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Can you capitalize demolition cost under

IFRS?
by Silvia
 PPE (IAS 16 AND RELATED) 11
Sometimes, when you need to acquire some land, you often purchase it with some obstacles
on it – you know, old structures like buildings, roads, fences, and other things.

What to do with the costs incurred to remove these obstacles?

In today’s article, I respond to the question from Zareena, Malaysia:

“We are auditors and need your advice on the following situation for our client:

They have freehold land with building with total cost of CU 20 mil. acquired in 2015.

The building was partly demolished in 2017 just before the year-end and right after the year
end, the demolition was completed and the client intends to sell the land.

The company never split the total cost of CU 20 mil. between the land element and building
element and the depreciation of building was never charged.

What shall be done with the demolition cost and the old building?”

Answer: Determine the intention!

Hmmm, I came across the same question many times during my work and it seems many
companies face more-less the same issue, just slightly twisted.

Let’s start with properties for own use under IAS 16 and let’s start with the demolition cost.
 

Demolition cost under IFRS

IAS 16 Property, Plant and Equipment does NOT directly address the demolition or removal
of obstacles.

Under IAS 16 par. 16, the cost of an item of property, plant and equipment includes
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 the management.

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What was the intention of the management when they purchased the building together with
the land?
Always look to the original intention or the reason why the building and land were acquired,
because this will give you further direction.

There are few scenarios possible:

 1. Scenario n. 1: The company acquired land with building to demolish the building,
make some improvements on the land and then sell the land.In this case, the
intention was to acquire the land and the demolition cost of building is seen simply as
a cost directly attributable to bringing the land to the condition to be operated in the
manner intended by the management.Logically, you should add these demolition costs
to the cost of the land as some land improvement.
2. Scenario n. 2: The company acquired land with building to demolish the building,
develop the site, build a new building and then use it.In this case, it’s a bit more
complicated, because the intention is to have the new building and IAS 16 says in par.
58 that the building and land shall be classified as two separate items.Primary
intention was to build a new building and therefore, demolition costs of old building
are incremental to the new building, or in other words – you would not incur the
demolition cost without wanting to build the new building.

So, in this case, you should capitalize the demolition costs to the cost of new building.

3. Scenario n.3: The company acquired land with building, then used the old building
for some short time and then demolished it with the intention to build a new
building.In this case, the management’s intention at acquisition was to use the
existing structure and thus demolition relates to the disposal of the old
building.Therefore, you would not capitalize it to the cost of new building, but you
would expense it as incurred.

You should also be careful about the fact that the demolition should occur within some
reasonable time after the acquisition in order to prove the intention.

For example, you acquired the land and building in 2016 and you did nothing, and then in
2018 you decided to demolish the building and sell the land.

In this case, it’s questionable whether it was your intention to do so and whether you can
simply say it’s the land improvement.
OK, that’s it for the demolition cost itself.
 

Carrying amount of old buildings

What should you do with the carrying amount of the old structures or buildings? Can you
capitalize them to the cost of new buildings? Or expense?

There is no clear IFRS guidance on this point, but there are some accepted practices and other
available guidance.

The main aspect to examine is how the old building was acquired and previously used:

If you previously used the old building yourself and you decided to demolish it and build the
new one, then you should simply derecognize the old building with gain or loss reported in
profit or loss.More specifically, there’s usually some period between the decision to demolish
and actual demolition, so you should probably accelerate depreciation over shorter remaining
useful life and test the building for any impairment under IAS 36.