Good Day!

Q&A No. 2017-02 Capitalization of operating lease cost as part of construction costs of a building

This Q&A responds to issues regarding the capitalization of operating lease costs as part of construction costs of a building.

Issue:
Do operating lease costs constitute part of the cost of: 

  • Constructing a building (PAS 2, Inventories) and will be sold.
  • Constructing a building (PAS 16, Property, Plant and Equipment) and will be for own use.
  • Leasehold Improvements that are held for own use.

Fact Pattern

ScenariosConsensus and Basis for Consensus
Land is leased and building is constructed to
be held for sale


On January 1, 20X0, an entity enters into an operating lease of land for a term of 20 years. Under the lease agreement, the entity makes an
initial upfront payment of P1,000 and pays rent
of P200 quarterly in advance.

The entity intends to construct a building on the land, as part of its ordinary business activities, plans to sell the building once construction is completed. However, the entity must obtain planning permission for the building, and this process takes three years. Construction of building begins on January 1, 20X3 and is completed in two years.

The building is sold but the lease of land is retained by the entity. The entity intends to sublease the land to the buyer for the rest of its lease term with landowner.

Capitalize as part of construction costs
The entity intends to hold the building for sale in the ordinary course of the business, therefore, the building meets the definition of inventories under PAS 2.

The lease costs during the construction period are costs that are incurred in bringing the inventories to their current condition.

Expense as incurred
The entity recognizes the operating lease costs as an expense since there is no distinction between the right to use a leased asset during and after the construction period.
Land is leased and a building is constructed
that will be owner-occupied


Same with above scenario except that the owner
plans to occupy the building itself once
construction is completed.
Capitalize as part of construction costs
The lease costs during the construction period
are costs that are incurred in bringing the
building to their current condition.

Expense as incurred
Operating lease costs are not directly attributable costs as the entity will have incurred these costs anyway regardless whether construction of the building started.
Building is leased and leasehold improvements are made

On January 1, 20X0, the entity enters into a 10 year lease of building at a rent of P200 payable quarterly in advance.

To make the building suitable for its requirements, the entity makes substantial leasehold improvements at the beginning of the lease. During this time, the building must be vacant and the entity can only move in after
work is completed. On April 1, 20X0, the entity moves into the property.
Capitalize as leasehold improvements
Capitalize the lease costs as leasehold improvements during the period in which the building is vacant and is not being in used.

Expense as incurred
The lease payments are for the right to use the existing building itself (whereas in scenario 1 & 2, the building does not yet exist), therefore, the operating lease costs are expense as incurred.

Q&A No. 2017-03 PAS 28 – Elimination of profits and losses resulting from transactions between associates and/or joint venture

This Q&A responds to issue regarding elimination of transactions between associates/joint ventures when the investor accounts for these associates and/or joint venture using the equity method.

Fact PatternConsensus and Basis of Consensus
Entity H has the following interests in associates A and B:

Interest in A – 25%
Interest in B – 30%

During the reporting period, Entity A sold inventory to Entity B, all of which remains on Entity B’s statement of financial position at the
end of the reporting period.

Cost of inventory for A – P1,000,000
Proceeds from sale of by A – P1,200,000

The unrealized profit arising from the transactions between associates and/or joint ventures is eliminated to the extent of the investor’s interest in the associates and/or joint venture.

Entity H eliminates P15,000 (i.e. 25%x30%xP200,000) as its share of the profits that is unrealized.

Par. 28 of PAS 28, Investment in Associates and Joint Ventures, states:

“Gains and losses resulting from ‘upstream and downstream’ transactions between an entity (including consolidated subsidiaries) and its associate or joint venture are recognized in the entity’s financial statements only to the extent of the unrelated investor’s interest in the associate or joint venture”.

Please see attached PDF copies of PIC Q&A 2017-02 and 03 for further reading.