(AS 16) Borrowing Costs

Scope

This Statement should be applied in accounting for borrowing costs.

This Statement does not deal with the actual or imputed cost of owners equity, including preference share capital not classified as a liability.

Definitions
The following terms are used in this Statement with the meanings specified:

Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

Definitions

Borrowing costs may include:

interest and commitment charges on bank borrowings and other short-term and long-term borrowings;
amortisation of discounts or premiums relating to borrowings;

amortisation of ancillary costs incurred in connection with the arrangement of borrowings;

finance charges in respect of assets acquired under finance leases or under other similar arrangements; and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Borrowing costs include interest paid on shortterm borrowings such as working capital finance that existed when the qualifying asset was being purchased, constructed or produced. Borrowing costs exclude actual or imputed cost of owners equity, including preference share capital not classified as a liability however interst (dividend) paid on preference shares will fall within the definition of borrowing costs. Borrowing cost excludes sales tax deferral as sales tax deferral is an operating liability and cannot be termed as loan.

Principles of Borrowing Cost Capitalisation

Borrowing costs incurred on constructing or acquiring a qualifying asset, which takes a substantial period of time for construction, is capitalised as cost of that asset.
All other Borrowing costs are charged to P&L Account.

Borrowing costs incurred only upto the stage the asset is put to use are capitalised.c

Qualifying Assets

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Assets that are ready for their intended use or sale when acquired are not termed as qualifying assets. Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring them to a saleable condition, and investment properties. Other investments, and those inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired also are not qualifying assets. Borrowing costs relating to sugar held in stock cannot be capitalised because it is not attributable to the acquisition or production of the asset.

ASI-1-Substantial Period of Time

The issue as to what constitutes a substantial period of time primarily depends on the facts and circumstances of each case. However, ordinarily, a period of twelve months is considered as substantial period of time unless a shorter or longer period can be justified on the basis of facts and circumstances of the case. In estimating the period, time which an asset takes, technologically and commercially, to get it ready for its intended use or sale should be considered. The following assets ordinarily take twelve months or more to get ready for intended use or sale unless the contrary can be proved by the enterprise: i. assets that are constructed or otherwise produced for an enterprises own use, e.g., assets constructed under major capital expansions. ii assets intended for sale or lease that are constructed or otherwise produced as discrete projects (for example, ships or real estate developments).

In case of inventories, substantial period of time is considered to be involved where time is the major factor in bringing about a change in the condition of inventories. For example, liquor is often required to be kept in store for more than twelve months for maturing.

Recognition of Borrowing Costs

Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred.
Borrowing costs are capitalised as part of the cost of a qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred.

Commencement of Capitalisation
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The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied: expenditure for the acquisition, construction production of a qualifying asset is being incurred; borrowing costs are being incurred; and or

activities that are necessary to prepare the asset for its intended use or sale are in progress.

Suspension of Capitalisation

Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted. For example; security maintenance, regulatory follow up and compliance etc.
Capitalisation of Borrowing costs is also not suspended when there is a temporary delay. For example, capitalisation continues during the extended period needed for inventories to mature or the extended period during which high water levels delay construction of a bridge, if such high water levels are common during the construction period in the geographic region involved.

Cessation of Capitalisation

Capitalisation of borrowing costs should 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 its intended use or sale when its physical construction or production is complete even though routine administrative work might still continue. If minor modifications, such as the decoration of a property to the users specification, are all that are outstanding, this indicates that substantially all the activities are complete.

When the construction of a qualifying asset is completed in parts and a completed part is capable of being used while construction continues for the other parts, capitalisation of borrowing costs in relation to a part should cease when substantially all the activities necessary to prepare that part for its intended use or sale are complete.
A business park comprising several buildings, each of which can be used individually, is an example of a qualifying asset for which each part is capable of being used while construction continues for the other parts. An example of a qualifying asset that needs to be complete before any part can be used is an industrial plant involving several processes which are carried out in sequence at different parts of the plant within the same site, such as a steel mill.

Borrowing Cost Includes Exchange Differences (ASI-10)

Borrowing cost includes exchange differences arising from foreign currency borrowings to the extent that they are regarded as adjustment to interest costs. The costs that are incurred pre-installation of an asset are capitalised and those that are incurred post installation of an asset are charged to revenue. For example; Sometimes foreign currency loans are availed at reduced interest rates. However, some of the benefit of low interest rate is eroded by adverse moment in foreign currency rates. That portion only can be capitalised under ASI-10.

Burning Issues

Proportionate interest on fund utilized including on advances made to suppliers for the qualifying asset should be capitalised. The loan used for working capital should not be capitalised. Interest expenses once capitalised correctly in accordance with AS-16, cannot be decapitalised thereafter even if the interest amount is waived.

Burning Issues
Borrowing

costs incurred during the normal period ( not during abnormal period ) of trial run should be capitalised.

Investments

are not qualifying assets under AS16, hence interest cannot be capitalised. As investments are immediately ready for use, unlike plant or factory, which requires time for its construction.

Disclosures in Financial Statements

o

The financial statements should disclose: the accounting policy adopted for borrowing costs; and the amount of borrowing costs capitalised during the period.

Thank You