IAS 23: Borrowing Costs

Content
1 Objective and Scope

2 Definition

3 Recognition

4 Capitalisation

5 Key Differences
Agenda

Objective and Scope

Definitions

Recognition

Capitalisation

Disclosure Requirements
Objective and scope

Borrowing costs that are directly attributable to the acquisition, construction or production of
a qualifying asset form part of the cost of that asset.
Other borrowing costs are recognised as an expense.

► IAS 23 does not apply to:

Qualifying assets Inventories manufactured

measured at fair value in large quantities on a
(e.g., biological assets) repetitive basis
Definitions

Borrowing Costs
► These are interest and other costs incurred by an entity in connection with borrowing of funds
which includes:
► Interest expense
► Finance charges
► Exchange differences on foreign currency borrowings as an adjustment to interest costs

It doesn’t include actual or imputed cost of equity, including preferred capital not classified as a
liability
Definitions

Qualifying Asset
► An asset that necessarily takes a substantial period of time to get ready for its intended use or
sale

► But does not include assets ready for use or sale when acquired
Qualifying asset

Following are some of the examples of assets which can be classified as qualifying assets.
► A power plant which will take a substantial period of time to get ready to generate electricity

► A hydroelectric dam that serves the needs of a town and can take several years to get ready

► A toll bridge which takes can take a couple of years to construct before it can be opened for
the public to use
► Inventories that require a substantial period of time to bring them to a saleable condition
Recognition

Borrowing Cost

Directly attributable to
acquisition, construction
Other Borrowing costs
or production of a
qualifying asset

Capitalise Treat as an Expense

Commencement of capitalisation

Capitalisation should commence when all conditions met:

Activities necessary
Expenditure Borrowing to prepare the
for the asset
are being
costs are asset for its
being incurred intended use or
incurred
sale are in progress

Expenditures are reduced by any progress payments received and grants received (IAS 20) in
connection with the asset.
Commencement of capitalisation – example

For example:
► Borrowing costs incurred while land is under development are capitalised during the period in
which activities related to the development are being undertaken.
► However, borrowing costs incurred while land acquired for building purposes is held without
any associated development activity having commenced do not qualify for capitalisation.
Suspension of capitalisation

Capitalisation should be suspended during extended periods in which active development is

interrupted.

Capitalisation is not suspended when:

► Substantial technical and administrative work is being carried out

► Temporary delay is a necessary part to prepare an asset for its intended use or sale
Cessation of capitalisation

Capitalisation should cease when: (in case of asset as a whole)

► Substantially all the activities necessary to prepare the qualifying asset for its intended use
or sale are complete

In case routine administrative work or minor modifications, such as the decoration of a property
are outstanding, it will still be considered that substantially all the activities are complete.
Cessation of capitalisation

Capitalisation should cease when: (in case of asset in parts)

► In case of construction of a qualifying asset is in parts and each part is capable of being
used while construction continues, when substantially all the activities necessary to prepare
the part for its intended use or sale are complete.

► For eg: A business park comprising several buildings, each of which can be used
individually
Example

► Apex issued an unsecured loan on 1 April 2015.

► The loan was specifically issued to finance the building of the new store which meets the
definition of a qualifying asset in IAS 23. Construction of the store commenced on 1 May
2015 and it was completed and ready for use on 28 February 2017, but did not open for
trading until 1 April 2017.

► During the year Apex suspended the construction of the new store for a two-month period
during July and August 2016.
Example (contd.)

► Capitalisation commences from when expenditure is incurred (1 May 2015) and must cease
when the asset is ready for its intended use (28 February 2017); in this case a 22- month
period.

► However, interest cannot be capitalised during a period where development activity is

suspended; in this case the two months of July and August 2016.
Length of substantial period of time

► Under Indian GAAP, ordinarily, a period of twelve months is considered as

substantial period of time
► Unless a shorter or longer period can be justified

► IFRS (also Ind AS) is silent on this aspect

► This would call for significant judgement, e.g., an entity may considering the nature of
asset, amount of interest costs, etc. may decide capitalising interest costs on an asset
requiring say 8 months for its completion
Example

Apex issued a $10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1
April 2015. The loan is redeemable at a premium and the effective finance cost is 7·5% per
annum.

The loan was specifically issued to finance the building of the new store which meets the
definition of a qualifying asset in IAS 23. Construction of the store commenced on 1 May
2015 and it was completed and ready for use on 28 February 2016, but did not open for
trading until 1 April 2016.

During the year trading at Apex’s other stores was below expectations so Apex suspended
the construction of the new store for a two-month period during July and August 2015. The
proceeds of the loan were temporarily invested for the month of April 2015 and earned
interest of $40,000.

Calculate the net borrowing cost that should be capitalized as part of the cost of the new
store and the finance cost that should be reported in the statement of profit or loss for the
year ended 31 March 2016.
Solution

The effective rate is 7·5%, so the total finance cost for the year ended 31 March 2016 is
$750,000 ($10 million × 7·5%).

Capitalization commences from when expenditure is incurred (1 May 2015) and must
cease when the asset is ready for its intended use (28 February 2016); in this case a 10-
month period.

However, interest cannot be capitalized during a period where development activity is

suspended; in this case the two months of July and August 2015. Thus only eight months of
the year’s finance cost can be capitalized = $500,000 ($750,000 × 8/12).

The remaining four-months finance costs of $250,000 must be expensed.

Solution

According to IAS 23 interest earned from the temporary investment of specific loans
should be deducted from the amount of finance costs that can be capitalized. However, in
this case, the interest was earned during a period in which the finance costs were not
capitalized. Thus the $40,000 interest received would be credited to profit or loss and not
to the capitalized finance costs.

In summary:
Profit or loss for the year ended 31 March 2016: $000
Finance cost (debit) (250)
Investment income (credit) 40

Statement of financial position as at 31 March 2016:

Property, plant and equipment (finance cost element only) 500
Types of borrowings

Specific General
Borrowings Borrowings
Specific borrowings

To the extent that an entity borrows funds specifically for the purpose of obtaining a
qualifying asset

The amount capitalised should be the actual borrowing costs net of any income
earned on the temporary investment of those borrowings.
Case study – calculation of amount to be capitalised

► On 1 Apr 2014, a company engages in the development of a property, which is

expected to take five years to complete, at a cost of $ 6 million. For this purpose, a
bank loan of $ 6 million with an effective interest rate at 6% was taken out on 31
March 2014 and fully drawn.

► Interest income earned at 3% on the unapplied funds during the period was $
114,000.

► What is the amount of interest to be capitalised for the year ended 31 Dec 2014?
Case study – calculation of amount to be capitalised

Solution

► Total interest charge for the year ended 31 Dec 2014 is $270,000.

► Amount to be capitalised is $156,000 (i.e., $270,000 less $114,000)

General borrowings

► In case of general borrowings, borrowing costs related to the funds utilised for
acquisition, construction or production of a qualifying asset, to be capitalised shall be
calculated by applying a capitalisation rate to the expenditures on the related asset.
► The capitalisation rate should be the weighted average of the borrowing costs
applicable to the borrowings of the entity that are outstanding during the period, other
than specific borrowings

Borrowing costs capitalised during a period should not

exceed the amount of borrowing costs incurred during that
period
Case study – calculation of capitalisation rate

An entity has three sources of borrowing in the period. All the borrowings are used to
finance the production of qualifying assets.

Outstanding liability Interest

5 years bank loan $ 6 million $0.8m
20 years bank loan $ 10million $0.6m
Bank Overdraft (average) $ 4 million $0.5m

Calculate the appropriate capitalisation rate.

Case study – calculation of capitalisation rate

Particulars Loan Interest

5 Year Bank Loan $ 6 million $0.8m
20 years bank loan $10million $0.6m
Bank Overdraft (average) $4 million $0.5m

► Capitalisation rate is
► (0.8+0.6+0.5)/(6+10+4) = 9.50%
Case study

► On July 1 20X9 entity A were contracted for the construction of a building for $2.2m. The
land under the building is regarded as a separate asset and is not part of the qualifying
assets.
► The building was completed at the end of the June 20Y0, and during the period the
following payments were made to the contractor:

Payment date Amount ($’000)

1 July 20X9 200
30 September 20X9 600
31 March 20Y0 1,200
30 June 20Y0 200
Total 2,200
Case study

► Entity A’s borrowings at its year end of 30 June 20Y0 were as follows:

► 10% 4-year note with simple interest payable annually, which relates specifically to
the project; debt outstanding at 30 June 20Y0 amounted to $700,000. Interest of $
65,000 was incurred on these borrowings during the year and interest income of $
20,000 was earned on these funds while they were held in anticipation of payments;

► 12.5% 10-year note with simple interest payable annually; debt outstanding at 1 July
20X9 amounted to $ 1,000,000 and remained unchanged during the year end
Case study

► 10% 10-year note with simple interest payable annually; debt outstanding at 1 July
20X9 amounted to $ 1,500,000 and remained unchanged during the year.

► What amount of the borrowing costs may be capitalized at year end?

Case study – solution

Analysis of Expenditure

Date Expenditure ($000) Amount allocated to Weighted for period

general borrowings outstanding ($000)
($000)

1 July 20X9 200 0 0

30 September 20x9 600 100* 100 X 9/12
31 March 20Y0 1,200 1,200 1,200 X 3/12
30 June 20Y0 200 200 200 X0/12
Case study – solution

Specific Borrowings of $ 700,000 fully utilized hence remainder of expenditure now

allocated to general borrowings.

The capitalisation rate relating to general borrowings should be the weighted average of the
borrowing costs applicable to the entity’s borrowings that are outstanding during the period,
other than borrowings made specifically for the purpose of obtaining a qualifying asset

Weighted average borrowing cost

= [(12.5% of 1000) + (10% of 1500)]/ (1000 + 1500) = 11%

Case study – solution

Borrowing Cost to be capitalized:

Amount ($)
Specific Loan 65,000
General Borrowing ($ 375,000 X 11%) 41,250
Total 116,250
Less interest income on (20,000)
specific borrowings
Amount eligible for capitalization 86,250

Therefore, the borrowing costs to be capitalized are $86,250

Foreign exchange adjustments

The manner of arriving at foreign exchange adjustments shall be as follows:

► The adjustment should be not exceed the difference between the cost of borrowing in
functional currency and cost of borrowing in a foreign currency.
► Where there is an unrealised exchange loss which is treated as an adjustment to
interest and subsequently there is a realised or unrealised gain in respect of the
settlement or translation of the same borrowing, the gain to the extent of the loss
previously recognised as an adjustment should also be recognised as an adjustment to
interest.
Disclosure

► The amount of borrowing costs capitalised during the period

► The capitalisation rate used to determine the amount of borrowing costs eligible for
capitalisation
Key differences with IFRS and IGAAP

Difference IAS Indian GAAP

Scope IAS 23 scopes out: No such scope exception
• Qualifying assets measured at
fair value (e.g., biological
assets)
• Inventories produced in large
quantities on a repetitive basis.
Components of Reference to effective interest rate No reference to effective interest
borrowing costs rate
Substantial period of No such presumption; it should be 12 months ordinarily considered as
time determined based on a substantial period of time, unless
management’s judgement a shorter or longer period can be
justified
Key differences with IFRS and Ind AS

There is no GAAP difference

Thank You