Accounting Treatment of Relocation and Rental Costs During Factory Reconstruction

1. Question

Gamma Manufacturing Limited, hereinafter referred to as “the company” is a leading producer of industrial components. The company has been operating from its main factory premises for over 30 years. Over time, the factory building has deteriorated significantly, resulting in frequent repair requirements. After a detailed technical assessment, the management decides to undertake a full scale redevelopment of the existing factory.

To ensure that ongoing customer commitments are not disrupted during the reconstruction phase, the company arranges to continue its manufacturing operations from an alternate location on a temporary basis. Accordingly, the company relocates its production machinery, equipment, and personnel to the new premises. During this transition, the company incurs various costs aggregating to ₹20 lakh. These include:

(a) ₹3 lakh spent on installing and commissioning the production machinery at the temporary facility.

(b) ₹12 lakh paid as rental charges for occupying the alternate premises during the redevelopment period.

(c) ₹5 lakh incurred towards dismantling, removing, transporting, and unloading the existing machinery and other production facilities from the old factory to the temporary site.

The management of the company notes that these costs have arisen solely due to the decision to redevelop the factory building. Thus, the management is uncertain whether the relocation, rental, dismantling, and installation costs incurred because of the redevelopment qualify for capitalisation as part of the cost of the new factory building under Ind AS 16, or whether such expenses should instead be recognised in the statement of profit and loss as incurred.

2. Relevant Provisions

Ind AS 16 – Property, Plant and Equipment

Para 7 of Ind AS 16

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

a) it is probable that future economic benefits associated with the item will flow to the entity

b) the cost of the item can be measured reliably

Para 20 of Ind AS 16

Recognition of costs in the carrying amount of an item of property, plant and equipment ceases when the item is in the location and condition necessary for it to be capable of operating in the manner intended by management. Therefore, costs incurred in using or redeploying an item are not included in the carrying amount of that item. For example, the following costs are not included in the carrying amount of an item of property, plant and equipment:

a) costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity

b) initial operating losses, such as those incurred while demand for the item’s output builds up

c) costs of relocating or reorganising part or all of an entity’s operations

Para 22 of Ind AS 16

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. If an entity makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale. Therefore, any internal profits are eliminated in arriving at such costs. Similarly, 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.

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