Construction-in-Progress: When to Capitalise and How to Track Under IAS 16
Construction-in-Progress (CIP) is one of the most consistently scrutinised line items in an enterprise balance sheet. Auditors look for CIP balances that have been sitting for more than two years — a common indicator that capitalisation has been deliberately deferred to manage depreciation charges or tax liability. Tax authorities in multiple jurisdictions treat prolonged CIP balances as a signal of potential income misstatement.
Getting CIP right requires understanding three things: when costs start accumulating, what triggers the capitalisation event, and how to account for complex multi-component assets. IAS 16 provides the framework; the difficulty is applying it consistently across dozens of concurrent projects in a multi-site enterprise without a dedicated tracking system.
The IAS 16 Recognition Test
Under IAS 16 Para 7, a fixed asset is recognised when — and only when — two conditions are simultaneously met:
- It is probable that future economic benefits associated with the asset will flow to the entity.
- The cost of the asset can be measured reliably.
For CIP, the second condition is usually met from the moment the first invoice is received. The first condition — probable future economic benefits — is the judgment call. For a factory fit-out that is still under construction, probability is high once the project is committed. For a speculative development project that might be abandoned, the probability test may not be met until the project reaches a defined milestone.
The practical implication: costs should begin accumulating in the CIP account when the project is committed (contract signed, major purchase orders placed) and the asset is being constructed or prepared for its intended use.
The Capitalisation Trigger: "Ready for Intended Use"
Assets must be transferred from CIP to fixed assets — and depreciation started — when they are available for use in the manner intended by management. This is not when the asset is actually put into use. It is when it is ready. An enterprise cannot defer depreciation by simply choosing not to use a completed asset.
What documentation evidences "ready for use"?
Commissioning certificates, completion certificates from contractors, occupancy permits for buildings, trial run completion records for machinery, and board or management sign-off approvals. Auditors will ask for these documents for any CIP balance that converts to a fixed asset during the year — and for any CIP balance that has been open for more than 12–18 months without conversion.
Component Accounting for Large Assets (IAS 16 Para 43)
When a large asset is constructed, IAS 16 requires that each significant component with a different useful life be depreciated separately. This is component accounting — and it is an area where many enterprises either do not comply or comply incorrectly.
Consider a manufacturing plant constructed at a cost of $12M. The structural elements may have a 40-year life. The electrical and mechanical systems, 15 years. The interior fit-out, 10 years. The production line equipment, 8 years. Depreciating the entire plant over 40 years overstates assets and understates the depreciation charge — a position auditors will challenge. TRAXX allows a single CIP project to be split into components at the point of capitalisation, with each component assigned its own useful life and depreciation schedule, all linked to the parent asset record.
Borrowing Costs Under IAS 23
Where an entity borrows funds specifically to finance the construction of a qualifying asset (one that necessarily takes a substantial period to prepare for its intended use), IAS 23 requires that borrowing costs directly attributable to the construction be capitalised — added to the cost of the asset — rather than expensed in the period. This treatment increases the asset's carrying value and the depreciation base, but reduces the interest expense charge in the P&L during construction. For large capital projects, the quantum can be material. CIP tracking must therefore capture not just contractor invoices and material costs, but also the borrowing cost allocation attributable to the project in each reporting period.
The Two Most Common CIP Audit Issues
- CIP balance ageing more than 24 months: Auditors treat this as an automatic flag for investigation. Is the project genuinely still under construction? Has it been abandoned? Was it completed but not capitalised? In each case, the answer requires documentary evidence — and if the project is complete, immediate capitalisation with retrospective depreciation may be required.
- Incomplete cost accumulation: Internal labour costs and directly attributable overheads must be included in the cost of a self-constructed asset under IAS 16 Para 22. Enterprises that only capture contractor invoices in CIP — and expense internal engineering time — understate the asset cost and overclaim revenue expenses in the period of construction.