Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing of funds. They may include, for example:
- Interest on bank overdrafts, short-term and long-term loans
- Amortisation of discounts or premiums related to borrowing
- Finance charges in respect of finance leases
- Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
The Standard only applies to borrowing costs related to external borrowings and not to equity. Therefore, the Standard does not deal with the imputed or actual cost of equity, including preference share capital not classified as equity.
IAS 23 Borrowing Costs regulates the extent to which entities are allowed to capitalise borrowing costs incurred on money borrowed to finance the acquisition of certain assets.
Borrowing costs must be capitalised as part of the cost of an asset when:
- It is probable that the costs will result in future economic benefits and the costs can be measured reliably; and
- They are directly attributable and they would have been avoided if the asset was not bought, constructed or produced.
Note that this is a departure from the previous position which existed up to 1st January 2009, where a benchmark treatment and an allowed alternative were available to entities.
Other borrowing costs are recognised as an expense in the period they were incurred. A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use or sale. Examples of such assets include:
- Inventories that require substantial time periods to bring them to saleable condition
- Manufacturing plants
- Investment properties
BORROWING COSTS ELIGIBLE FOR CAPITALISATION
When an entity borrows funds specifically to acquire a qualifying asset, the borrowing costs relating to that asset should be readily identifiable. Such costs are directly attributable since they would have been avoided if the asset had not been acquired, constructed or produced.
However, if the financing activity of an entity is centrally co-ordinated, it may be difficult to identify the relationship between particular borrowings and a qualifying asset. In this case, IAS 23 says that judgement must be exercised.
If funds are borrowed generally and used to obtain a qualifying asset, the amount of funds eligible for capitalisation is calculated by applying a “capitalisation rate” to the cost of the asset. This rate is the weighted average of the borrowing costs that are applicable to the borrowings of the entity that are outstanding during the period.
On the other hand, if the funds have been specifically borrowed to acquire the asset, the amount of funds that can be capitalised is calculated as follows:
Actual borrowing costs incurred on that borrowing
Less: Any investment income on the temporary investment of those borrowings*
*Borrowed funds are sometimes temporarily invested pending their expenditure on qualifying assets.
COMMENCEMENT OF CAPITALISATION
The capitalisation of borrowing costs shall commence when:
- Expenditures for the asset are being incurred
- Borrowing costs are being incurred and
- Activities that are necessary to prepare the asset for its intended use or sale are in progress. This includes not only physical work constructing the asset but also technical and administration work prior to the commencement of construction.
CESSATION OF CAPITALISATION
The capitalisation of borrowing costs shall cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
An asset is normally ready for use or sale when the physical construction of the asset is complete.
SUSPENSION OF CAPITALISATION
The capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.
Thus, for example, borrowing costs incurred during builders’ holidays would continue to be capitalised, whereas borrowing costs incurred during prolonged industrial disputes would not be capitalised.
Where assets are financed by specific borrowings, IAS 23 requires that the cost of this specific borrowing, related to the financing, be capitalised.
However, where the general borrowings of the company are used to finance qualifying assets, then a weighted average cost of capital (excluding any specific borrowings) should be applied to the average investment in the asset.
In addition, any interest from the temporary investment of any surplus funds relating to the financing of the assets is treated as a reduction of the borrowing cost.
The financial statements must disclose:
- The accounting policy adopted
- The amount of borrowing costs capitalised during the period
- The capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.