Can you capitalize it as PPE or not?
Is it an item of property, plant and equipment or a part of its cost?
Or is it a piece of inventories instead?
Or just an expense that goes straight in profit or loss?
Hmmm, what about an intangible asset?
In 90% of all cases, the answer to the above questions is clear – it’s obvious that buildings, machinery or other BIG pieces of tangible assets presumably used for more than 1 period are PPE.
But I’m convinced that you have come across at least 1 or 2 situations in which you were not so sure about the right conclusion.
I can confirm it based on a number of e-mail questions I receive in relation to this topic.
Let me give you my answers to the most common ones.
What does IAS 16 Property, Plant and Equipment prescribe?
Property, plant and equipment are tangible items that:
- Are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
- Are expected to be used during more than 1 period.
That’s the definition taken right from IAS 16.
Also, IAS 16 answers our first and basic question: When should we recognize an item of PPE?
The answer in IAS 16 is taken directly from the Conceptual Framework: the cost of an item of property, plant and equipment shall be recognized as an asset if, and only if:
- It is probable that future economic benefits associated with the item will flow to the entity; and
- The cost of the item can be measured reliably.
Therefore, in general, when you’re assessing whether some item shall or shall NOT be treated as an item of PPE, you need to take the following factors into account:
- the purpose for which an item is acquired and / or held
- the useful life of an item (longer than 1 period)
- future economic benefits flowing to the entity and
- cost is reliably measurable.
OK. So we have just set up the fundamentals.
But while it’s easy to assess and categorize some assets, other assets are not so clear and we need to use judgment and often apply the concept of materiality in order to make a conclusion.
Now let’s take a look at several unclear or shady examples.
Should we capitalize spare parts?
There is no uniform opinion about capitalizing spare parts. Instead, spare parts require your own judgment of a specific situation.
In most cases, spare parts and servicing equipment are included in inventories and treated in line with IAS 2 Inventories.
However, major spare parts can qualify for PPE, especially when they can only be used in connection with an item of PPE. For example, some reserves engines for airplanes would rather be included in PPE than in inventories.
Let me give you an example of the opposite situation.
I received a question from my reader about treatment of a big amount of sand (or other construction material). He wrote me that it was a great opportunity to get this sand at a very good price, therefore the company piled up a big stock.
However, a company was not going to use the sand immediately in the construction process. The sand could have stayed in the warehouse for many years.
What to do in this case?
In my opinion, although the sand indeed did have “useful life” longer than 1 period, it’s NOT an item of PPE.
It was a raw material and its purpose was to be consumed in the production process – which perfectly meets the definition of inventories.
Instead of charging depreciation of the sand, I would rather check whether the cost of sand exceeds its net realizable value at the end of each reporting period and if not, then I would leave it in inventories until it’s consumed.
Should we capitalize small items acquired in large amounts?
Imagine you run a library.
There are thousands of books there, each has an acquisition cost of a few dollars (whatever currency) and it will definitely be used for more than 1 period.
Should you treat each book separately and as a result, recognize it in profit or loss when acquired? Or should you treat all books as 1 item of PPE?
Other similar examples are tool sets, furniture sets, pallets and returnable containers which are used in more than one accounting period, but the cost of 1 piece is low or even negligible.
What to do in this case? How to treat these small items in large amounts?
Again, there’s no uniform answer.
Standard IAS 16 (9) says that the unit of measurement for recognition of PPE is NOT prescribed.
In other words, sometimes it’s appropriate to aggregate individually insignificant items and to apply the criteria to the aggregate value. And sometimes, it’s not.
In our library example, it can be appropriate to treat books as 1 single asset (or a few assets) and depreciate these assets, especially if a running a library belongs to main revenue-producing activities.
Should we capitalize improvements on a leasehold property?
Imagine you rented an office space. The big one.
But, you need to adjust it to fit your needs and therefore, you decide to install glass partitions to divide the space and make it look more elegantly.
Glass partitions are damn expensive. They represent a significant investment.
However, they cannot be used separately without the office space and once your rental contract expires, glass partitions are useless for you. You can’t even take them out and install them in another place.
How to treat your investment in the improvement of leasehold property?
I repeat again: there’s no uniform answer and it depends on your contract and specific circumstances.
First of all – are future economic benefits from these improvements probable? Maybe yes, as glass partitions make the office space usable for you.
Another question – are you going to use these improvements for more than 1 period?
In most cases, you can estimate improvement’s useful life quite reliably and therefore, it’s appropriate to capitalize them as an item of PPE. The useful life will basically depend on the term of your lease, so you need to take that into account.
Should we capitalize pre-operating expenses?
You are establishing a business. Before you can actually start a production process, you need to obtain permits, hire employees and do a lot of things – and all of this costs money.
You need to pay salaries, rent, professional advisers and you might incur many other types of expenses in the pre-operating stage of your business.
Can you capitalize these pre-operating expenses?
In most cases – NO. You cannot capitalize them as a separate intangible asset.
Because they do not meet the definition of an intangible asset in line with IAS 38 as they are not identifiable, i.e.:
- They cannot be separated and sold/transferred, and
- They do not arise from contractual or other legal rights.
There is one exception when you actually can capitalize pre-operating expenses.
When you construct an item of PPE and your pre-operating expenses were incurred in relation to constructing that PPE, then you can capitalize them if they meet the IAS 16 criteria.
For example, when you build a production hall during the pre-operating stage, you can include salaries of direct production workers to the cost of that production hall.
These are 4 the most discussed and ambiguous examples of capitalizing/not capitalizing an item as PPE. Please help me share this article with your friends or colleagues and if you have some question or remark, just leave me a comment right below this article.
I’ll also welcome your answers and experiences – you’ll help to make Internet a better place!
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Hi, My company has constructed boat in China, so time to time my managers used to travel in Shipyard in china to get an update on boat construction & we paid fee to designer to design those customized boat, so should i capitalize all expense it off. I have booked all cost in CWIP under one project name. Now it is time to capitalize since boat is delivered to us.
Thank you for the lovely article. I just want to check if we hire a consultant to advice on an expansion plan of a building, can we capitalize that cost.
It depends on what the consultant performs. In general, if he does sort of research/feasibility of the project, then no. If this is some engineering work, then yes.
Should the costs of electronic control door access system be capitalized in both freehold and leasehold buildings? The buildings neither the lease are new. Thank you.
Hi Cher, yes, you can capitalize “leasehold improvement” (e.g. electronic control door) as a separate item of PPE and depreciate it over shorter of its useful life or lease term.
How do you treat consultation fees charged for advising on best ways of increasing production. Do you capitalise or expense .The amount is usd$240 000.00 and production is expected to increase after the study.
Well no, that’s is a feasibility study, similar to research. The reason is that this particular study is NOT directly attributable to the acquisition of that specific asset.
What should be the minimum threshold amount for capitalizing an asset.
Hi Naser, IAS 16 does not give you the precise value and it really depends on your materiality (significant amount). This is individual in each company.
Hi we are an digital company. We will soon be re-branding. Can we capitalize the labour hours for all those working on re-branding especially the ones working on the app. IAS 38 mentions internally created brands cannot be capitalised. However, we are changing our brand name to align it with our new parent entity.
No, Niki, you cannot capitalize these costs.
Hi , we are a manufacturing company , we are planning to enhancing some capability on one of our process , which require small material but heavy labor hours (say 20% Material & 80% Labor hours cost internally) can we capitalize this cost in our books as par of our PPE
Are these costs attributable to the specific piece of PPE?
Hi, thanks so much for this useful article! In relation to small items bought in large amounts e.g. chairs, laptops, should this go on the FAR as 1 asset, or individually listed and therefore individually depreciated?
Also, does it matter if they were not purchased on the same day? e.g. I bought 10 laptops in January (total below threshold), and another 10 in March (total below threshold), and another 10 in June, but the sum of those 3 purchases were above threshold and material to the company.
Hi Silvia, Your work is well appreciated. As for the IFRSbox forum, It is well thought idea.
Hello Silvia thanks so much for this useful information. I have one question related to FDA Costs.
If we capex these, they should be written of over the useful life of our products. What is the definition of a useful life of a product . If you have 1000 products with completely different life cycle how would you handle this. can we use an average rate for all the products to amortize these costs? Thank you for your feedback. Kr Liliane
If the company owns a property and used it as hotel and beach resorts, in the property, they build a minibars and healthclub in this property and they earned extra income from these part of the property as in selling food and beverage and etc. My question is can I capitalized the renovation cost? Based on my understanding, we should capitalized the expenses, but I the information from the website (under the element of ancillary service ) I provide below mentioned that we should not capitalized the expenses as it is not necessary to bring the the item to the location and condition. for example, income may be earned through using a building site as a car park until construction starts.
In my case there is an Heavy machinery(Wheel Excavator) which was received for the organization in january 2020 but i got the road worthiness certificate(Which is a legal requirement) on may 2020 when should i capitalize the machinery on january or may 2020?
Well, apparently you can capitalize it at the moment when you acquire it, but you cannot start depreciating the asset in January, because it is available for use only in May 2020.
I have one question. This is related to a non-refundable deposit paid for fit-out fees.
This fit-out fees is to be used by the owner when we move out from property for the utility fees.
My question is when should I expense off this fit-out fees?
Is it now or the year we move out in the future?
Plus, what accounting standard should I refer to for this situation?
Hi Good day to you Silvia,
I need your opinion on development car and benchmark car. My company is an automotive company. During the development period, we developed a car for testing, should this car register as PPE? We also bought a competitor car for bench marking purpose where we do the testing, should this car also register as PPE?
Yes, both are PPE, because they both meet the definition of PPE. The question is whether you will use them for longer than one year.
I have a question and hope that someone can answer me? We bought a new truck trailer (PPE), but before we could use it, we had to repair and respray the whole trailer in order for it to be roadworthy etc. Must this repair cost be expensed to P/L or must this be capitalized as part of the acquisition cost of the trailer?
I guess that you had to repaid the car to bring it to the intended location and state, so yes, capitalize.
Hi, I have one question.
We bought a vehicle and one of the cost that was included on the Invoice as a sepearate line item was maintenance plan for 5 years. Do we need to capitalise the cost of maintenance plan with the vehicle? and which standard paragraph can it be applied in relation to the answer?
No. Maintenance is an ongoing cost, not directly attributable to the asset acquisition itself, but to maintaining the asset in its operating condition.
We paid for a permit to the government in order to be allowed to construct a building. Can we capitalize the cost of the permit?
Also, for the same building, we had to incur expenses to remove an old structure from the land to clear the space. Can this cost be capitalized?
Thanks for your reply.
I have a question here. There is AUC project on hold from long time and guessing this project is treated as dead. Now how do we treat this in our accounting books? like can we keep this in AUC? or where should be move this?Project related materials are still available and can be reusable for any other projects. Please advise
Hi Maddy, well, if something can be reused, I recommend reclassification of that part to inventories and then performing “lower of NRV and cost” test in order not to overstate the inventories. For the remaining part, just perform impairment test in line with IAS 36 if you think there is a slight chance of going forward. If the management decides it is done for good, then derecognize it (with loss in profit or loss).
Can you capitalize the occupational rent when you are in the process of purchasing the office building for staff prior to transfer taking place from the deeds office.
No, because it does not relate to acquisition of PPE – it relates to having a place for your employees in that specific period.
Or can you structure a deal to purchase office building in such a way that the occupational rent gets included to be part of the purchase price of the building e.g. if purchase price of the building is R20million and occupational rent for 3 months is going to be R1,2million. can you structure the purchase price to be R21.2m.
Hi Silvia – can a company capitalize assets which are being bought as a contingency due to Covid-19? See detailed example below …
A company operates 2 x factories and both use different equipment to manufacture different finished goods. Due to Covid-19 and to mitigate the risk of either factory having to close due to a Covid outbreak amongst the workforce, the company decides to purchases duplicate assets to be stored at the other location so that production would be able to continue (ie Factory A machinery stored at Factory B, and Factory B machinery stored at Factory A).
In this scenario, could the company capitalise these duplicate assets – whilst they would not immediately go into use, management consider that it is probable that they will be used at some point over the next 12 months.
Any thoughts appreciated
Yes, in my opinion, you can capitalize back-up assets even if they are not used in the business for the purpose other than serving as a back-up. I wrote more about it here. S.
Hi Silvia, please can you assist me with 2 questions: 1) lease improvements that are made by the lessee but paid for by the lessor, do they become part of your IFRS16 right of use asset value, for example carpeting in the office space? 2) a data set is purchased to market your product to individuals on the list. You have full use of the list which is valued at 100,000, but you are paying it off in installments over 3 years. Can you classify this as an intangible asset, and do you recognize the full right of use value immediately, or as you pay for it over the 3 years?
My employer’s case is quite exceptional. Would it be possible to capitalise improvements for a leasehold if the plan is to sublet it?
Thank you, I find your website very helpful
Hi Estrella, yes, as soon as improvements meet the definition of PPE themselves. S.
In my cases, the company project (O&G plant) has extended since there are incidents happen in project progress. So the the cost which we called as Pre-COD Results was rose significantly. It’s correct that we do capitalize the cost or should we expense off the cost?
Thank you, I find your website very helpful.
I have a situation where Division A which is a service business has transferred an asset to Division B so that Division B can work on the asset for 2 years for development reasons, then after these two years the Division B will transfer the asset back to Division A for use in service business. Should this be classified as PPE in Division B’s books or as inventory? Many thanks!
Hi Silvia – how do you account for a temporary change in use of an asset? We have an asset that was classified in Inventory that now fits the PPE category but will be sold on in a few years time and will go back into inventory. Should this be classified as PPE or should it be classified as inventory because it’s future use is that it will be sold on?
Can you capitalise building plans and permits as part of leasehold improvements? e.g. the tenant is making alterations to premises and the alterations require certain permissions and authorisations from the local authority. Do these costs form part of the leasehold improvement? Thanks for a super valuable resource.
Our company is now requesting that uniforms be treated as fixed assets and be depreciated over 2 or 3 years. (so-called new AUC accounting policy ??)
Previously we expensed uniforms as and when we purchased the uniforms because they are purchased for immediate issue to the staff. I do not agree with this new accounting policy – how on earth could I verify the existence of such an asset at year end. Once the clothing has been issued, I would consider the ‘asset’ to no longer be of value. But note that the uniforms are a required dress for certain staff functions, and maybe this is the deemed ongoing value of the uniforms.
well, this issue is indeed a matter of judgment. Perhaps it is possible to ask staff to bring their uniforms at the year-end and physically count them, thus verify their existence. In general, I guess that the unit cost of a uniform is not material, so unless you are using huge number of uniforms that would in aggregate be material, then expensing it makes more sense and saves hassle. However if an aggregate amount of uniforms is significant, then it is perhaps better to treat them as PPE with useful life of 2-3 years as you suggested. S.
Can we capitalize the pre-operative period rental charges for workshop?
Can we capitalize the pre-development costs?
We sell industrial products for which we pay certification fees that are necessary to sell them. These legal certification fees are for example asked by European Union to sell on that territory and are valid for 3 years. These fees can be directly linked to specific products we build or product families.
Can we capitalize these legal costs as intangible assets ? If yes, I suppose we can amortize them over 3 years.
it seems these costs are associated with certain license to sell the products and to me, they meet the definition of intangible asset, since this license is controlled by you, it has no physical substance and it is identifiable by means of a legislation. Without deeper examination it seems to me that yes, you can capitalize this license and amortize over 3 years.
2 questions :-
(1) If the spare parts are attributable to a ride (Disney/USS), can the item be capitalised or inventorise?
(2) We have a project starting soon and we have outsourced our security jobs to a external company that will provide the service for 2-3 years, depend on the progress of the project, can we capitalised such security cost to the project and how should this work? allocated to the project?
Can interior design expenses to self construction building after it gets ready for use be capitalized?
We hired designers in our company, now these designers are helping in different projects, can we capitalize the salaries paid to them on proportionate basis for each CWIP of project?
Yes, you can, as soon as you are able to come up with the reliable cost-attribution method (calculation of cost attributable to the specific project).
My company is building an accounting software program. Apart from consultants, regular employees are involved in the development. Ive seen costs (for employees) ranging from accommodation, meals, air and taxi fares. Alot of the main costs include all the travel, meals, accommodation of our inhouse IT guy.
Should these all costs be included as part of the capital value of the asset?
xyz ltd is leasing a new office block . Xyz ltd will need to have to incur refurbishment expenses . XYZ Ltd will sub lease part of the office block to ABC lTD . Can ABC Ltd capitalise the refurbishment cost incurred that the main lessee will recharge ?
HI, I have a client I am auditing. They are in manufacturing and distribution industry. They bought trucks for delivery and capitalized these, straightforward. They also then capitalized branding costs they did to these trucks, eg painting and advertising. My question is does IAS 16 allow this
Yes, as soon as the painting is done on the tracks directly, since these costs are directly attributable to bringing the asset into the desired condition for use.
Can we capitalize Shipping Container demurrage and detention expense as per IAS 16?
We are facing this problem recently.