IAS 23-BORROWING COST
OBJECTIVE:
To prescribe the accounting treatment for borrowing cost.
DEFINITIONS:
Borrowing costs are interest and other costs, incurred by an entity in connection with the borrowing of funds in order to construct an asset.
Borrowing cost includes
- Interest on bank overdraft and short term borrowing;
- Finance lease charges in respect of finance lease; and
- Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment of interest cost
- Issuance costs
- Discount on issuance and premium on redemption
Qualifying asset: A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale (e.g. inventories, manufacturing plants, power generation facilities, intangible assets, investment properties etc.). However, financial assets, inventories produced over short period of time and assets ready for intended sale are not qualifying assets.
ACCOUNTING TREATMENT:
Recognition
An entity should capitalize the borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset and, therefore, should be capitalized.
Other borrowing costs are expensed in statement of profit or loss when occurred.
Return on any surplus funds invested is first deducted from the amount of interest and then the remaining amount is capitalized.
Specific Funds
The borrowing cost of funds, borrowed specifically for the qualifying asset, is the actual cost incurred on the funds during the period less any investment income on the temporary investment of funds.
General funds
The borrowing cost of funds, borrowed generally, will be determined by applying a capitalization rate to the expenditures incurred on those assets. The capitalization rate is the weighted average rate of the borrowings cost applicable to the borrowings of the entity outstanding during that period other than specific borrowings. The amount of borrowing cost capitalized during a period should not exceed the borrowing costs incurred during the period. (Group borrowings)
Excess of carrying amount of the qualifying asset over recoverable amount
When the carrying amount exceeds the recoverable amount of that asset, the asset should be written down to its recoverable value. (IAS 36)
PERIOD OF CAPITALIZATION
Commencement of capitalization
The capitalization commences: –
- Expenditures for the assets are being incurred;
- Borrowing costs are being incurred; and
- Activities necessary to prepare the asset for its intended use/sale are in progress
Expenditures on a qualifying asset include only those expenditures, which have resulted in transfer of cash/other asset or assumption of interest bearing liabilities and will be reduced by any Government Grant (IAS –20).
The activities necessary to complete the qualifying asset include beside physical construction the technical/administrative work such as obtaining permits prior to physical construction. However, such activities exclude the holding of an asset when no production or development that changes the asset‘s condition is taking place (e.g. borrowing cost incurred while land is under development are capitalized during the period when activities related to the development are in progress).
Suspension of capitalization
Capitalization should cease when during the extended period the active development is interrupted.
Examples are:-
- Borrowing costs incurred during extended periods when activities to prepare an asset for its intended use/sale are interrupted (costs of holding partially completed assets)
- On temporary delays the capitalization is not suspended (Geographical region involved – delays due to high water levels, inventories to mature for sale, due to bad weather, strikes etc)
Cessation of capitalization
The capitalization should cease, when substantially all the activities necessary to complete the qualifying asset for its intended use/sale are complete (physical construction is complete, administrative or decorative work may continue).
When the construction of a qualifying asset is in parts the capitalization of borrowing cost should cease, when the relevant part is complete for its intended use/sale (building park).
DISCLOSURE
- The accounting policy adopted.
- Amount of borrowing cost capitalized during the period.
- Capitalization rate used.
