Sometimes you have to purchase land with obstacles. These are old structures such as roads and buildings. but do you pay for the removal of these obstacles? And how do audit firms in Dubai usually capitalize on demolition costs in regard to IFRS? Today's article answers the question "What companies in Dubai, UAE with the demolition costs and the old buildings?" Let's begin with properties for personal use under IAS 16, and then let's move on to the demolition cost.
Demolition Expenses Based on IFRS
IAS 16 Property, Plant and Equipment talks about demolition or elimination of obstacles indirectly. The cost of an item or property, plant, or equipment is all costs directly incurred in bringing it to the condition required for it to operate as intended by management. Was the original intention of the management to purchase the building and land together? This will help company audit teams to determine the original intent or reason for the acquisition of the land and building.
There are few scenarios possible:
First Scenario
The company purchased land with a building in order to demolish the building and make improvements on the land before selling the land. It bought the land with the intent to demolish the building. In this instance, the cost of demolition is simply a cost that was directly incurred to bring the land into the desired condition. Financial audit specialists should add these demolition costs to the land's cost as some form of land improvement.
Second Scenario
The company purchased land and a building for demolition, development, and construction of a new building. It's more complicated in this instance because the company intends to build a new building. IAS 16 states in par. 58, the land and building must be considered separate items. The primary intention was to build new buildings. Therefore, the demolition costs of an old building are added to the new building. In this instance, company audit services must focus on the demolition costs of the new building cost.
Third Scenario
The company bought land and built a building. It then used the building briefly, then demolished it to make way for a new building. The management intended to use the existing structure, and demolition was related to the disposal. Internal auditors would not capitalize it for the new building cost, but expense it as incurred. To prove your intention, you should be aware that demolition must occur within a reasonable amount of time following the acquisition. You might have the property and building acquired in 2016, but you did not do anything. In 2018, you decide to demolish it and sell it. It's unclear if this was your intention. You can also say that it's the land improvements.
Read more: Opportunities with IFRS 16 that audit services in UAE should know
A Large Number Of Historic Buildings Are Being Preserved
What should companies in Dubai, UAE do about the excess carrying cost of old buildings or structures? Are they worth capitalizing on to pay for new buildings? Or an expense? This is not a clear IFRS guidance, but there are accepted practices and other guidance.
It Is Important To Consider How The Building Was Acquired
If you have used an older building and decided to demolish it in order to build the new one, you can simply derecognize the building. Profit or loss should be reported as a gain. You should accelerate depreciation over a shorter useful life, and check for impairments under IAS 36. It is acceptable to divide the purchase price of land if you acquire the land with an old building that you intend to demolish and rebuild the new asset. This would work in most cases since you wouldn't buy a highly valuable building to demolish.
Developers: Demolition Within The Normal Course Of Business
What About Developers And Builders Who Purchase The Land And Build On It?
This is IAS 2 Inventory.
The cost of demolition and old building are considered inventories. It means that inventories must be kept at a lower cost and a higher net realizable value.
Example: An Old Building On Land.
A Dubai Entity X purchased a parcel of land with an old building for AED 400,000. The intention was to demolish it and build a new one. Because the building is in disrepair, its fair value is very close to zero. It can only be used after substantial investments in repairs and refurbishment. X spent AED 20 000 on the demolition of the building. In such a case, it would be appropriate to assign all of the purchase prices to the land.
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Sources
https://www.iasplus.com/en-gb/standards/ias/ias16
https://www.ifrs.org/issued-standards/list-of-standards/ias-16-property-plant-and-equipment/
Kasun Liyanage is an Audit Manager with over 7 years of experience dealing with diversified corporate clients. He not only manages the team’s work schedule but also is an expert in handling audit areas such as external audits and fraud investigation, Internal control benchmarking and best practices and well as preparation of financial statements and IFRS compliance.
