Choosing your accounting policies carefully when it comes to capitalising costs is vital, particularly if your company is constructing an asset. Understanding what FRS 102 sets out as being acceptable to capitalise is very important, because it can have a significant impact on the reported financial performance of the company.
FRS 102 Section 17 sets out that the cost of an item of property, plant and equipment can comprise of its purchase price and associated costs, such as legal fees; any associated costs of bringing the asset to its intended state; costs associated with dismantling the site at the end of the project; and any borrowing costs associated with the asset. The two we will consider in this article are what could be allowable in associated costs and borrowing costs.
Associated costs
When setting an accounting policy, it is important to be consistent within classes of assets and within a group reporting situation. It is also important for management to be clear about what the intended state of the asset is when considering the policy. This could be something as straightforward as the cost of delivering an asset to site, along with the costs of assembly and installation, and then the asset being immediately ready for use. But this could also be when expected output of an asset reaches an intended level. If we used for example an asset which generates an output, management may set a policy that an asset has arrived at its intended state when it reaches a set capacity level i.e., 65% of its intended output. Or if an asset requires a period of testing before being signed off as fully operational, then management may be able to argue that the asset has not yet reached its intended state. In this scenario, management could determine that any costs associated with arriving at this intended level could be capitalised. This would be a key judgement which management would need to justify and disclose.
Included within associated costs could be costs such as project management costs, if specific to construction or development, staff costs for those working on the asset, and insurance costs. In some circumstances it is possible to capitalise insurance costs on the basis that without insurance, construction could not take place and so, it is an essential cost towards the build. However, it could only be the insurance element specific to the build, not insurance generally. Again, this would be a key judgement set out by management which would be required to be disclosed in the financial statements.
Borrowing costs
FRS 102 is clear that borrowing costs associated with the development of an asset may be capitalised so long as the conditions set out in Section 25 are met. This is on the basis that the borrowings are for a qualifying asset and are directly attributable to the acquisition, construction, or production of the said asset, and would not have been needed otherwise. At the point at which the asset is completed, the capitalisation of the borrowing costs should end. The borrowing costs from this point will then be recognised as an expense through the profit and loss account. This could get complicated where you may have multiple parts in a build which complete at various points. If you find yourself in this situation, please do get in contact with us and we can advise you on the best course of action depending on your circumstances.
To summarise, it is always important to consider all of your options when choosing an accounting policy for capitalising items as there may be more options available to you than you initially thought. It is also essential to consider the tax impacts of any decision you take.