Chapter 5: Cost incurred subsequent to initial recognition

Recognition of cost ceases once an item of property, plant, and equipment is in the location and condition to be used as intended by management. However, an entity might incur further costs on that asset at a later date. Subsequent costs should be capitalized only if they meet the recognition criteria as an asset. All other subsequent costs should be recognized as an expense in the period in which they are incurred.

The decision to capitalize or expense involves consideration of the future economic benefits originally expected from the asset. Subsequent costs that merely maintain the economic benefits originally expected are considered repairs and maintenance and are recognized as an expense.

Subsequent costs are included in an asset’s carrying amount (or recognized as a separate asset, as appropriate) only when it is probable that additional future economic benefits associated with the item will flow to the entity and the cost of the item can be measured reliably.

Additional future economic benefits would normally arise in situations where the subsequent costs increase productive capacity, an additional ability to generate future economic benefits, or an extension in the expected useful life.

Initial costs of safety or environmental regulation Items of property, plant and equipment might be acquired that do not generate economic benefits on their own but are necessary to enable other assets to do so. Examples are assets necessary to ensure safety or to comply with environmental regulations. These are recognized because they enable other assets to generate economic benefits. However, the resultant carrying amount of those assets and the related assets are reviewed for impairment to ensure that the combined carrying amount does not exceed the combined recoverable amount. An example is a chemical manufacturer that has to install new chemical handling processes to comply with environmental requirements. The plant enhancements are capitalized to the extent that they are recoverable (when grouped with the related chemical plant), because without them the entity is unable to manufacture and sell chemicals.

Capitalizing the cost of remodeling a supermarket Entity A, a supermarket chain, is renovating one of its major stores. The store will have more available space for in-store promotion outlets after the renovation and will include a restaurant. Management is preparing the budgets for the year after the store re-opens, which include the cost of remodeling and the expectation of a 15% increase in sales resulting from the store renovations, which will attract new customers. The expenditure in remodeling the store will create future economic benefits (in the form of a 15% increase in sales) and the cost of remodeling can be measured reliably, so it should be capitalized.

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Subsequent expenditure and probable future economic benefits It might be clear whether subsequent expenditure should be capitalized or expensed. For example, the cost of adding a new wing to a hotel should be capitalized. The additional rooms increase the revenue-earning capacity of the hotel, so it is probable that future economic benefits will arise and the cost can be reliably measured. By contrast, the cost of cleaning the hotel is a period cost of servicing the hotel and should be expensed as incurred. However, some expenditure will fall between these two extremes, and judgement will be required to determine whether such expenditure should be capitalized or expensed.

Derecognition of items that have subsequently been replaced A hotel operator refurbishes its hotels every ten years, on average. The cost of refurbishment is considered a replacement of assets capitalized (i.e., the recognition criteria in IAS 16 are met). The replacement indicates, however, that previously recognized assets may now be required to be derecognised, typically giving rise to a loss to the extent that they have not already been depreciated.

Substantial modification costs IAS 16 does not distinguish between subsequent expenditure that maintains the existing service potential of an asset (‘repairs and maintenance’) and subsequent expenditure that enhances that service potential (‘improvements’). Instead, all major subsequent expenditure should be capitalized, provided that it is probable that future economic benefits will flow to the entity, and any part of the existing asset that has been replaced should be derecognised, irrespective of whether it has been depreciated separately. However, the costs of the day-to-day servicing of property, plant and equipment are not capitalized, even though they are arguably incurred in the pursuit of future economic benefits, because they are not sufficiently certain to be recognized in the carrying amount of an asset under the general recognition principle. Accordingly, when an entity incurs both maintenance costs and substantial modification costs in relation to a specific item of property, plant and equipment, the expenditure should be analyzed according to its nature. Any costs of day-to-day servicing should be accounted for in profit or loss, but substantial modification costs should be capitalized as part of the cost of the asset if it is probable that future economic benefits associated with the modification will flow to the entity. For example, a retail outlet needs to be redecorated each year. Because the expenditure is incurred on a regular basis and is not particularly large, the retailer treats the redecoration as part of the day-to-day servicing of the store and recognizes an expense as it is incurred. In the current year, the entity has asked the supplier carrying out the redecoration work to install new partitioning, which is intended to make the outlet more profitable and result in additional future economic benefits. The redecoration costs should be recognized in profit or loss as an expense under IAS 16, while the incremental partitioning costs should be capitalized if they satisfy the recognition criteria set out in IAS 16 (i.e., the cost incurred to install new partitioning can be measured reliably and it is probable that future economic benefits associated with the partitioning will flow to the entity). To the extent that the new partitioning replaces existing partitioning, the partitioning being replaced should be derecognised.

Subsequent expenditure on an impaired asset When an entity incurs capital expenditure on an item of property, plant and equipment in respect of which an impairment loss has previously been recognized, the expenditure should be recognized in accordance with IAS 16 and included in the cost of the asset if the criteria in IAS 16 are met. In order for those criteria to be met, it must be probable that the future economic benefits associated with the expenditure will flow to the entity. An entity will generally only choose to incur additional expenditure on an impaired asset when it expects that expenditure to generate net future economic benefits. If this is the case, the criteria in IAS 16 are likely to be met. Note that this analysis applies equally to subsequent expenditure on a completed asset and continuing expenditure on an asset in the course of construction.

Land clearing costs – example A ski slope operator has developed a piece of land into a ski resort; as part of the development, the operator has cut down trees, cleared and graded the land and hills, and constructed ski lifts. The tree cutting, land clearing and grading costs should be capitalized as part of the cost of the land. These costs are expenditures directly attributable to bringing the land to working condition for its intended use and, therefore, are part of the cost of the land, not the ski lifts. As required under IAS 16, when the cost of site dismantlement, removal and restoration is included in the cost of land, that portion of the land asset is depreciated over the period of benefits obtained by incurring those costs.

Compensation for late delivery of an asset Under the terms of a contract for the purchase of an asset, a supplier may be required to compensate the purchaser (e.g., in the form of penalty payments or additional discounts) if the asset is not delivered on time. In the vast majority of cases, such compensation will represent a reduction in the cost of the asset for the purchaser and it should be accounted for accordingly. For example, when compensation is calculated as a percentage of the contract price or based on notional damages suffered by the purchaser (e.g., a fixed rate per day), the compensation represents a penalty imposed on the supplier for the delayed delivery of the asset and it should be accounted for as a reduction in the cost of the asset. However, in very limited circumstances when the contract specifies that the supplier will reimburse actual costs incurred by the purchaser as a result of the delayed delivery, it may be appropriate to account for those elements as reimbursements of costs under IAS 37.  Such a treatment may be appropriate if: the costs being reimbursed are clearly identifiable and are actual incremental costs incurred by the purchaser as a result of the delay; and the compensation is payable whether or not the asset is eventually delivered to the purchaser. If it is determined that the amounts are appropriately accounted for as reimbursements, they should be recognized in profit or loss when it is virtually certain that they will be received (see IAS 37). Under IAS 37, they may be offset against the related costs in profit or loss or presented as ‘other income’.

Costs not suitable for capitalization Costs listed in IAS 16 as unsuitable for capitalization and, therefore, to be expensed when incurred are: costs of opening a new facility; costs of introducing a new product or service (including costs of advertising and promotional activities); costs of conducting business in a new location, or with a new class of customer (including costs of staff training); and administration and other general overhead costs.

Training costs – example An entity acquires equipment of a type that its employees have never operated before. During the installation period, the employees receive extensive training on the equipment. The cost to the entity includes the incremental cost of hiring experts to conduct the training, and the directly attributable cost of wages of the employees during the training period. The equipment could not be used by the entity unless its employees received the training. These training costs do not qualify as a component of the cost of the equipment; they do not fall within the scope of costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by the management. The equipment would be capable of operating in the manner intended by the management without the entity incurring the training cost – even though the employees would not know how to operate the equipment. In accordance with IAS 38, the training costs will typically be recognized as an expense when incurred.

Cost of a self-constructed asset

Components of cost for a self-constructed asset

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. IAS 16 states that 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 the asset for sale, per the principles of IAS 2.

Depreciation of leasehold land during the construction of a building for own use When an entity constructs a building (within the scope of IAS 16) on leasehold land, the depreciation of the leasehold land right-of-use asset during the construction period should be incorporated in the cost of the building. This is because the depreciation of the leasehold land is an unavoidable cost that is directly attributable to the construction activity and to bringing the building to the condition capable of operating in the manner intended by management. This treatment is consistent with IAS 16, which states that the cost of an item of property, plant and equipment may include the depreciation of right-of-use assets that are used to construct, add to, replace part of, or service an item of property, plant and equipment.

Costs incurred to demolish pre-existing structures The costs that may be included in the carrying amount of an asset are limited to those that arise directly from the construction or acquisition of the asset. When, for example, costs are incurred to demolish existing structures in order to build on a site, the cost of demolition may be incremental to the construction cost or it may be associated with derecognition of a previously held asset. It depends on whether the existing structures were previously used in the entity’s business, or were acquired as part of the site with the specific intention of demolishing them. In the latter case, the demolition costs are clearly incremental and should be included in the cost of the new asset. In the former case, the cost of the old asset should be written off to profit or loss through accelerated depreciation once the decision to demolish is made; the demolition costs incurred relate to the derecognition of the old asset and should be expensed when incurred. For example, in 20X1, Company E purchased land and buildings for CU100 million (land: CU40 million and building: CU60 million). The building is used by Company E in its business; it is classified as property, plant and equipment and is depreciated over its estimated useful life. In 20X3, Company E demolishes the building and constructs a new building for its own use on the same piece of land. The carrying amount of the old building prior to demolition was CU55 million. The carrying amount of CU55 million should be written off to profit or loss rather than being capitalized as part of the cost of the new building. Under IAS 16, Company E is required to depreciate the building to its residual value over its useful life. The remaining useful life of Company E’s building is equivalent to the period from when Company E decided to demolish the building to the demolition date in 20X3. The residual value of the building is zero because the building will be demolished. Therefore, after management’s decision to demolish the building, Company E should revise its estimates for both the remaining useful life and the residual value of the building and should adjust the depreciation expense accordingly, resulting in a write-down of the building to zero before demolition.

Offsetting proceeds from selling output against costs of testing property, plant and equipment – example Entity R is constructing a petrochemical complex with several autonomous manufacturing facilities. Construction of some of the facilities has been completed; these have been certified as ready for commercial production by the relevant authority and they have commenced producing chemicals that are sold on the market. Other facilities are still in the commissioning phase and they are not yet ready for production. IAS 16 states that the cost of an item of property, plant and equipment comprises “any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management”. Prior to the May 2020 amendments to IAS 16, IAS 16 states that costs directly attributable to bringing an asset to the location and condition necessary for it to be capable of operating in the manner intended by management include “costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment)“. For entities that have not yet adopted the May 2020 amendments to IAS 16, the question arises as to whether, in the circumstances described, it is appropriate to offset the proceeds received from selling chemicals produced by the completed manufacturing facilities against the costs of testing the other facilities still in the commissioning phase (i.e. whether such proceeds could be accounted for as a reduction in the cost of facilities under construction, rather than recognized as revenue in profit or loss). IAS 16 does not provide any specific guidance in respect of assets or projects that are completed in parts and the extent to which one part can be considered to be ‘in the location and condition necessary for it to be capable of operating in the manner intended by management’ while construction of other parts continues. IAS 23 does, however, address this topic in the context of capitalizing borrowing costs on qualifying assets, as follows. “When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalizing borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale. A business park comprising several buildings, each of which can be used individually, is an example of a qualifying asset for which each part is capable of being usable while construction continues on other parts. An example of a qualifying asset that needs to be complete before any part can be used is an industrial plant involving several processes which are carried out in sequence at different parts of the plant within the same site, such as a steel mill.” Applying this principle to the circumstances under consideration, it is likely that the petrochemical complex should be thought of as consisting of a number of parts (the autonomous manufacturing facilities), each of which is capable of operating in the manner intended by management while construction of the other parts continues. Consequently, when an individual facility has been completed and is ready for commercial use, it should be considered to be in the location and condition necessary for it to be capable of operating in the manner intended by management. When that point is reached, proceeds received from the sale of chemicals produced by that facility should be recognized as revenue in profit or loss (subject to meeting the requirements of IFRS 15 because those chemicals are produced after the facility is operational and, consequently, proceeds from their sale do not qualify for deduction from the cost of the asset in accordance with IAS 16.

Cost of abnormal amounts of waste in producing a self-constructed asset – example A power company, Company P, signed a contract with a contractor to construct a power plant. Company P believed that the quality of the construction work was poor and terminated the construction contract. The contractor sued Company P for breach of contract and Company P lost. Company P then paid a lump sum to the contractor as compensation for the breach of contract, and the construction work was resumed thereafter. The lump sum compensation paid to the contractor should be recognized immediately as an expense rather than being added to the construction cost of the power plant. The amount does not fall within the scope of costs that are directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. This cost is similar in nature to the cost of abnormal amounts of wasted material, labor or other resources described in IAS 16 and, therefore, should be expensed.

Additional requirements for self-constructed assets The following principles also apply in relation to self-constructed assets: any internal profits are eliminated in arriving at the cost of an asset; the cost of abnormal amounts of wasted material, labor or other resources incurred in the production of the self-constructed asset are excluded from its cost; and borrowing costs incurred during the period of production should be included in accordance with IAS 23 if the self-constructed asset meets the definition of a qualifying asset.

Cost of dismantling, removal and site restoration Costs incurred by an entity in respect of obligations for dismantling, removing and restoring the site on which an item of property, plant and equipment is located are recognized and measured in accordance with IAS 37. If the obligations are incurred when the asset is acquired, or during a period when the item is used other than to produce inventories, they are included in the cost of the item of property, plant and equipment. If the obligations are incurred during a period when the entity uses the item of property, plant and equipment to produce inventories, the costs are accounted for under IAS 2.

Start-up or commissioning period It is appropriate to recognize directly attributable costs in the carrying amount of an item of property, plant and equipment during a commissioning period in which it is not possible to operate at normal levels because of the need to run machinery, test equipment, or ensure the proper operation of the equipment. This circumstance generally relates to the physical preparation for use. An example would be a printing press if it is necessary to run it for a period in order to achieve full functionality.

Incidental operations Some operations occur in connection with the construction or development of an item of property, plant and equipment, but are not necessary to bring the item to the location and condition necessary for it to be capable of operating in the manner intended by management. These incidental operations may occur before or during the construction or development activities. For example, income may be earned through using a building site as a car park until construction starts. Because these incidental operations are not necessary to bring an item of property, plant and equipment to the location and condition necessary for it to be capable of operating in the manner intended by management, the income and related expenses of incidental operations are recognized in profit or loss, and included in their respective classifications of income and expense.

Reimbursement of part of the cost of an asset – example Company A enters into a contract with Company B to produce and sell a specific product. Company A needs to transform a major part of its plant to be able to produce that product, and commissions the transformation work from a third party, Company C, unconnected with Company A and Company B. The transformation costs are significant and exclusively for the purpose of this sales contract. As a result, Company A and Company B enter into an agreement under which Company B will reimburse Company A for a portion of the transformation costs. The cash received from Company B can only be used by Company A to offset the costs of the transformation. From the perspective of Company, A, two transactions are occurring: the purchase of services (transformation costs) from Company C, and the supply of products to Company B. Accordingly, Company A must determine whether the amount receivable from Company B relates to the former or to the latter. The arrangement between Company A and Company B is within the scope of IFRS 15. While, in the circumstances described, the cash from Company B must be used to acquire transformation services from Company C that will create assets controlled by Company A and to be used exclusively to provide Company B with the supply of a specific product, the amount received as a reimbursement from Company B should be treated as revenue in accordance with IFRS 15, and not as a reduction in the cost of the transformation. This is because Company B’s contract is only with Company A and, therefore, the transaction price (as defined in IFRS 15) will include all amounts payable by Company B to Company A. The following accounting should be applied: when Company A receives the reimbursement from Company B, the amount should be deferred and subsequently recognized as revenue in accordance with the requirements of IFRS 15 in relation to the specific contract; and the cost of the transformation should be recognized separately as property, plant and equipment, without any offset of the amount received from Company B.

Rebate of broker’s commission to purchaser of property – example During negotiations to purchase a property, the purchaser was unwilling to accept the seller’s best offer. To induce the purchaser to proceed with the transaction, the broker agreed to rebate a portion of the seller-paid commission to the purchaser. As far as the purchaser is concerned, only one transaction has occurred – the purchase of property. The commission rebate is not immediate income to the purchaser. The seller’s best offer is not the price that the purchaser actually paid. If the purchaser had been required to pay a brokerage commission, that commission would have been part of the cost of the property as a cost necessarily incurred to obtain the asset. In the circumstances described, the commission rebate is similarly a component of the cost of the property.

Utility fees paid to a government In some jurisdictions, developers of factories, offices, apartment buildings and shopping malls must pay a ‘capacity fee‘ to the government for the privilege of being able to purchase, on an ongoing basis, defined quantities of electricity and other utilities beyond certain minimum quantities that can be purchased without paying the fee. The fee is paid on a one-off basis and covers supply, either on an indefinite basis or at least for a substantial number of years. However, the building owner still pays the market rate to purchase the electricity and other utilities. The capacity fee attaches to the entity that owns the building, and it can be transferred to another building if the capacity allowed by the fee is not fully utilized. Because a capacity fee is transferable between buildings, it is not part of the cost of the building but should be recognized as a purchased intangible asset in its own right. As such, it is subject to the requirements of IAS 38 relating to amortization and impairment. If, instead, a capacity fee was attached to the building and not transferable, it would be recognized as part of the cost of the building and depreciated.

The costs of the day-to-day servicing of an item of property, plant, and equipment are not recognized as an asset, because they do not add to the future economic benefits of the item.

These costs maintain the asset’s potential to deliver the future economic benefits expected when the asset was originally acquired. Day-to-day servicing costs include costs of labor and consumables and might include the cost of small replacement parts. This type of expenditure is often described as ‘repairs and maintenance’.

Cessation of capitalization 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.

Determining when an item is in the location and condition necessary for it to be capable of operating in the manner intended by management In the case of a self-constructed asset, or the installation of a major asset, a policy decision should be made and applied consistently as to what event or activity characterizes the point at which an asset’s physical construction/installation is complete (i.e., when the item is in the location and condition necessary for it to be capable of operating in the manner intended by management), so that all costs incurred after that point are identified and expensed. When a commissioning period is involved, it will similarly be essential to determine in principle the point that characterizes reaching the capability of operating at normal levels, and then to ensure that costs incurred after reaching that point are captured and expensed. When there is delay in achieving final physical completion, costs arising during the period of delay are likely to fall into the category of abnormal costs and so be expensed as incurred. Borrowing costs incurred during such a period of delay will not qualify for capitalization under IAS 23, which requires that capitalization should cease when active development is suspended. Regulatory consents (e.g., health and safety clearance) are sometimes required before an asset may be used legally. Cost capitalization will not necessarily continue until such consents are in place. Management will normally seek to ensure that such consents are in place very close to the time-frame for physical completion and testing, and that they do not delay the commencement of operations. Avoidable delays in obtaining consents which prevent the start of operations should be seen as abnormal and similar in effect to an industrial dispute, with the result that capitalization should cease. The words ‘capable of operating in the manner intended by management‘ in IAS 16 cannot be used to justify ongoing capitalization of costs (and postponement of depreciation) once the asset has actually been brought into use just because the asset does not live up to management’s original intentions. This may, however, constitute an impairment indicator under IAS 36.

Capitalization of costs incurred between the completion of a building and the date of approval for occupation – example On 20 September 20X0, Company A completed the construction of a building intended for use as its administrative headquarters. By law, the local health and safety authority must approve the offices for occupation before any activity can commence. This approval can be requested only when the building is physically complete, and it takes on average three months to obtain the approval. The health and safety authority issued the approval for occupation on 20 December 20X0. In the three months from 20 September 20X0, Company A incurred CU10 of building management costs (e.g., utility and security expenses) and interest expenses. (The building is identified as a qualifying asset under IAS 23.) The costs incurred by Company A between 20 September 20X0 (when the building was physically completed) and 20 December 20X0 (when the approval for occupation was issued) should be included in the initial cost of the building. The management costs incurred are considered “directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management”. In addition, obtaining the approval for occupation is considered to be an activity “necessary to prepare the qualifying asset for its intended use or sale”; therefore, Company A should continue to capitalize borrowing costs until the approval is obtained. However, any abnormal amounts of wasted resources incurred in obtaining that approval should not be capitalized. For example, if the approval for occupation had taken longer than the customary three-month period from the completion of construction, due to avoidable delays caused by Company A failing to provide the required information to the health and safety authority, Company A could include in the original cost of the building only costs incurred during the time usually required to obtain the approval for occupation (in the circumstances under consideration, three months). If the delays were due to a slow response from the health and safety authority (without cause by Company A), the capitalization period would be extended.

Rehabilitation liability – change in legislation – example Company X acquired a building in 20X1. Asbestos was used in the construction of the building. During 20X5, legislation is enacted which requires Company X either to remove the asbestos or to vacate the building. Company X obtains a reliable estimate of the costs of removing the asbestos. In accordance with IAS 37, Company X recognizes a provision for the cost of removing the asbestos. IAS 16 states that the cost of an item of property, plant and equipment should include the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which the entity incurred either when the item was acquired, or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. IAS 16 confirms that IAS 16 does not specifically address how an entity should account for the “cost of obligations an entity did not face when it acquired the item, such as an obligation triggered by a law change enacted after the asset was acquired”. Company X should therefore assess whether the costs of removing the asbestos meet the general recognition criteria in IAS 16. In this scenario: the cost of removing the asbestos can be reliably measured; and it is probable that economic benefits associated with the asbestos removal will flow to Company X (because the building would otherwise be vacated). Therefore, Company X should capitalize the estimated cost of removing the asbestos. The change in legislation is also an indicator of impairment; consequently, when the legislation is enacted, Company X should estimate the recoverable amount of the building.

Major inspections or overhauls

The term ‘overhaul’ is frequently used to describe the process of inspecting and maintaining an asset. Overhaul costs typically include replacement of parts and major repairs and maintenance. Major repair and maintenance programs carried out as part of a periodic inspection and overhaul, and that meet the recognition criteria, might well qualify for recognition as an asset.

The cost of each major inspection is recognized as part of the carrying amount of the item of property, plant, and equipment as a replacement if it meets the asset recognition criteria in the standard.

Any remaining carrying amount relating to the previous inspection is derecognized. The cost of the previous inspection does not need to have been separately identified and depreciated when the item was acquired or constructed.

The estimated cost of a future similar inspection can be used as a proxy for the carrying value that needs to be de-recognized if this was not separately identified previously.

Mandatory inspection and overhaul as a component An aircraft might be required by law to be inspected/overhauled every three years. A proportion of the cost of the asset, equivalent to the expected overhaul cost, is identified and depreciated over the period to the next inspection/overhaul if it represents a significant part of the asset’s cost. The actual cost of the overhaul or inspection is then capitalized, provided that it is probable that future economic benefits will flow to the entity and the cost can be measured reliably. This inspection/overhaul cost is then depreciated over the period to the next inspection/overhaul. The cost and depreciation originally attributed to the overhaul is de-recognized once the cost of the new overhaul has been capitalized, to avoid double counting. The remainder of the asset is depreciated over the full useful life of the asset, on the basis that the appropriate overhauls will be carried out as they are due.

Assets recognized on the exercise of a purchase option in a lease contract When a lessee exercises a purchase option in a lease to acquire the underlying asset from the lessor, the lessee (now owner) has a choice to measure the cost of the underlying asset (recognized as an item of property, plant and equipment) at either: the net carrying amount of the right-of-use asset at the time of transfer (the net approach); or the cost of the right-of-use asset at the time of transfer. In this case, any accumulated depreciation and impairment losses of the right-of-use asset are also transferred to the property, plant and equipment at the time of transfer (the gross approach). For example, if the net carrying amount of the right-of-use asset at the time of transfer is: CU Cost 1,000 Accumulated depreciation and impairment losses  800 Net carrying amount  200 The cost of the newly recognized property, plant and equipment item may be measured either at: Net approach Gross approach CU CU Cost 200 1,000 Accumulated depreciation and impairment losses    –  800 Net carrying amount  200  200 A lessee should apply the method chosen consistently to all such transactions. Under either approach, if the exercise price of the purchase option was not recognized as part of the measurement of the lease liability and the right-of-use asset because the lessee was not reasonably certain to exercise that option at inception of the lease, the exercise price paid upon exercise of the option would be added to the cost of the item of property, plant and equipment. Note that under the net approach, the net carrying amount of the right-of-use asset at the time of transfer becomes the deemed cost of the property, plant and equipment item. This deemed cost is the basis for subsequent depreciation and impairment tests (such that previously recognized impairment losses on the right-of-use asset, if any, cannot be subsequently reversed).