What it means
When a company buys a machine, the cost goes to fixed assets on the day it arrives and depreciation starts when it is ready for use. When a company builds a factory over two years, the costs arrive continuously and the factory is not ready for use until the end.
Construction in progress is the holding account for those two years: it accumulates what the factory has cost so far, sits within fixed assets on the balance sheet, and is not depreciated until the factory is complete. What goes into CIP follows the same rules as the cost of any fixed asset.
Directly attributable costs: the purchase price of materials and equipment, contractor and subcontractor payments, site preparation, installation and assembly, professional fees (architects, engineers, surveyors, legal), testing to confirm the asset works, and the labour and overheads of the company's own staff working on the project. Borrowing costs: under IFRS (IAS 23) and US GAAP (ASC 835), interest on funds borrowed to finance the construction of a qualifying asset is capitalised into CIP during the construction period, at the actual rate on specific borrowings or a weighted average rate on general borrowings, and capitalisation stops when the asset is substantially complete.
What does not go in: administrative and general overheads not attributable to the project, training of staff to operate the asset, costs of operating at below capacity after completion, abnormal costs of wasted materials or labour, and costs incurred while the project is suspended. The transfer out of CIP happens when the asset is ready for its intended use, which is a judgement: substantially complete, capable of operating in the manner management intended, with testing done.
At that point the balance moves to buildings, plant, equipment or the relevant category, the useful life and depreciation method are set, and depreciation starts. Projects are often transferred in parts as components become usable.
Controls around CIP address three risks. Costs that should be expensed are capitalised into CIP, inflating assets and profit; the boundary between attributable and non-attributable, and between construction and operation, is where the judgement lies.
Completed assets are left in CIP, delaying depreciation; a project that has been in use for a year but remains in CIP is understating expense. And projects that will not deliver value are carried at cost; a plant whose market has disappeared during construction, or whose cost has overrun beyond its economic value, must be impaired.
For readers of accounts, the CIP balance and its movement show the company's investment programme: a rising balance means building ahead of use, and the eventual transfer will raise depreciation. The note disclosing capitalised interest shows how much of the year's interest cost has been deferred into assets rather than charged to profit.
Large or long-standing CIP balances relative to the asset base prompt questions about completion, overruns and recoverability.
In practice
Real-world examples.
Example
A utility carries $2 billion of construction in progress for a power station, capitalising $80 million a year of interest until commissioning.
Example
A retailer's CIP holds the fit-out costs of twelve stores under construction, each transferred to fixtures and fittings on opening.
Example
A software company's CIP includes the development costs of an internal system that has passed the application development stage, transferred to intangible assets at go-live.
Think of it
“Construction in progress tracks costs of building something-accumulating expenses until it's finished.
Formula
Calculation
CIP closing balance = Opening balance + Costs incurred in period (materials, labour, contractors, fees, attributable overheads) + Capitalised borrowing costs minus Transfers to fixed assets on completion minus Impairments
Capitalised borrowing costs (specific loan) = Loan balance x Interest rate x Period of construction (less income on temporary investment of the funds)
Capitalised borrowing costs (general borrowings) = Weighted average expenditure on the asset x Weighted average borrowing rate
Depreciation begins on transfer: Annual depreciation = (Transferred cost minus Residual value) / Useful life
Worked example. A food manufacturer builds a new processing plant over 18 months. Costs incurred:
- Land purchase: $2,000,000 (recorded as land, not CIP, since it is not constructed and not depreciated)
- Site preparation and foundations: $1,400,000
- Building contractor: $6,500,000
- Processing equipment: $4,800,000, plus installation $700,000
- Architects, engineers and project management fees: $650,000
- The company's own engineering staff assigned full-time to the project: $420,000
- Testing runs to commission the equipment: $180,000
- Training of production staff: $150,000 (expensed, not CIP)
- Initial operating losses in the first two months after start-up while output ramped up: $260,000 (expensed)
- A three-month suspension of work during a planning dispute, during which the site security and insurance cost $90,000 (expensed, since the standards exclude costs during extended suspension)
- Borrowing: a specific construction loan of $8,000,000 at 6.5% drawn progressively; interest incurred during the 18-month construction period $610,000, of which $40,000 relates to the suspension period (not capitalised); interest earned on temporarily undrawn funds $25,000 (deducted)
CIP accumulation:
- Site preparation $1,400,000 + building $6,500,000 + equipment $4,800,000 + installation $700,000 + fees $650,000 + own staff $420,000 + testing $180,000 = $14,650,000
- Capitalised interest = $610,000 minus $40,000 minus $25,000 = $545,000
- CIP total at completion = $15,195,000
Expensed: training $150,000; start-up losses $260,000; suspension costs $90,000; suspension-period interest $40,000. Total $540,000 charged to profit.
Transfer on completion: building (site preparation, building contractor, the building's share of fees and staff and interest) about $9,400,000 to buildings, 40-year life; equipment (equipment, installation, testing, their share of fees, staff and interest) about $5,795,000 to plant and machinery, 12-year life. Annual depreciation from completion: $235,000 + $483,000 = $718,000.
Balance sheet during construction: CIP rose from nil to $15,195,000 over 18 months, within fixed assets, with no depreciation. Profit during construction was higher by the capitalised interest of $545,000 than it would have been had the interest been expensed; from completion, profit bears $718,000 a year of depreciation that includes the recovery of that interest over the assets' lives.
Impairment check: at completion, the plant's expected output and margins support a value in use of $18,000,000, above the $15,195,000 carrying amount; no impairment. Had a major customer been lost during construction, reducing value in use to $12,000,000, an impairment of $3,195,000 would have been recognised on completion (or earlier, when the indication arose).Case study
Seen in the real world.
A manufacturing group's balance sheet showed construction in progress of $28,000,000, up from $9,000,000 three years earlier, while its depreciation charge had barely moved. A new group financial controller reviewed the account. It contained a $12,000,000 production line that had been in full operation for fourteen months but had never been transferred because the project manager had not signed the completion certificate over a dispute with the contractor; $4,000,000 of costs on a warehouse project that had been abandoned a year earlier when the site was sold; $2,500,000 of general engineering department salaries that had been coded to CIP by a default setting; and $1,800,000 of interest capitalised on a general borrowing rate that had not been updated since the group's debt was refinanced at a lower cost.
The corrections: the production line was transferred and fourteen months of depreciation ($1,400,000) charged; the abandoned warehouse costs were written off; the engineering salaries were reclassified to expense and the prior year adjusted; and the interest was recalculated, reducing the capitalised amount by $600,000. Profit for the year fell by $6,400,000 after the adjustments, and the prior year was restated.
The controller's report recommended a monthly CIP review listing every project, its budget, spend, status and expected completion, a rule that any asset in operation is transferred within the month, and a quarterly recoverability review. Her observation was that CIP had become the account where costs went to avoid the income statement.
Watch out
Common mistakes.
- Leaving completed assets in CIP, which delays depreciation and overstates profit.
- Capitalising costs that do not qualify: training, start-up losses, administrative overheads, costs during suspension, and interest beyond the construction period.
- Failing to test CIP for impairment when the project's economics change during construction.
Questions
People also ask.
When does depreciation start on a constructed asset?
When it is ready for its intended use, not when it is first used and not when the invoices are all paid. Substantial completion and successful testing are the usual markers.
Is interest on construction loans capitalised?
Yes, under both IFRS and US GAAP, for qualifying assets that take a substantial period to build: interest during the construction period is added to the asset's cost, net of income on temporarily invested funds, and capitalisation stops on completion or during extended suspension.
What is the difference between construction in progress and work in progress?
CIP is the cost of a fixed asset the company is building for its own use. Work in progress is partly finished inventory (in manufacturing) or the cost of a contract asset being built for a customer (in construction).
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