Capitalization of mobilization costs as costs to fulfil a contract with a customer

Capitalization of mobilization costs as costs to fulfil a contract with a customer

Fact pattern:

Mobilization costs are costs incurred by an entity to move its personnel, equipment and supplies to a project site. Mobilization costs may be incurred by an entity either before, at or after inception of a contract with a customer. Such costs are common amongst various industries/ sectors. For example, outsourcing entities often incur costs relating to the design, migration and testing of data centres when preparing to provide services under a new contract. Another example is auto component supplier entity incurring cost on designing and developing tooling prior to the production of automotive parts under an automotive supplier contract. A third example is EPC contractor incurring cost on moving personnel, equipment and supplies at the construction site.

Issues:

Can mobilization costs incurred to fulfil a contract with a customer be capitalized under Ind AS 115 Revenue from Contracts with Customers?

Accounting consideration:

The assessment of whether mobilization costs can be capitalized will depend on whether cost incurred is (1) within the scope of Ind AS 115; and (2) meet Ind AS 115 criteria for capitalization.

1. Are the costs within the scope of IND AS 115?

As per paragraph 96 of Ind AS 115, the entity should first determine whether the mobilization costs are specifically addressed by another standard and, if so, the costs are outside the scope of Ind AS 115. Costs specifically addressed in another Ind AS (whether treated as capitalisation or expense) are covered under the respective Ind AS.

If accounting for mobilization costs is not specifically addressed in another Ind AS or it is not clear whether these are within the scope of another Ind AS, an entity should further analyze whether the mobilization costs are:

• Specific to the asset or applicable to more than one customer under unrelated contracts, in which case these likely would not be in the scope of Ind AS 115. For example, moving an asset between different premises of the entity to better utilize the asset in preparation for future contracts with many customers is unlikely to be covered in the scope of Ind AS 115, or
• Specific to the contract with the customer, in which case it would be within the scope of Ind AS 115. For example, moving an asset to a remote location at the customer’s request, which does not provide a benefit to the entity beyond ensuring it is in a position to fulfil its obligation(s) to the customer under the contract.

2. Do the costs meet the criteria in paragraph 95 of Ind AS 115 to be capitalized?

Ind AS 115 includes three criteria that must be met for costs to fulfil a contract within its scope can be capitalized:

A. The costs directly relate to a contract or to an anticipated contract that the entity can specifically identify.

Paragraph 97 of Ind AS 115 states that:

“Costs that relate directly to a contract include any of the following:

• Direct labour
• Direct materials
• Allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance and depreciation of tools, equipment and right-of-use assets used in fulfilling the contract)...”
• Costs that are explicitly chargeable to the customer under the contract; and
• Other costs that are incurred only because an entity entered into the contract (for example, payments to subcontractors).”

Given below is an inclusive list of indicators which may suggest that a cost, by function rather than by nature is directly related to the contract:

• The costs are explicitly or implicitly chargeable to the customer under the contract
• The costs are incurred only because the entity entered into the contract
• The parties to the contract explicitly or implicitly agree that the seller must move equipment etc. to a specific location

B. The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in future under the contract.

In determining whether mobilization costs generate or enhance resources of the entity would consider the following (not limited to):

• Costs are incurred in order for the entity to be able to fulfil the contract; and
• Location is implicitly or explicitly an attribute of the contract. In simple words, the contract requires that the entity to fulfil its performance obligations at a particular location.

In addition, an entity must determine if the resource(s) will be used in satisfying or continuing to satisfy performance obligations in the future periods. Once a performance obligation is met, related fulfilment costs cannot continue to be capitalized.

Hence, costs are only capitalized if they pertain to future performance. If the split between past and future performance costs is unclear and these costs do not qualify for capitalization under other Ind AS, they are expensed as incurred.

C. The costs are expected to be recovered:

For costs to meet the ‘expected to be recovered’ criterion, they need to be either explicitly reimbursable under the contract or reflected through the pricing on the contract and recoverable through margin.

Viewpoint:

We believe entities would be required to assess mobilization costs incurred to fulfil contract with customers on case-to- cases basis considering the criteria stated above. If the costs are within the scope of Ind AS 115 and fulfil all the criteria as defined above, then such costs will be capitalized. This may require exercise of significant judgment.