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In March 2007, IASB issued the revised IAS 23, Borrowing Costs, which eliminated the option of recognizing borrowing costs immediately as an expense, to the extent that they are directly attributable to the acquisition, construction, or production of a qualifying asset. This revision was a result of the Short-Term Convergence project with the FASB. The revised standard provides that a reporting entity should capitalize those borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset as part of the initial carrying value of that asset, and that all other borrowing costs should be recognized as an expense in the period in which the entity incurs them. Key changes introduced by this revised standard include:
All borrowing costs must be capitalized if they are directly attributable to the acquisition, construction or production of a qualifying asset. The previous benchmark treatment, recognizing immediately all such financing costs as period expenses, is eliminated. Under the new approach, which was an allowable alternative treatment in the past, all these costs must be added to the carrying value of the assets, when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably, consistent with the US GAAP approach. Borrowing costs that do not require capitalization relate to Assets measured at fair value (for example, a biological asset), although an entity can present items in profit or loss as if borrowing costs had been subject to capitalization, before measuring them to their fair values. Inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis, even if they take a substantial period of time to get ready for their intended use or sale.
Borrowing costs are defined as interest and other costs that an entity incurs in connection with the borrowing of funds. Such costs may include interest on bank overdrafts and short-term as well as long-term borrowings, amortization of discounts and premiums related to borrowings as well as any ancillary costs incurred in connection with the transaction of borrowings, finance charges related to finance leases (in accordance with IAS 17, Leases) and exchange differences arising from foreign currency borrowings to the extent they are treated as an adjustment to interest costs. Borrowing costs eligible for capitalization, directly attributable to the acquisition, construction or production of a qualifying asset, are those borrowing costs that would have been avoided if the expenditure on this asset had not been made. They include actual borrowing costs incurred less any investment income on the temporary investment of those borrowings.
interest capitalization has been applied to those asset acquisition and construction situations in which: Assets are being constructed for an entity’s own use or for which deposit or progress payments are made Assets are produced as discrete projects that are intended for lease or sale Investments are being made that are accounted for by the equity method. including preferred capital not classified as a liability. When land is in the process of being developed. many years’ experience with SFAS 34 provided certain insights that may prove germane to this matter. Generally. on the other hand. Other investments. the land is being developed for a building.The amount of borrowing costs eligible for capitalization is determined by applying a capitalization rate to the expenditures on that asset. If. IAS 23 does not deal with the actual or imputed cost of equity. If land is being developed for lots. where the investee is using funds to acquire qualifying assets for its principal operations which have not yet begun. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use and may include inventories. the capitalized interest cost is added to the cost of the land. as well as assets that are ready for their intended use or sale when acquired. and investment properties measured at cost that are being redeveloped. intangible assets. the capitalized interest cost should instead be added to the cost of the building. power generation facilities. and inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time. While IAS 23 does not give further insight into the limitations of this definition. The capitalization rate is the weighted-average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period. Qualifying assets are those that normally take an extended period of time to prepare for their intended uses. it is a qualifying asset. other than borrowings made specifically for the purpose of obtaining a qualifying asset. The capitalization of interest costs would probably not apply to the following situations: . manufacturing plants. are not qualifying assets. inventories and land that are not undergoing preparation for intended use are not qualifying assets. In general. The related borrowing costs are then matched against revenues when the lots are sold. The interest cost is then matched against future revenues as the building is depreciated. properties that will become self-constructed investment properties once their construction or development is complete. The amount of borrowing costs capitalized during a period cannot exceed the amount of borrowing costs incurred.
the interest costs incurred thereon should be deemed eligible for capitalization. or of other ancillary borrowing costs such as commitment fees . and other costs. compared to the effect of expensing interest When qualifying assets are already in use or ready for use When qualifying assets are not being used and are not awaiting activities to get them ready for use When qualifying assets are not included in a consolidated statement of financial position When principal operations of an investee accounted for under the equity method have already begun When regulated investees capitalize both the cost of debt and equity capital When assets are acquired with grants and gifts restricted by the donor to the extent that funds are available from those grants and gifts If funds are borrowed specifically for the purpose of obtaining a qualified asset. although in some construction projects funds are drawn from the lender’s credit facility only as vendors’ invoices. at any given time. a portion of which is applied to the asset construction or acquisition program. are actually paid. however. net of any interest earned from the temporary investment of idle funds. It is likely that there will not be a perfect match between funds borrowed and funds actually applied to the asset production process. Only the interest incurred on the project should be included as a cost of the project. Interest cost could include the following: Interest on debt having explicit interest rates Interest related to finance leases Amortization of any related discount or premium on borrowings. a variety of credit facilities may be used to generate a pool of funds. In those instances. Interest Of Credit Facilities Used To Generate Pool Of Funds In other situations. The routine production of inventories in large quantities on a repetitive basis For any asset acquisition or self-construction. when the effects of capitalization would not be material. the amount of interest to be capitalized will be determined by applying an average borrowing cost to the amount of funds committed to the project.
Thus. and capitalized costs are generally used in place of capital expenditures unless there is a material difference. The total amount of interest actually incurred by the entity during the relevant time frame is the ceiling for the amount of interest cost capitalized.The amount of interest to be capitalized is that portion that could have been avoided if the qualifying asset had not been acquired. the best criterion to use is the identification and determination of that portion of interest that could have been avoided if the qualifying assets had not been acquired. particularly in the case of consolidated financial statements. the capitalized amount is the incremental amount of interest cost incurred by the entity to finance the acquired asset. On a consolidated financial reporting basis. the interest cost capitalized should be limited to the amount that the separate entity has incurred. or daily. Theoretically. and that amount should include interest on intercompany borrowings. The selection of borrowings to be used in the calculation of the weighted-average of rates requires judgment. Reasonable approximations of net capital expenditures are acceptable. A weighted-average of the rates of the borrowings of the entity should be used. If the average capitalized expenditures exceed the specific new borrowings for the time frame involved. monthly. Most long-lived assets will be acquired with debt having interest compounded. The interest incurred is a gross amount and is not netted against interest earned except in rare cases. Simple interest is computed on the principal alone. This requirement more accurately reflects the interest cost that is actually incurred by the entity in bringing the long-lived asset to a properly functioning condition and location. whereas compound interest is computed on principal and on any accumulated interest that has not been paid. which of course would be eliminated in consolidated financial statements. The base (which should be used to multiply the weighted-average rate by) is the average amount of accumulated net capital expenditures incurred for qualifying assets during the relevant reporting period. Thus. The interest being paid on the underlying debt may be either simple or subject to compounding. Compounding may be yearly. and that feature should be considered when computing the amount of interest to be capitalized. In resolving this problem. If financial statements are issued separately. however. Capitalized costs and expenditures are not synonymous terms. this ceiling is defined as the sum of the parent’s interest cost plus that incurred by its consolidated subsidiaries. the amount capitalized cannot exceed the amount actually incurred during the period. the excess expenditures amount should be multiplied by the weighted-average of rates and not by the rate associated with the specific debt. . a capitalized cost financed by a trade payable for which no interest is recognized is not a capital expenditure to which the capitalization rate should be applied.
000 $3.100. made the following payments during 2011: January 1. was to make five payments in 2011. The building was completed December 31. contracted with Leo Company to construct a building for $20.000 9/12 6/30/2011 $ 6. Example Of Accounting For Capitalized Interest Costs Assume the following: On January 1.000 12/12 3/31/2011 $ 4.000 $20. 5-year note dated 12/31/2009 with simple interest and interest payable annually on December 31 $7.000 .000 June 30.500.000.150. 2011 $ 4.SIC 2 states that if interest cost is capitalized.000 March 31.500.000 Date Expenditure 1/1/2011 $ 2.000 The amount of interest to be capitalized during 2011 is computed as follows: Average Accumulated Expenditures Average Cap.000 December 31. 4-year note dated 1/1/2011 with interest compounded quarterly. 2011 $ 3.400.000 6/12 9/30/2011 $ 4. 10-year note dated 12/31/2007 with simple interest and interest payable annually on December 31 $6. 2011.000 $3. Both principal and interest due 12/31/11 (relates specifically to building project) $8. had the following debt outstanding at December 31. this fact must not result in the asset being reported at an amount in excess of recoverable amount. 2011 $ 6.000.000 September 30.000. 2011: A 12%.000.000 A 10%.100.000 Lie Dharma Putra Corp.000.000 $1.050.500.000.000.000. 2011 $ 2. Lie Dharma Putra Corp.000. with the last payment scheduled for the date of completion.000 3/12 12/31/2011 $ 3. Lie Dharma Putra Corp. 2011.400. Any excess interest cost is thus an impairment. Lie Dharma Putra Corp.000 0/12 $ 20.000. Accumulated period* Expenditures $2.000 on land that Lie Dharma Putra had purchased years earlier.000 $9. 2011 $ 4. to be recognized immediately in expense.000.100.000 A 12%.
000 Total interest = $2. 10-year note ($6. Three conditions must be met before the capitalization period should begin: Expenditures for the asset are being incurred Borrowing costs are being incurred Activities that are necessary to prepare the asset for its intended use are in progress .000 = 11. = $1.12551) – $8. is multiplied by the factor for the future amount of $1 for 4 periods at 3% to determine the amount of principal and interest due in 2011. 10-year note $ 6.066.980 (= $2.840 $ 650. 4-year note [($8.000] = $1.138.000 $ 600.840 The interest cost to be capitalized is the lesser of $1.500.000.000 $13.000 $1.000.000.138. ** Weighted-average interest rate Principal Interest 10%.500.860 Note: * The principal.506.840 – $1.000 × 12%) = $ 840. 2011).000 $ 840.08% Determining The Time Period For Capitalization Of Borrowing Costs An entity should begin capitalizing borrowing costs on the commencement date.066.1108** = $ 72.840 10%.440.000.000/$13.000 × 10%) = $ 600.367.860) must be expensed.500.506.000 = $1.860 (avoidable interest) or $2.440.000 = $1.000 12%.000. 5-year note ($7.000 × 1.000 × 0.506. $8.500.000 Total interest / Total principal The actual interest is: 12%.020 $9.000.000 × 1. The remaining $1.840 (actual interest).000 12%.150. 5-year note $ 7. Potential Interest Cost to Be Capitalized ($8.12551)* – $8.500.138.Note: * The number of months between the date when expenditures were made and the date on which interest capitalization stops (December 31.000.
Necessary activities are interpreted in a very broad manner. The measure should be substantially complete. not absolutely finished. transfers of other assets or the assumption of interest-bearing liabilities. borrowing costs can be capitalized. the capitalization of interest costs stops for each part as it becomes ready to function as intended. Capitalization would cease when the project has been substantially completed. however. and may continue after physical work has ceased. They start with the planning process and continue until the qualifying asset is substantially complete and ready to function as intended. These activities may include technical and administrative work prior to actual commencement of physical work.As long as these conditions continue. However. unless the break in activity is significant. and are reduced by any progress payments and grants received for that asset. it is usually ignored. Suspension And Cessation Of Capitalization If there is an extended period during which there is no activity to prepare the asset for its intended use. if the entity intentionally suspends or delays the activities for some reason. if delays are normal and to be expected given the nature of the construction project (such as a suspension of building construction during the winter months). Expenditures incurred for the asset include only those that have resulted in payments of cash. Also. The fact that routine minor administrative matters still need to be attended to would not mean that the project had not been completed. As a practical matter. such as obtaining permits and approvals. An asset that must be entirely complete before the parts can be used as intended can continue to capitalize interest costs until the total asset becomes ready to function. . capitalization of borrowing costs should be suspended. This would occur when the asset is ready for its intended use or for sale to a customer. this would have been anticipated as a cost and would not warrant even a temporary cessation of borrowing cost capitalization. Brief. If the asset is completed in a piecemeal fashion. in other words. interest costs should not be capitalized from the point of suspension or delay until substantial activities in regard to the asset resume. normal interruptions do not stop the capitalization of interest costs.
exceeds its recoverable amount (if property. Companies that currently apply the benchmark treatment of recognizing borrowing costs as an expense will need changes in systems and processes in order to collect relevant information and calculate the amount of borrowing costs to be capitalized. and equipment.Costs In Excess Of Recoverable Amounts When the carrying amount or the expected ultimate cost of the qualifying asset. Other transactions. the financial statements must disclose (1) the amount of borrowing costs capitalized during the period. recognizing fair value increases. recovery of a previously recognized loss will be reported in earnings. or equipment) or net realizable value (if an item held for resale). in which case. revaluation) treatment. this rate will be the weighted-average of rates on all borrowings included in an allocation pool or the actual rate on specific debt identified with a given asset acquisition or construction project. to be recognized immediately in expense.e. . Effective Date Revised IAS 23 should be applied for annual periods beginning on or after January 1. Disclosure Requirements With respect to an entity’s accounting for borrowing costs. it should apply to all qualifying assets for which the commencement date for capitalization of borrowing costs is on or after that date. Any excess interest cost is thus an impairment. including capitalized interest cost. plant. with earlier application permitted.. such as foreign currency borrowings and hedging activities. If an entity applies this Standard from an earlier date. a later write-up may occur due to use of the allowed alternative (i. property. In the case of plant. may also impact the amount of borrowing costs subject to capitalization. it will be necessary to record an adjustment necessary to write the asset carrying value down. US Foreign Private Issuers may need to maintain two sets of capitalization information—one set under IFRS and one under US GAAP. 2012. In addition. as described earlier. As noted. and (2) the capitalization rate used to determine the amount of borrowing costs eligible for capitalization.
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