Capitalization of delay charges

[kamranACA]

I have to refer some paragraphs of IAS-16 from which I hope a lot of people can draw reasonable inference on the topic.

Paragraph 15 of IAS-16 requires that an item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.
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Paragraph 16 explains the elements that can constitute the cost of such asset as under

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.
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None of the above elements can infer any possibility of capitalizing delaying penalties etc in the cost of the asset being constructed. However, in above quoted list, the item (b) raises some questions as to what should be considered as DIRECTLY ATTRIBUTABLE when the cost is in question.

To rule out illogical inferences and conclusions we must patiently look at the words ………… “IN THE MANNER INTENDED BY MANAGEMENT”……. .

I believe no management intends to NECESSARILY burden itself with penalties and incur such avoidable expenses intentionally or willfully. Saying that some penalties are directly attributed because there was an intention of delaying the completion and incurring such penalty would be weird.

The (b) element allows the cost that is incurred to bring the asset in location and condition NECESSARY for it to be capable of operating IN THE MANNER INTENDED by the management. Firstly, the penalties are always avoidable, so cannot be termed as “necessary”. Secondly, no management ever originally “intends” to pay them off.

Therefore, whether or not these are due to failure at administrative part, these cannot make part of elements of the cost. This is very important not to forget about; and I hope a careful reading of this point would clear many ambiguities.
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Further to this understanding, Paragraph 17 of IAS-16 has given certain examples of directly attributable costs which do not include any such penalties etc.
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Apart from the above discussion, Paragraph 21 of IAS-16 states

…………..“Some operations occur in connection with the construction or development of an item of property, plant and equipment, BUT ARE NOT NECESSARY TO BRING THE ITEM TO THE LOCATION AND CONDITION NECESSARY for it to be capable of operating IN THE MANNER INTENDED BY MANAGEMENT. These incidental operations may occur before or during the construction or development activities. For example, income may be earned through using a building site as a car park until construction starts. Because incidental operations are not necessary to bring an item to the location and condition necessary for it to be capable of operating in the manner intended by management, the income and related expenses of incidental operations are recognized in profit or loss and included in their respective classifications of income and expense…………………

Although the above paragraph does not specifically talk about penalties, yet, it states that INCIDENTAL operations (I tend to include HAPPENINGS as well) may occur during construction phase but because such incidental HAPPENINGS are not NECESSARY and are not INTENDED by the management, these do not give rise to capitalization.

In fact penalties are always incidental during the construction phase (if there are such conditions) but are never necessary and are never intended. Therefore, this supports the conclusion that these cannot be capitulated.
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Further to this, penalties do not increase life of an asset, do not increase profitability, do not increase working capacity or quality of the asset etc, AND are also originally avoidable, these cannot be capitalized as per my understanding.

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I hope the above discussion would benefit the readers in drawing their own conclusions.

Regards,