First of all not every directly attributable cost can amount to capitalization as cost of the asset. IAS 16 requires more than just a cost to be directly attributable before it qualifies for capitalization as cost of the asset or to be included in the carrying amount of the non-current asset or fixed asset.
According to IAS 16 Para 16(b) 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.
In simple words cost should be directly attributable and in addition to that this directly attributable cost must be incurred to bring the asset into working conditions as intended and if such costs are not incurred then asset cannot be operated to its maximum capability or as intended by the users of such assets.
Most of the time training costs are not necessary to bring the asset into intended location and condition therefore they are expensed as they are incurred. However, for the sake of argument, if we accept that certain training cost is necessary to bring the asset into working condition then we will have to check whether training costs meet the definition and recognition criteria of asset as set out in IASB framework or not.
According to IASB framework asset is defined as:
An asset is a resource:
- controlled by the entity as a result of past events and
- from which future economic benefits are expected to flow to the entity.
Personnel like direct labour, administrative and sales staff is neither owned nor controlled by the entity. Humans are not just like any other assets. Therefore, if personnel in relation to which training cost is incurred are not controllable then how can we control the benefits that are expected to be rendered from training costs?
Also, no entity can expect with reasonable certainty that future economic benefits from training will flow to the entity as sometimes training increases the productivity of the labour and sometimes not. Just another fact is that different people have different learning capability some learns more from training and thus are capable of providing more benefit and some don’t learn anything and no considerable change in their performance. Also, the benefits that arise from training cost are connected with the labour which can resign, retire etc and leave the entity and thus flow of benefits (if any) will stop.
In short, we can conclude that there is considerable uncertainty surrounding training costs to qualify for capitalization and also the faithful representation which is one of the principle qualitative characteristics of financial statements directs us not to report such transactions and events which are surrounded by significant uncertainty as it can cause unreliable reporting.
So, here are some of the many different reasons which advocates that training costs are not capitalized.
There can be one exception which is extremely rare that application of training is limited to a single entity (may be because only this single entity has the relevant facility to apply such knowledge for example new ERP solution) and also personnel are not expected to leave the entity either because they are bound by contract or some attractive incentives. And as contracts are legally enforceable thus such costs can be capitalized and amortized over a period of contract. But again there are so many complications involved in doing so as entity will have to clearly state the policy about how training and other costs incurred has improved the efficiency and effectiveness of labour in management’s opinion.
However, this is just a “possible” exception NOT validated by any standard and have to be judged on case to case basis. But this might be just the exception I have made up and not a good enough exception as the standard is clear about training costs that they shall not be recognized.
But there is one good enough reason for this which also backed up by legal history is of Cleveland Electric Illuminating Co case. In this case it was found that training cost is part of a start-up costs because such training was required before company could receive the licence to “load” the nuclear reactor with the “fuel”. And as start-up costs are capitalized therefore, training cost would be capitalized.
Delving further in history we have a ruling of INDOPCO in which following notable points were specifically made:
- Capital and revenue expenditures are distinguished not on the basis of kinds of expenditures rather by studying their degree
- For capitalization, asset does not necessarily have to be separate and distinct in nature.
- Expenditures that provide future benefits over a period longer than one accounting period need careful examination of the expenditures of the circumstances as mere extended benefits do not amount to capitalization.
- Keeping the above points in mind, however, such training costs must be capitalized where the training is intended primarily to obtain future benefits significantly beyond those traditionally associated with training provided in the ordinary course of a taxpayer’s trade or business.