India Treatment of Demolition cost

[harshab6]

Hi Expert,

I am bit confusion on treatment of Demolition cost.

As per US GAAP

• If land and building are purchased with the initial intent to use the land and demolish the building, capitalize the cost to demolish the building as land improvement.
• If land and building are purchased with the initial intent to use the land, demolish the building and build a new building, capitalize the cost to demolish the building as part of the cost of the new building if the demolition occurs soon thereafter.
• If land and building are purchased with the initial intent to use the land and the building, expense the costs to demolish the existing building at a later date. The demolition costs are an expense associated with the cost of using the existing asset and are not capitalized in the cost of the new asset.

I have three question.

If it’s a own building and the owner of the building demolishes few floor and builds a new floor whether the demolition cost be treated as capex or Opex.

If the building is purchased on lease and the leasee demolishes the existing Interiors and builds a new Interior as per his business convenience will the demolition cost be treated as Capex or Opex

its a own building and the owner of the building demolishes existing interiors and builds new interior will the demolition cost treated as Capex or Opex

 

[kirby]

Looks like a homework question. So what is your answer and your reasoning for each?

 

[harshab6]

No Its not a home work question .its a practical scenario I am an intern and recently our company made few leasehold Imp work in leased building prior to lease we demolished floor and rebuilt it.Our Tax auditors argues that it should be treated as Opex since in case of own building as per GAAP If land and building are purchased with the initial intent to use the land and the building, expense the costs to demolish the existing building at a later date. The demolition costs are an expense associated with the cost of using the existing asset and are not capitalized in the cost of the new asset. But I am of the view that since our company don't own that building and it purchased for lease we need add demolition as a part of leased project and capitalize the same.

Answer to the question below are my viewpoint

If it’s a own building and the owner of the building demolishes few floor and builds a new floor whether the demolition cost be treated as capex or Opex-if the owner purchased new building with intent to use the building and in later stage if he demolishes the building it should be treated as opex but If its a immediate purchase of building and then owner demolishes building and builds new building then it should be treated as capex

If the building is purchased on lease and the leasee demolishes the existing Interiors and builds a new Interior as per his business convenience will the demolition cost be treated as Capex or Opex?-I think this should capex since demolition cost is part of leasehold imp

its a own building and the owner of the building demolishes existing interiors and builds new interior will the demolition cost treated as Capex or Opex-Since the demolition is done in later stage the demo cost should be treated as opex

Let me know what do you think?

Once again thanks for quick respond.

 

[kirby]

OK, let's have fun with this. Assume you constructed a robot. Costs were: Head $1,000 Arms and legs $500 each for the 4 parts.. Torso $750. Total $3,750.
Now - an arm is damaged and cost to fix is $25. CAPEX OR OPEX? and why?
Next an arm is replaced with same type arm for $600 CAPEX or OPEX and why?
Next an arm is replaced with a vastly more functional arm for $600. CAPEX or OPEX and why?
Next the head is fixed for $2,000 - same functionality. CAPEX or OPEX and why?

After this we will get to original question

 

[harshab6]

an arm is damaged and cost to fix is $25-this gradually comes under repair and maintenance as doesn't improve the functionality of the Robot hence need to be treated as opex.
Next an arm is replaced with same type arm for $600 CAPEX or OPEX and why-there is no improvement in functionality hence need to treated as opex.
an arm is replaced with a vastly more functional arm for $600. CAPEX or OPEX and why-Since this increases the functionality of the product hence treated as Capex
the head is fixed for $2,000 - same functionality. CAPEX or OPEX and why-this doesn't increase the functionality hence treated as opex

Regards,
Harsha

 

[kirby]

an arm is replaced with a vastly more functional arm for $600. CAPEX or OPEX and why-Since this increases the functionality of the product hence treated as Capex

Well, so now per your detail fixed asset records, You now have a robot with three arms? What do you say to that?

 

[kirby]

We did not finish but if you are OK with that so am I

 

[harshab6]

I was bit Busy with Month End Close activity so I was not able to look into Post. Answering to your question.

Well, so now per your detail fixed asset records, You now have a robot with three arms? What do you say to that? its a improved version of robot and since it increases the functionality it should b treated as Capex.
Yaa I get what are you trying to convey that anything increases the functionality should be treated as capex and its absolutely right as per capitalization policy as per accounting standard.
But My concern is on Demolition cost treated in case of own building and leased building as below point mentions. as per Gaap

If land and building are purchased with the initial intent to use the land and the building, expense the costs to demolish the existing building at a later date. The demolition costs are an expense associated with the cost of using the existing asset and are not capitalized in the cost of the new asset.I am not sure whether this refers to complete demolition of building in later stage and building a new building or does it refers to partial demolition and is the same policy is also followed for leasehold imp.

 

[kirby]

First back to finish on the robot. Can't have costs for three arms so need to write off the replaced arm. Can you see how that relates to your topics?

 

[kirby]

Back to your original three questions -
First note that the guidance you cited in your first post all had to do with an ORIGINAL PURCHASE but the examples you used all had to do with an ALREADY OWNED or ALREADY LEASED building. Usually this is called a renovation or a "betterment."
Anyway, the demolition cost for your three examples are all treated as CAPEX. Reason is that it is part of the cost of putting the new asset in place.
Here's the issue though - the cost of the existing asset should be written off - which is the robot example. This writeoff is rarely thought of and rarely done, except it happens sometimes in a roof replacement because the roof is sometimes viewed as an identifiable "separate" component of the building.