Question

The following situation is related to the activities and events of Superman Company in the year 2018. The financial year end for the company is 31 December.

In the past, the company expensed borrowing costs on construction of its factory. The company has changed its policy this year and now capitalizes as it is incurred. In 2017 accounts, borrowing costs expensed was $ 2,500,000 and this year's borrowing costs incurred was $ 3,800,000. The factory is still under construction.

Identify the type of accounting changes and discuss the proper accounting treatment.

Answer 1

The basic rule for assets under construction is that all cost related to that asset until it is put to use should be capitalised. This is not only followed for assets under construction but for all the assets.

The assets should be installed completely and should be ready for use. All costs till that asset is ready is capitalised and depreciated over the period of asset. All prospective expense are revenue expenditure.

But all expense before asset is put to use is capital and nature. And capital nature expenses cannot be expensed out to Profit and Loss account. The only way to expense out such expense is by way of depreciation of asset.

If company has expensed put any capital expenditure then it has to reverse the expenditure and capitalise it.

The accounting policy in this respect is clear and their is no ambiguity. The option to capitalise of expense out has not been given.

Thus, in present case the company had expensed out borrowing cost on construction of factory. This treatment is against the accounting principles. Hence, the company has to capitalise the borrowing cost in total cost of the building and then depreciate it over life of the building.

The building has still not been completed, hence all borrowing cost up to completion will be part of the building cost.

Hence, $ 2,500,000 for past year and $ 3,800,000 of present year will be capitalised.

The correct accounting treatment will be to debit the building cost and credit the reserves and surplus. The past year balance sheet has been completed and cannot be changed.

Hence, reserves surplus should be credited and increased as borrowing cost of building is not revenue expenditure and building cost will be debited.

For current year, the entry is building cost to be debited and increased and credit will go to bank account or loan account.

The above treatment and accounting policy should be followed.