Here’s another issue recently discussed by Canada’s IFRS Discussion Group
- Company A owns a major infrastructure asset under construction. The contract with the construction company, Company B, contains a force majeure clause that provides some relief in the event that Company B is prevented from performing construction work due to an event out of its control that cannot be avoided or mitigated (e.g. a pandemic or other global health issues such as COVID-19).
- The relief includes financial compensation to be paid to Company B by Company A for additional costs incurred by Company B, such as the payment of salaries to its employees when the job site is closed, for putting in place additional safety measures for COVID-19 protection, and for productivity losses.
- Company A accounts for its asset under construction using IAS 16 Property, Plant and Equipment, IAS 23 Borrowing Costs and other related standards.
These types of scenarios aren’t new of course, but the pandemic may have made them more common, given emergency measures imposed by governments. The group considered how Company A should account for those additional costs. On the one hand you might think they should be capitalized, as a basic application of IAS 16.16: “The cost of an item of property, plant and equipment comprises … 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.” Alternatively, perhaps they should be immediately expensed, as an application of IAS 16.22: “the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset.” Or maybe it depends on the facts and circumstances, for instance:
- … any amounts paid to a contractor for periods of time when the construction has stopped, such as during a lock-down period, should not be capitalized because they are clearly abnormal wastage that are not directly linked to the construction of the asset.
- For other costs incurred because of COVID-19, such as enhanced personal protective equipment or lower productivity due to social distancing requirements at the construction site, further analysis is needed. For example, if a contract was entered into for construction services during the pandemic, these types of costs would be embedded in the base contract price, which is capitalized as part of the cost of the asset under construction. Similarly… these types of costs should be capitalized on a contract entered into prior to the pandemic.
Most group members preferred that last view, that it depends on the facts and circumstances. A few members thought though that the costs should be capitalized: regardless of other considerations: they’re incurred as part of the construction contract and are directly attributable to bringing the asset to the condition necessary for use (if Company A refused to pay them, it might be at risk of breaching the contract, preventing the completion of the project).
The group then noted that if the costs are capitalized, they may be a potential indicator of impairment of the asset under construction, and Company A needs to further analyze its own circumstances to determine whether they constitute actual indicators of impairment warranting an impairment test. Relevant factors include the relative amount of the additional costs to be paid to Company B; the results of previous impairment tests, including the amount by which the recoverable amount exceeded the carrying value of the asset or cash-generating unit; the impact of potential delays in construction of the asset; and the potential government support or insurance proceeds.
They also threw in a couple more issues. Any insurance proceeds should only be recognized when it is virtually certain that reimbursement will be received; when the underlying costs being reimbursed by the insurance proceeds have been capitalized, the insurance proceeds should offset against the carrying value of the asset under construction (however, proceeds compensating a company for loss recognized due to business interruption will be recognized generally as income). And any government grants relating to assets should be presented either as deferred income (a liability) or as a reduction of the carrying value of the asset, and subsequently recognized in profit or loss on a systematic basis.
It’s yet another example of how Covid-19 sometimes seems to have supercharged much of accounting, not usually by raising new issues, but by elevating the relevance and urgency of some of the old ones. For instance, before getting to this issue, the IFRS discussion group had already discussed the pandemic in the context of revenue recognition, government grants, other impairment issues, employee costs, credit losses on receivables, leases, income statement presentation, and of course disclosure. But the good news is that cash is still what it always was. Well, sort of…
The opinions expressed are solely those of the author