Chasing Myths: Common Misapplications of IFRS and Their Implications

Myth #1: Capitalized Production Costs

Capitalized production costs refer to costs incurred with work performed by the undertaking for its own purposes, and capitalized. This occurs in situations where the entity engages in the construction of tangible fixed assets for its own use (for instance, the construction of a warehouse) utilizing its internal resources, such as labor and materials, and capitalizes the associated costs as part of the asset's carrying amount.

In some jurisdictions, it is common practice to recognize these capitalized costs as income, presented as a separate line item in the statement of profit or loss. This common practice is based on the recognition of an expense corresponding to the consumption of the resources involved (some of which may even be external) and, simultaneously, the recognition of income and a tangible fixed asset at the cost of those consumed resources. This approach reflects the entity's internal allocation of costs but is not aligned with the conceptual definitions of income and expenses as outlined in #IASB’s Conceptual Framework (2018).

Definition of income: “income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims”.

In the case of internally constructed assets, the "income" recognized does not represent an inflow of economic benefits from external transactions or events. Instead, it is derived from the internal allocation of costs, which does not increase the entity's net economic benefits. Thus, this practice misrepresents the economic reality, as no genuine increase in assets or reduction in liabilities occurs due to external activity.

Definition of expenses: “expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims”.

When an entity uses its resources (e.g., labor, materials) to construct an asset, these outflows are not considered expenses under the framework, as they are directly linked to the creation of an asset rather than a reduction in economic benefits. Recognizing them as "expenses" contradicts the framework's guidance, as such costs are instead part of the asset's carrying amount.

This does not align with the IASB's Conceptual Framework (2018), which requires income and expenses to result from external transactions or events that increase or decrease the entity’s net economic benefits. Recognizing internal transfers as income distorts financial performance and fails to faithfully represent the underlying economic reality.

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