cost of insurance in the contract price. 2) If we import any material on CIF basis all cost including insurance will be capitalized.3) If I dont undertake this project I will not take any insurance policy.
I kindly request you please clarify me
Lets say that we have signed a contract for a new software for CU 10,000.
CU 8,000 for the software and CU 2,000 for implementation, training and 6-month support.
How, in your opinion, to treat this CU 2,000?
you can capitalize implementation, but not the training (it is excluded) and not 6-month support (it is not necessary to bring the software to use). Therefore, you should split CU 2 000. S.
Thanks Silvia for giving your opinion.
I thought the same way as you did. The question is how to split this cost since the provider of the software did not split the cost in the invoice.
All of theses ( Implementation, Training and 6-month support)came under a single item that costs CU 2,000.
maybe you could ask your supplier to help you. I think it’s a big project, so your supplier might be willing to give you all the data you need. Alternatively, you can try to estimate how much it would cost you if bought separately and try to split based on proportions. S.
From you to Mr. Mostafa,
Sir, All this cost shall be capitalized. As this cost CU 2000 is unavoidable to bring the software into present condition. Regards
My question is also regarding Letter of Credit charges. My company imports a significant amount of inventory and fixed assets from abroad. Many of our suppliers require us to open a Letter of Credit which incurs LC charges from the bank. Can we capitalize those LC charges, both in the initial recognition of fixed assets (IAS 16) and inventory (IAS 2). Will highly appreciate reasons for why either treatment is correct. Thanks and much appreciated
Thanks for your clear and simple explanations. I have one question.
Consider an entity is constructing a building and it has several contracts (for Mechanical and Electrical Engineering, Interior Decoration, supply of furniture, construction, etc).
Say the entity terminates the Interior Decoration contract and pays the Interior Decoration Company compensation for termination of contract and not work done.
Should the compensation for termination of contract be capitalized in the building?
Thanks for your answer.
I don’t think so, because the compensation is usually not a directly attributable cost to bringing the asset to its intended location and use. S.
my question is why we add penalty in calculation of lease liability in lessee accounting under IFRS 16?
hi, i am an internal auditor for a year at state owned company. for a long period, my company include travel expense as cost of ppe and external auditor never correct it, and always give unqualified opinion. what should i do? if i recommend to correct it, then all previous audited financial statement should be restated?
as I wrote in the above article, you might find a good argument for capitalizing travel expenses – in some cases, they can be seen as the cost of service, but it needs to be assessed case by case.
Anyway – it happens a lot that the financial statements contain errors and auditors issue unqualified opinion. Maybe the reason was that the errors were not material and the financial statements still present the true and fair view. Also, auditors can make mistakes, too.
I would recommend to investigate why travel expenses were capitalized (and have good arguments for that) in the first instance. S.
We have a couple of engineers directing and coordinating the building of a new facility. Are the salaries considered as general overhead or van they be capitalized under IFRS (IAS16)
they can be capitalized – well, as apportioned on some reasonable basis, because they are not general admin overheads. You would not incur these costs without building a facility 😉
Hi Silvia, thank you for your clear and very complete summary. I however still have a question about a specific issue.
What I have in mind is a school considering a major reconstruction and extension of its self-owned building. During the course of the work, all teaching activities will need to be relocated in on or several rented buildings.
Could we imagine the possibility of capitalising rental costs during the work period, as directly attributable costs ? (it is necessary to completely empty the building to perform its transformation) I guess this is a rather aggressive approach 😉
Michel, I think you answered the question yourself 🙂 You cannot capitalize these rental costs because you incur them to continue your business (generate revenues) and NOT to complete the reconstruction of the building.
Could you please tell me if we can capitalise the hotel cost of the consultant who has come to develop a software. Can we classify this expense as directly attributable to the cost of the asset?
Nalini, please look above to the article, I think I explained this issue. S.
Great lesson that is to the point! Can i also ask, for instances when a property is undergoing the construction stage, can the loan interest incurred prior to completion be capitalised? This refers to properties acquired under the progress billing method in my country. Thanks!
Can we capitalize subsequent legal fees costs or claims for an arbitration process directly attributable to a construction or building that is capable of operating in the manner intended by management?
Hi all, I am looking for an answer to a similar question. We are incurring legal fees while going through court with a contractor who didn’t satisfy the construction requirements as stated in the contract. Another contractor is completing the last few steps of the construction. Our lawyer advised that we will be reimbursed for legal fees and are also not required to pay any payments withheld from that contractor. Can I capitalize legal costs, reimbursements and any withholdings?
Thanks for the examples. Are you able to capitalise the Buyer Agent Fees, ie the cost of paying an Agent to help you purchase a new Building?
i am a bit confused here. How can we capitalise the buyer agent fees as it is not a directly attributable cost to bring the asset to the location and condition necessary. This instance the company needed an agent to get the building. In other words, that company could have acquired a building without an agent, and in such a case buyer’s agent fee would not have been necessary. It is the same thing that you mentioned in the article regarding the insurance to get a loan(CFO case).
Thanks Silvia- this article has cleared doubts i had and a bit confusion. Thanks. Rich
Wonderfully written Silvia….Thank you
Appreciate the examples used to simplified the topic.
What is the adavantage of capitalizing travel expenses in an account, especially Tax account? Thanks…
Ikem, it depends on the situation of a particular company. E.g. some company might operate at loss and in this case, they try to capitalize as much as possible (not to increase loss and postpone the expenses to the future periods when they have profits). S.
WONDERFUL EFFORT BY YOU TO GIVE IDEAS ABOUT CAPITALIZATION OF COST REGARDING ACQUIRING ASSETS.WAITING FOR IAS 15
Dear Noman, IAS 15 does not apply anymore. I wrote several articles about IFRS 15, for example here and here. S.
can we capitalyse costs for or converting the use of an asset from one to another use? Like changing the caffeteria to offices?
Can we capitalize the LC charges incurred on a loan which is taken to finance a asset?
Dear Rasan, what are LC charges? Anyway, if it’s a qualifying asset under IAS 23, then you can capitalize borrowing cost and any charges on loans (including the initial fees) should be treated using effective interest method, therefore are capitalized as an interest cost.
Thanks for giving such a valuable article on “Directly Attributable Costs”. Long a go I heard that first insurance should be capitalized. Please clarity this
see, there are different approaches to this and maybe you would be able to justify it – it also depends on your own legislation and your auditors. IFRS standards do NOT say anything about capitalizing insurance. S.
why feasibility study cost should not be capitalised bcz it is critical for the selection of and site to operate there on?or to build up?
Zeeshan, the reason is that it is considered “research activity” and research activities cannot be capitalized, in most cases.
I really enjoyed your article. This article will go a long way in aiding me.
Thank you, glad to help 🙂
Informative article which can easily be understood.
Really very useful article
I was wondering whether under IFRS 16, the amortization charge on right of use of land during construction can be capitalized as part of the building costs.
Similarly as with rental expense described above 😉
Never seen such detailed but straight to the point write up on Directly Attributable Costs. God bless you.
Thanks for simplifying IAS16
Great article, is there also some article on ifrs5?
Thanks for the clarity.
I would like you to give us some detail knowledge about consolidation of account .
Thanks & Regards,
Thank you for your lesson
I would like you to give us some knowledge about Discontinued operation.
Mam, Thank you very much. Hello! Mam, Are you fine? I would ask some question. What is the difference between fair value and net realizable value? I don’t understand that. when I asked my college teacher not exactly find answer. Please, Mam that question answer send to my email.
NRV = Fair value less cost to sell. The difference is cost to sell – simply and quickly speaking.
Thanks mam, I understand that