Under paragraph 16 of AASB 116 Property, Plant and Equipment (AASB 116) the cost of an item of PPE includes make good costs, where the obligation was incurred either when the item was acquired or as a consequence of having used the item.
Example: Make good costs
Examples of PPE make good costs may include the costs to:
- restore a leased building at the end of lease term to its condition at lease commencement
- dismantle a piece of machinery to allow for its removal from the entity’s premises
- remove an aircraft, by transporting it to a disposal facility, due to a condition of purchase being that it must be disposed of in a particular manner.
Initial recognition of make good provisions
On initial implementation of AASB 16, on the 1 July 2019 transition date, make good accounting should remain unchanged for existing leases. A lessee should recognise a provision under AASB 137 Provisions, Contingent Liabilities and Contingent Assets (AASB 137) for the expected make good costs at lease end and a corresponding leasehold improvements asset inclusive of capitalised make good costs under AASB 116.
For leases commencing after the transition date, paragraph 24(d) and paragraph 25 of AASB 16 specify that estimated make good costs must be included in the cost of the lessee’s ROU asset when the lessee incurs an obligation for those costs. However, where the make good obligation specifically relates to leasehold improvements undertaken by the lessee, the make good provision should continue to be capitalised as part of the lessee’s leasehold improvements asset rather than to the ROU asset.
For example, where the lease contract requires the lessee to remove any fitout work undertaken by the lessee at lease end, any make good provision relating to this obligation should be capitalised to the corresponding leasehold improvement asset, rather than the ROU asset. However, where the lease contract requires the lessee to undertake general restoration of the leased premises not related to specific lessee fitout, such as repainting, carpet cleaning and servicing of air conditioning and lift systems, any make good provision should be capitalised to the ROU asset.
Note 19: Initial recognition of make good provisions
No change is required to make good provisions relating to existing leases on AASB 16 transition date. For new leases commencing after transition date, AASB 16 requires estimated make good costs to be included in the lessee’s ROU asset. However, where the make good obligation specifically relates to leasehold improvements undertaken by the lessee, the make good provision must continue to be capitalised as part of the relevant leasehold improvement asset rather than to the ROU asset.
Changes to make good provisions
Changes in lease make good provisions should be accounted for in accordance with AASB 137, AASB Interpretation 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities (Interpretation 1) and RMG-114 Accounting for decommissioning, restoration and similar provisions to make good (RMG-114). AASB 137 requires Commonwealth entities to review make good provisions annually to reflect current best estimates of the timing and the amount required to settle the obligation and the appropriate discount rate.
Under Interpretation 1, accounting for changes in make good provisions due to changes in estimates of the amount or timing of payments at settlement or from a change in the discount rate, depends on whether the related asset is:
- the ROU asset measured at cost (includes some make good provisions relating to leases which commenced after AASB 16 transition date)
- a leasehold improvement asset measured at fair value (includes make good provisions on existing leases on initial implementation of AASB 16).
Where the make good provision is capitalised to a ROU asset measured at cost, Interpretation 1 requires changes in make good provision estimates to be adjusted against the ROU asset as follows:
- increases in the make good provision would increase the corresponding ROU asset
- decreases in the make good provision would decrease the corresponding ROU asset, except that decreases in excess of the carrying value of the ROU asset would be recognised as gains.
Where the make good provision is capitalised to a leasehold improvement asset measured at fair value, Interpretation 1 requires changes in make good provisions estimates to be treated as a revaluation adjustment as follows:
- increases in the provision would decrease the relevant Asset Revaluation Reserve (ARR) balance or result in an expense where there is no ARR balance
- decreases in the provision would increase the ARR balance or result in a gain if reversing a previous devaluation expense for that asset class.
In both cases, where the related asset is at the end of their useful life, all subsequent changes in the make good provision should be recognised in the income statement as they occur. Unwinding of the present value of make good provisions should be recognised as interest expense (unwinding of restoration and decommissioning provision expense) as it occurs.
Note 20: Changes to make good provisions
Changes in lease make good provision estimates must be accounted for in accordance with Interpretation 1 and will depend on whether the make good is recognised as part of a leasehold improvement asset held at fair value or as part of the ROU asset held at cost.