Initial recognition of self-constructed assets

Essentially the same principles that have been established for recognition of the cost of purchased assets also apply to self-constructed assets. All costs that must be incurred to complete the construction of the asset can be added to the amount to be recognized initially, subject only to the constraint that if these costs exceed the recoverable amount, the excess must be expensed currently. This rule is necessary to avoid the "gold-plated hammer syndrome," whereby a misguided or unfortunate asset construction project incurs excessive costs that then find their way into the statement of financial position, consequently overstating the entity's current net worth and distorting future periods' earnings. Of course, internal (intra-company) profits cannot be allocated to construction costs. The standard specifies that "abnormal amounts" of wasted material, labor or other resources may not be added to the cost of the asset.

Self-constructed assets should include the cost of borrowed funds used during the period of construction (as set forth by IAS 23 regarding on capitalization of borrowing costs).

The other issue that arises most commonly in connection with self-constructed fixed assets relates to overhead allocations.

While capitalization of all direct costs (labor, materials, and variable overhead) is clearly required and proper, a controversy exists regarding the treatment of fixed overhead. Two alternative views of how to treat fixed overhead are to either :

1. Charge the asset with its fair, pro rata share of fixed overhead (i.e., use the same basis of allocation used for inventory); or

2. Charge the fixed asset account with only the identifiable incremental amount of fixed overhead.

While international standards do not address this concern, it may be instructive to consider the non-binding guidance to be found in US GAAP. AICPA Accounting Research Monograph 1 has suggested that :

----- in the absence of compelling evidence to the contrary, overhead costs considered to have "discernible future benefits" for the purposes of determining the cost of inventory should be presumed to have "discernible future benefits" for the purpose of determining the cost of a self-constructed depreciable asset.

The implication of this statement is that a logical similar to what was applied to determining which acquisition costs may be included in inventory might reasonably also be applied to the costing of PPE. Also, consistent with the standards applicable to inventories, if the costs of PPE items exceed realizable values, any excess costs should be written off to expense and not deferred to future periods.

(Sources : Wiley IFRS 2008 : Interpretation and Application of International Financial Reporting Standards - Barry J. Epstein, Eva K. Jermakowicz)