Assets under construction accounting uses a temporary balance sheet account, often labeled AUC or construction in progress, to accumulate every cost tied to building a long-term asset until that asset is substantially complete and ready for use. Once the build is done, the balance moves to a permanent fixed asset account, depreciation begins, and the AUC account returns to zero for the next project. Misclassifying costs during this window either inflates current-period expenses or overstates the asset’s cost basis, and either error carries forward through the asset’s entire depreciable life.
Which Costs Go Into AUC and Which Stay on the Income Statement
The dividing line is directness. A cost belongs in AUC if it exists because you are building the asset. A cost stays on the income statement if it would exist regardless of the project.
Capitalizable costs include:
- Raw materials that become part of the structure, plus wages for construction crews and on-site supervisors.
- Professional fees paid to architects, engineers, surveyors, and attorneys handling zoning or title work.
- Building permits, environmental clearances, and similar regulatory fees.
- Testing and commissioning costs to run equipment through trial operations or verify that building systems meet specifications.
- Site preparation work like grading and drainage to make the land construction-ready.
General corporate overhead unrelated to the project, routine maintenance on existing operational assets, and administrative costs that would be incurred anyway are period expenses. The same logic governs indirect costs: only incremental overhead that exists because of the project belongs in AUC. A project manager hired for the build, temporary power at the site, or a field office set up for the job all qualify. Headquarters rent and corporate accounting salaries do not.
Property Taxes and Insurance
Property taxes and insurance on the asset under construction are capitalized during periods when activities to get the property ready for use are actively in progress. Undeveloped land held for future construction, with no development activity yet, generates period expenses instead. Once the asset is substantially complete, these carrying costs stop being capitalized and get expensed as incurred.1EY. Financial Reporting Developments: Real Estate Project Costs
Land, Land Improvements, and Building
Not everything spent during construction belongs in the building account. Utility systems, landscaping, parking lots, and fencing that serve the broader site are classified as land improvements and depreciated on their own schedule, or in some cases treated as part of the land itself and not depreciated. Internal plumbing and electrical wiring inside the building are capitalized as part of the building. The test is whether the improvement is physically attached to and primarily serves the building or supports the site as a whole.
Demolition has its own rule. If you buy property intending to tear down an existing building and construct something new, the demolition costs and the entire purchase price of the old building are capitalized to land, which is never depreciated. If you bought the property without demolition plans and only later decided to tear the structure down, the remaining book value plus net demolition costs are a loss in the period of demolition and do not carry over to the replacement building.2eCFR. 26 CFR 1.165-3 Demolition of Buildings
When Capitalization Starts and When It Stops
Capitalization begins when three conditions are present at the same time: you have started spending on the asset, activities to get it ready for use are underway, and interest costs are being incurred. Qualifying activities are interpreted broadly. Developing architectural plans, applying for permits, and conducting feasibility studies all count, not just physical construction.3FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
Capitalization stops when the asset is substantially complete and ready for its intended use, even if operations have not actually started. Substantially complete means the major construction work is done and the asset is in the condition and location needed for use. A few punch-list items or minor cosmetic finishes are not a reason to keep capitalizing.
Interruptions Mid-Project
This is where accountants often stumble. If your company deliberately suspends substantially all construction activity, you also suspend capitalization. Brief interruptions, external delays like labor disputes or permitting holdups, and slowdowns inherent to construction do not trigger a suspension. Those kinds of pauses are treated as a normal part of getting the asset ready, so the carrying costs during them stay in the asset’s cost.1EY. Financial Reporting Developments: Real Estate Project Costs
Capitalizing Interest on Construction Borrowings
Interest paid to finance construction is not simply expensed. Under GAAP, a portion of that interest must be capitalized to AUC when the effect is material. The concept is called avoidable interest: you capitalize only the interest you could have avoided if you had not made the construction expenditures.3FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
The standard method uses weighted-average accumulated expenditures (WAAE). You calculate the average amount of money tied up in the project over the period, weighting each expenditure by how long it was outstanding. If you took out a loan specifically for the project, apply that loan’s rate to the WAAE up to the amount of the specific borrowing. Expenditures beyond that specific loan get multiplied by a weighted average of your other outstanding borrowing rates.3FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
There is a hard ceiling. The amount capitalized cannot exceed the total interest cost the company actually incurred during the period. You are reallocating real interest expense, not creating fictional cost. Interest capitalization follows the same start-and-stop rules as other AUC costs and ends when the asset is substantially complete.
Internal-Use Software Follows Its Own Framework
Major IT systems qualify for capitalization, but software follows ASC 350-40 rather than the general property, plant, and equipment rules. The development process breaks into three stages, and only one of them supports capitalization.
- Preliminary project stage. All costs are expensed. This covers exploratory research, evaluating vendors, and deciding whether to move forward.
- Application development stage. Costs are capitalized. Capitalization begins once management has authorized and committed funding to a project that will probably be completed. Coding, configuration, hardware installation, and testing all fall here, and capitalization stops when the software is substantially complete and ready for use.
- Post-implementation stage. All costs are expensed. Training, ongoing maintenance, and post-go-live bug fixes are period costs.
The line between the preliminary and application development stages is a frequent audit issue. The clearest marker for the shift is formal management authorization and funding commitment to a defined scope. Cloud arrangements add a layer: if you control the software or have the contractual right to take possession of it, the same three-stage framework applies. For hosted services where you have no right to the underlying software, the implementation costs generally follow the same capitalization logic but are classified differently on the balance sheet.
Moving the Balance to a Fixed Asset and Starting Depreciation
When the asset is substantially complete, the entire AUC balance moves to the appropriate permanent fixed asset account. The journal entry debits the fixed asset account (Buildings, Machinery, or the relevant category) and credits AUC to zero it out. Depreciation begins at that point because the asset is ready for use, even if actual operations have not started.4BIA.gov. Assets Under Construction Accounting Management Handbook 27 IAM-15-H
At transfer, management sets the asset’s estimated useful life and residual value. Those estimates drive depreciation for the life of the asset, so errors compound. Most companies use straight-line depreciation for buildings and structures; equipment with heavier early-year usage may warrant an accelerated method like double-declining balance.
Component Depreciation
A building is not one monolithic asset. Structural shell, HVAC, roof, elevators, and electrical systems have different useful lives. Under U.S. GAAP, componentizing the cost and depreciating each piece on its own schedule is optional (it is mandatory under IFRS). Many companies adopt it anyway, because replacing a roof in year 15 of a 40-year building produces cleaner accounting when the roof was tracked separately from the start. Allocate costs using contractor invoice detail where you have it, and fall back on relative fair values or relative square footage when you do not.
Impairment and Abandoned Projects
Assets under construction are not immune to impairment. If circumstances suggest the carrying amount may not be recoverable, you have to test. Common triggers include costs running well beyond budget, a business shift that eliminates the need for the asset, or a market change that undermines the project’s rationale.
The recoverability test compares carrying amount to the undiscounted future cash flows the asset is expected to generate. If carrying amount exceeds those cash flows, you write the asset down to fair value and record the difference as a loss in the current period.
When a project is permanently abandoned with no alternative use, the entire AUC balance is written off. The entry debits an impairment loss account and credits AUC for the full carrying amount. There is no gradual wind-down; once the asset will never provide future economic benefit, immediate recognition is required under ASC 360. Partial abandonment is harder. If parts of the project are salvageable or can be repurposed, only the portion with no future benefit is written off, and the rest stays on the books at its recoverable amount. Auditors will scrutinize timing and completeness, so documentation matters.
Tax Rules Are Broader Than GAAP
The IRS applies its own capitalization regime under Section 263A, the Uniform Capitalization (UNICAP) rules, and it reaches further than GAAP in places. Any taxpayer that produces real or tangible personal property must capitalize both direct costs and a proper share of indirect costs, including allocable taxes.5Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses
UNICAP sweeps in indirect costs that GAAP often lets you expense: pension contributions, certain employee benefits, and a broader range of administrative overhead. That generates book-tax differences you have to track and reconcile.
Tax interest capitalization applies to what the regulations call designated property, with fixed thresholds rather than GAAP’s materiality test. Interest must be capitalized for any real property the taxpayer produces. For tangible personal property, the triggers are an estimated production period exceeding two years, or a production period exceeding one year combined with estimated production costs above $1,000,000.6eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
A de minimis exception applies to smaller jobs. If the production period is 90 days or less and total production expenditures (excluding land cost and the basis of existing property used in production) do not exceed $1,000,000 divided by the number of days in the production period, interest capitalization is not required.6eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
How AUC Shows Up on the Financial Statements
AUC sits on the balance sheet as a non-current asset within property, plant, and equipment. Most companies present it as a separate line item or disclose it parenthetically, which flags to readers that this investment is not yet earning revenue or being depreciated. Analysts watch that number for a sense of coming depreciation and how capital is being deployed.
The transfer from AUC to a permanent fixed asset account is a reclassification between two asset accounts. No cash moves, and nothing runs through the income statement. On the cash flow statement, the original expenditures were reported as investing outflows when cash was actually spent during construction. The transfer itself is a noncash activity that may require supplemental disclosure under ASC 230 but does not create a new cash flow line.
For capitalized interest, the notes must disclose both total interest cost incurred during the period and the portion capitalized. That gives readers the full borrowing picture and shows how much interest was shifted to the balance sheet rather than expensed.