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#20 LAND, BLDG, MACHINERY


FINANCIAL ACCOUNTING AND REPORTING                                                                                                                   

COST OF LAND

a)    Purchase price of the land and transaction cost.  Transaction cost includes non recoverable taxes like documentary stamps, land registration and transfer taxes.  This will also include legal fees, title search and title guarantee insurance and survey fee.  The purchase price shall be treated in one of the two following manners in case there is an old building on the land that was purchased BASED ON A NEW PIC.

·         If the OLD BUILDING IS USABLE regardless of the intention to demolish the building.  The purchase price shall be allocated based on the relative fair value of the land and old building.  Once again, inability to determine the fair value of both assets, the land and the building is a simple hurdle in allocating the purchase price.  It simply means that the determinable fair value shall be deducted from the total purchase price and allocated to the other asset.  For example if Land and a USABLE OLD BUILDING is acquired for 5,000,000 and the FV of the land is 5,400,000 and the building is 600,000.

·         4,500,000 shall be capitalized as land (5.4 / 6) and 500,000 shall be capitalized s building regardless if there is an intention to use the old building or demolish it to construct a new building as long as it is USABLE.
·         If we can only determine the fair value of the building, 600,000 will be the cost of the building and 4,400,000 (5,000,000 – 600,000) shall be the cost of the land.

·         If the OLD BUILDING IS UNUSABLE it is highly probable that the building shall be demolished right away and any intention to use it is diminished.  Therefore, the entire purchase price shall be recorded as LAND ONLY.

WHAT HAPPENS TO THE COST OF THE OLD USABLE BUILDING WHEN DEMOLISHED?

·         The answer will depend on the classification of the land and the new building to be constructed. 


PPE
Investment Property
Inventory
COST of OLD BUILDING
LOSS/EXPENSE
LOSS/EXPENSE
CAPITALIZED

DEMOLITION COST
CAPITALIZED AS BUILDING
CAPITALIZED AS INVESTMENT PROPERTY
CAPITALIZED AS INVENTORY
SALVAGED VALUE
DEDUCTED
DEDUCTED
DEDUCTED

                                                                                    Reasoning behind requirements:

·         Cost of OLD BUILDING – PPE and Investment property shall be initially measured at cost which includes cost that are “directly attributable” to bring the asset to the condition intended by management (PAS 16 and PAS 40), hence the cost of the old building is not directly attributable cost.  Meanwhile, the cost of inventories shall include “indirect cost such as indirect labor and overhead” (PAS 2), therefore this loose classification somewhat justifies the capitalization of the cost of the old building.  Unlike for PPE and IP where the requirement is very strict and specific.
·         DEMOLITION COST THAT IS CAPITALIZED - For ages, the demolition cost has been capitalized as land since this is cost to prepare the land for its intended use, but now the demolition cost has been likened to site preparation cost for items like machinery and equipment.  This is the basis of the conclusion of the PIC in capitalizing the demolision cost to the “NEW BUILDING (ACCOUNT)”.
·         However, it the classification is INVESTMENT PROPERTY or INVENTORY, only one account shall be used and there is no allocation between land and building.  Therefore the demolition cost is capitalized to that single account only.
·         REMEMBER THAT THIS WILL ONLY APPLY TO NEW BUILDING THAT IS DEMOLISHED.  AN OLD EXISTING BUILDING AND THE DEMOLITION COST SHALL ALWAYS BE EXPENSED.

b)    Unpaid mortgages and taxes in arrears assumed by the buyer.
c)    Special assessment
d)    Cost to relocate present occupants from existing operating lease contracts and informal settlers.
e)    Option money or the reservation fee for land that is finally acquired.  This should not be confused with earnest money that is a down payment and part of the purchase price.
f)     Cost of permanent improvements to the land that are determined to be nondrepreciable.  This once again should be clearly distinguished concrete and metal structures that are naturally temporary an subject to wear and tear with the potential for replacement.  Such items shall still be capitalized as “land improvement”  
  
BORROWING COSTS


Borrowing Cost
Interest and other costs incurred by an enterprise in connection with the borrowing of funds.  Borrowing cost may include:
a)    Interest expense calculated using the effective interest method.
b)    Finance charges in respect of finance leases
c)    Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Qualifying Asset
An asset that takes a substantial period of time to get ready for its intended use.  Examples include:
a)    Inventories
b)    Manufacturing plants
c)    Power generation facilities
d)    Intangible assets
e)    Investment properties.

Financial assets, and inventories that are manufactured, or otherwise produced, over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired are not qualifying assets.


Accounting Treatment The revised PAS 23 has specifically mentioned that interest on loans applied to qualifying assets should be capitalized.  This eliminates the benchmark and alternative treatment.

Borrowing Costs Eligible for Capitalization

Ø  Specific Borrowings - To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization on that asset shall be determined as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.

Ø  General Borrowings - To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization shall be determined by applying a capitalization rate to the expenditures on that asset.  The capitalization rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset.  The amount of borrowing costs capitalized during a period shall not exceed the amount of borrowing costs incurred during that period.




Commencement of Capitalization

The capitalization of borrowing costs, as part of the cost of a qualifying asset shall commence when:

(a)  Expenditures for the asset are being incurred
(b)  Borrowing costs are being incurred
(c)  Activities that are necessary to prepare the asset for its intended use or sale are in progress.

Suspension of Capitalization

Capitalization of borrowing costs shall be suspended during extended periods in which active development is interrupted.

Cessation of Capitalization

Capitalization of borrowing costs shall cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.  When the construction of a qualifying asset is completed in parts and each part is capable of being used while construction continues on other parts, capitalization of borrowing costs shall cease when substantially all the activities necessary to prepare that part for its intended use or sale are completed.

Disclosure

The financial statements shall disclose:

(a)  The accounting policy adopted for borrowing costs;
(b)  The amount of borrowing costs capitalized during the period; and
(c)  The capitalization rate used to determine the amount of borrowing costs eligible for capitalization.


- - END - -

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