Is Construction in Progress Depreciable?

Construction projects are significant undertakings, involving considerable investment before they generate revenue. Accounting for these projects involves understanding how costs are tracked and when they affect financial performance through depreciation. This article explains how construction costs are managed and whether “construction in progress” is eligible for depreciation.

What is Construction in Progress (CIP)

Construction in Progress (CIP) represents an asset account on a company’s balance sheet that accumulates all costs associated with an ongoing construction or development project. These projects are not yet completed and thus not ready for their intended use. Companies capitalize various expenses into the CIP account, including direct materials, direct labor costs, and indirect overheads such as architectural and engineering fees, permits, and interest costs incurred during construction.

CIP is distinct from fixed assets because it signifies an asset still under creation, not yet operational. While classified as a non-current asset, it remains separate from assets like buildings or machinery already in use. The CIP account serves as a temporary holding place for these accumulated costs until project completion.

The Concept of Depreciation

Depreciation is an accounting method used to systematically allocate the cost of a tangible asset over its estimated useful life. Its primary purpose is to match the expense of using an asset with the revenue it helps generate over time. This process reflects the gradual consumption, wear and tear, or obsolescence of an asset as it contributes to business operations.

By spreading the asset’s cost over its useful life, depreciation avoids recognizing the entire expense in the year of purchase, which would distort financial results. For an asset to be depreciated, it must be tangible, have a determinable useful life, and be owned for business operations. An asset must be “placed in service” before depreciation can begin.

When CIP Becomes Depreciable

Construction in Progress (CIP) itself is not eligible for depreciation. An asset only becomes depreciable once it is completed and considered “placed in service.” This means the asset is ready and available for its specifically assigned function, even if not yet actively utilized. For instance, a newly constructed office building is considered placed in service when it has received all necessary occupancy permits and is ready for tenants.

Similarly, a new piece of manufacturing equipment is placed in service once installed, tested, and capable of performing its intended tasks. At this point, the total accumulated costs from the CIP account are transferred to the appropriate fixed asset account on the balance sheet, such as “Buildings” or “Machinery and Equipment.” Only after this reclassification does the asset begin to be depreciated over its estimated useful life.

Financial Treatment After Completion

Once a construction project is complete and the asset is placed in service, the total cost accumulated in the CIP account is reclassified. This involves moving the entire capitalized amount from the temporary CIP account to a permanent fixed asset account, typically categorized under “Property, Plant, and Equipment” (PP&E) on the balance sheet. This accounting adjustment decreases the CIP balance and simultaneously increases the balance of the relevant fixed asset account.

Following this reclassification, the newly recognized fixed asset begins to undergo depreciation. The ongoing depreciation impacts both the balance sheet and the income statement. On the balance sheet, accumulated depreciation is recorded as a contra-asset account, reducing the asset’s book value over time. Concurrently, depreciation expense is recognized on the income statement, systematically allocating the asset’s cost against the revenues it helps generate.