TSG 2018-007 (PIC) Capitalization of Operating Lease Cost as Part of Construction Costs of a Building & Elimination of Profits and Losses Resulting from Transactions Between Associates

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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

Scenarios	Consensus 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 Pattern	Consensus 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”.

Fact Pattern

Consensus 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”.