MODULE 11: Borrowing Costs

RELATED STANDARDS: IAS 23 – Borrowing Costs

INTRODUCTION
This chapter addresses how an entity shall capitalize borrowing costs (interest
and other costs) that are directly attributable to the acquisition, construction or
production of a qualifying asset (an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale) as part of the cost of that asset. An
entity shall recognize other borrowing costs as an expense in the period in which it
incurs them.

Learning Objectives:
1. State the core principle of IAS 23.
2. Compute for capitalizable borrowing cost.

 Definition of Terms
 Borrowing costs – Interest and other costs that an entity incurs in connection
with the borrowing of funds.
 Capitalization – Recognizing a cost as part of the cost of an asset.
 Qualifying asset – An asset that necessarily takes a substantial period of time
to get ready for its intended use or sale.

 Scope
 Borrowing cost may include:
 Interest expense calculated by the effective interest method under IAS
39
 Finance charges in respect of finance leases recognized in accordance
with IAS 17 Leases; and
 Exchange differences arising from foreign currency borrowings to the
extent that they are regarded as an adjustment to interest costs.
 This standard does not deal with the actual or imputed cost of equity,
including any preferred capital not classified as a liability pursuant to IAS
32.
 A qualifying asset  could be
 Property, plant, and equipment and investment property during the con-
struction period
 Intangible assets during the development period
 "made-to-order" inventories.
 Assets that would otherwise be qualifying assets are excluded from the scope
of IAS 23:
 Qualifying assets measured at fair value, such as biological assets
accounted for under IAS 41 Agriculture.
 Inventories that are manufactured, or otherwise produced, in large quanti-
ties on a repetitive basis and that take a substantial period to get ready for
sale (for example, maturing whisky)
 Assets that are ready for their intended use or sale when acquired.

 Recognition
 Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset form part of the cost of that asset and,
therefore, should be capitalized. Other borrowing costs are recognized as an
expense.

 Measurement
 Where funds are borrowed specifically (specific borrowing)
 Borrowing costs eligible for capitalization are the actual costs incurred less
any income earned on the temporary investment of such borrowings.
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 Where funds are part of a general pool (general borrowing)

 Borrowing cost eligible for capitalization is determined by applying a capi-
talization rate to the expenditure on that asset.
 The capitalization rate will be the weighted average of the borrowing costs
applicable to the general pool.
 The amount of borrowing costs that an entity capitalizes during a period
shall not exceed the amount of borrowing costs it incurred during that
period.
 Income earned on the temporary investment of such borrowings is not
deducted from borrowing cost.

 Capitalization
 Commencement of capitalization
 Capitalization should commence when expenditures 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.
 Suspension of capitalization
 Capitalization should be suspended during periods in which active devel-
opment is interrupted.
 Cessation of capitalization
 Capitalization should cease when substantially all of the activities
necessary to prepare the asset for its intended use or sale are complete.
 If only minor modifications are outstanding, this indicates that substantially
all of the activities are complete.
 Where construction is completed in stages, which can be used while con-
struction of the other parts continues, capitalization of attributable
borrowing costs should cease when substantially all of the activities
necessary to prepare that part for its intended use or sale are complete.

 Disclosure
 Amount of borrowing cost capitalized during the period
 Capitalization rate used to determine the amount of borrowing cost eligible
for capitalization

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Illustrative Problems

1. Defined by IAS 23 as Interest and other costs that an entity incurs in

connection with the borrowing of funds.
A. Finance cost C. Interest cost
B. Borrowing cost D. Costs of debt

2. Defined by IAS 23 as an asset that necessarily takes a substantial period of

time to get ready for its intended use or sale.
A. Capital asset C. Qualifying asset
B. Long-term asset D. Capital expenditure

3. For purposes of capitalization of borrowing costs, which of the following is

least likely to be considered as qualifying asset?
A. Biological asset C. Manufacturing plant
B. Intangible asset D. Power generation facility

4. IAS 23 does not require capitalization of borrowing cost relating to the

following assets, except
A. Assets measured at fair value
B. Inventories manufactured in large quantities on repetitive basis even if they
take substantial period of time to get ready for sale.
C. Noncurrent assets that are ready for their intended use or sale when
acquired.
D. Real properties classified as investment properties

5. Under IAS 23, borrowing costs incurred in acquiring, producing or constructing

a qualifying asset are
A. Expensed in the period incurred.
B. Capitalized as part of the cost of the qualifying asset.
C. Expensed as benchmark treatment; capitalized as allowed alternative
treatment.
D. Capitalized as benchmark treatment; expensed as allowed alternative
treatment.

6. Investment income from the temporary investment of borrowing attributable to

the acquisition, construction or production of a qualifying asset is
A. Deducted from the borrowing cost related to both specific and general
borrowing.
B. Deducted from the borrowing cost related to specific borrowing.
C. Deducted from the borrowing cost related to general borrowing.
D. Recognized as investment income for both specific and general borrowing.

7. If a qualifying asset is financed by general borrowing, the borrowing cost

capitalized is equal to
A. Actual borrowing costs incurred during the construction period.
B. Total expenditure on the qualifying asset multiplied by a capitalization rate.
C. Average expenditures on the qualifying asset multiplied by a capitalization
rate or actual borrowing costs, whichever is higher.
D. Average expenditures on the qualifying asset multiplied by a capitalization
rate or actual borrowing costs, whichever is lower.

8. Which of the following is not part of the disclosure requirement under IAS 23?
A. Borrowing cost capitalized during the period.
B. Capitalization rate used to determine the borrowing cost to be capitalized.
C. Amount of specific and general borrowings used to finance the acquisition,
construction or production of a qualifying asset.

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D. None of the foregoing.

9. On April 1, Year 1, Bootleg Inc. obtained a one-year loan of P4 million

specifically to finance the construction of its new building. Borrowing costs for
year 1 amounted to P300,000. Part of the proceeds of the loan was invested
to earn P40,000 interest. The building as completed on December 31, Year 1.
What would be the amount of borrowing cost eligible for capitalization?
A. 260,000 B. 300,000 C. 340,000 D. none

10. On October 1, Year 1, Ali-Fu-Nga Corp. obtained a two-year, 12% loan of P6

million specifically to finance the construction of its new building. The building
was completed on November 30, Year 2. Pertinent details about the
construction and the loan are as follows:
Construction
Investment
Costs
Income earned
Period (excluding
from Loan
borrowing
Proceeds
costs)
Oct 1 to Dec 31, P 2,000,000 P 10,000
Year 1
Jan 1 to Nov 30, 5,000,000 40,000
Year 2
What would be the total cost of the new building as of December 31, Year 2?
A. 7,720,000 B. 7,670,000 C. 7,790,000 D. 7,840,000

11. Refer to no. 9. What would be the interest expense of Ali-Fu-Nga for Year 1
and Year 2, respectively?
A. 0 and 60,000 C. 540,000 and 60,000
B. 180,000 and 660,000 D. 720,000 and 0

12. Tug Yah Watt Enterprise had several general borrowings which were partly
used to finance the construction of a warehouse. Idle funds from the loans
proceeds were invested to earn interest income. The construction began on
January 1, Year 1 and ended on December 31, Year 1. Details of the general
borrowings are as follows:
Loan Principal Borrowing Investment
Costs Income
10% Bank loan P 2,800,000 P 280,000 P 80,000
10% Short-term 1,600,000 160,000 50,000
loan
12% Mortgage 2,000,000 240,000 70,000
Construction costs incurred during Year 1 are as follows:
Date Amount
January 01 P 4,000,000
March 31 2,000,000
June 30 4,000,000
September 30 2,000,000
December 31 1,000,000
What would be the amount of borrowing cost eligible for capitalization?
A. 480,000 B. 650,000 C. 680,000 D. 850,000

13. Agyhuff Inc. began the construction of its building on February 1, Year 1 and
ended on September 30, Year 1. The construction cost of P18 million was
funded from general borrowings. Details of the general borrowings during Year
1 are as follows:
Bank Loan Principal
DBO – 6% P 8,000,000
PBI – 6.6% 10,000,000
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RBCC – 7% 30,000,000
What would be the amount of borrowing cost eligible for capitalization?
A. 810,000 B. 911,250 C. 1,215,000 D. none

14. Bal-Ah-Kubak Corp. had loans outstanding during Year 1 and Year 2 as
follows:
Loan Principal Interest
Specific for P 10%
construction 2,000,000
General borrowing 15,000,000 12%
The construction of the self-constructed factory building began on January 1,
Year 1 and ended on December 31, Year 2. Expenditures incurred during the
construction period are as follows:
Date Amount
January 1, Year 1 P 2,000,000
July 1, Year 1 4,000,000
November 1, Year 3,000,000
1
July 1, Year 2 1,000,000
What would be the cost of the building under construction Bal-Ah-Kubak as of
December 31, Year 1?
A. 10,280,000 B. 11,000,000 C. 9,740,000 D. 9,500,000

15. Refer to no. 13. What would be the cost of the building of as of December 31,
Year 2?
A. 10,000,000 B. 11,660,000 C. 11,700,000 D. 11,500,000

16. Cool Logo Company borrowed a 3-year, 10% loan of P20 million partly for the
construction of its building and partly for administrative purposes on January
01, Year 1. The construction was started on January 1, Year 1 and was
completed on December 31, Year 1. Construction expenditures incurred
evenly throughout the year amounted to P12 million. Cool Logo earned
P200,000 interest from investing a portion of the loan proceeds. What would
be the amount of borrowing cost eligible for capitalization?
A. 400,000 B. 600,000 C. 1,000,000 D. 1,200,000

17. Boony Corp. obtained a general borrowing to partly finance a construction of a

manufacturing plant on April 1, Year 1. The construction began on April 1,
Year 1 and ended on December 31, Year 1. Actual borrowing cost was P1.2
million while the amount capitalized to the qualifying asset was P720,000.
Average construction expenditures totalled P12 million. What would be the
amount of the general borrowing (principal of the loan)?
A. 20,000,000 30,000,000 C. 15,000,000 D. 25,000,000

- End of discussion

“We must remember that intelligence is not enough. Intelligence plus character – that
is the goal of true education.” – Martin Luther King Jr.

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ANSWER KEY:

1. B
2. C
3. A
4. D
5. B
6. B
7. D
8. C
9. A
10. C
11. A
12. C
13. A
14. D
15. B
16. B
17. C

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