Capitalization of WIP
14 December 2008
If a company asks a third party to construct a fixed asset and at the end of the year, the fixed asset is not complete, but you have a statement of the costs incurred, would you capitalize the costs incurred under Construction in Progress with counterpart in accruals. Or would you record an entry only when it has been delivered to the company?
What IFRS would be applicable?
IFRS 16 would be applicable “Plant , Property and Equipemnt”
Items of property, plant, and equipment should be recognised as assets when it is probable that: [IAS 16.7]
- the future economic benefits associated with the asset will flow to the enterprise; and
- the cost of the asset can be measured reliably.
Trust this clarifies your doubt.
It appears to be a fit case for off balance sheet item and accordingly IFRS related to OBS comes in picture.
It should not be off balance sheet item, since both the criterion for capitalisation of an assets as mentioned in IAS 16( clause 16.7) are present in this case.
Please clarify what is ‘ IFRS related to OBS’
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We are a telecommunications company providing a mobile network and it is common to have huge Work in Progress on the Balance sheet over year end. Important though to establish contract in order for reward and risk to pass with the supplier or third party. Have a look at IAS 16 for PP&E.
IAS16 applicable for fixed assets in which ownership has passed on BUT here the case is different and ownership does not pass on until the site is completely handed over to the company. Ofcourse matter is to be decided with reference to the T&C entered into or agreed with Third party.
What I feel it would be appropriate to disclose the actual position by way of an appropriate NOTE to the Balance Sheet of the Company.
The relevant protion of IAS16 is reproduced below:
Property, plant and equipment
are tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes; and
(b) are expected to be used during more than one period.
The cost of an item of property, plant and equipment shall be recognised as an asset if,
and only if:
(a) it is probable that future economic benefits associated with the item will flow to
the entity; and
(b) the cost of the item can be measured reliably.
The word is ‘held’ which construed the possession of fixed assets in the hands of company or legally speaking the transfer of ownership. In the instant case neither the asset in question is in the possession of company nor the ownership in it has transferred to the company hence how it can be regarded as fixed asset at the moment, please clarify.
Thanks for all the comments.
i would look at it the other way round, i.e. do i have to record a liability in my books and thus record an asset under Work in Progress.
At year-end, when I get the statement saying how much of the project has been completed, I have a binding obligation through the contract that was signed and thus should record a liability for the work completed up till year-end. The counterpart of this liability would be fixed asset/ Work in Progress.
Does this make sense?
What journal entry is suggested then, to record the payments made to the supplier? Just curious.
The conclusion drawn appears sound.
Does the contract state that you pay in instalments ? If so I feel you need to recognize asset proportion to the amount you have paid for work already done.if nothing has been paid towards the contract then a note will be sufficient as stated by Ashutosh.
Yes, down payments to cover the period of installation and WIP capitalization takes place on the bits received in equipment and services delivered. We are replacing our Core network as we speak over a period of 84 days. It is also our year end 30 September. Some of the equipment is still under the control of the Supplier (by agreement) as that specific phase will only be implemented around March 2009 and for that we don’t disclose anything as it is not our property yet.
When we concluded the deal with the Supplier, we used DDU and took ownership of the equipment on delivery, hence IAS 16 applies.
Though I cant specifically quote an accounting standard, I feel you need to disclose by way of a note to your Financial statements ending 30t September 2008 ( under management commentary) with regard to equipment still with your suppliers.the information may be important to your stakeholder ( especially shareholders) who may want to know how there funds will be used in the near future.
Does this makes sense?
i am not yet an expert in financial statements but a student and so am just trying to see if my contributions can make sense.
In fact my view primarily co-relates the sequence of events and therefore, accounting treatment would follow the same preposition:
Step1: Create the liability in your books for the payment due against the work completed,
Step2: Account for the WIP as an asset, the completed portion
Step3: Put down a NOTE in the Balance Sheet disclosing full contractual value and time limit estimated for completion with the coningency or other related factors as per T&C agreed with.
Now the question of payment made or not made may accordingly be dealt with by simply passing the entries thru Vendor account.
What we do, based on the fact that we take ownership of the Equipment:
Dt CWIP (Asset) and Ct Supplier (liability) or in the case of Inventory Spares, Dt Inventory and Ct Supplier – sometimes, depending the case, the Equipment is held as Inventory iso CWIP.
Once final Commercial Acceptance is taken, we Ct CWIP and Dt Fixed Asset and start with Deprec – obviously by then the Supplier was paid.
Yes a note makes perfectly sense, under the Post Balance Sheet review (subsequent events) in the report of the directors, in our case. Even though we are a registered Limited company, we are non listed and then Financial Statement disclosures are not that stringent (or at least in my experience).
PS I think this is an excellent way of sharing international experience and subject knowledge! Thanks to the site and everybody sharing!
After all these emails, I have come to the following conclusion.
Under IFRS, a Company can record a Work in Progress with a corresponding liability at a period-end, if the following conditions are met:
1) there is an irrevocable agreement between the Company and the supplier
2) it is possible to measure the work done (i.e. a reliable estimate is possible)
3) it is clear that the item under construction at the supplier’s site belongs to the company (i.e. risks and rewards are borne by the COmpany).
The items above are a combination of IAS 16 and IAS 37.
I would believe you will need to disclose in the Financial statements as:
Capital expenditure in respect of purchase of PPE – approved and contracted for.