CHAPTER 14

BORROWING COST
Sources:
(1) Financial Reporting, ACCA Workbook, BPP Leaning Media. 2021. Chapter 3.
(2) FRS for Malaysia by Jane Lazar. 3rd Edition. Chapter 23.
(3) A Practical Guide to Financial Reporting Standards (Malaysia), 4TH Edition by Ng Eng Juan.
(4) IAS 23 Borrowing Cost
(5) http://www.iasplus.com/en/standards/ias/ias23
(6) Intermediate Financial Reporting – An IFRS Perspective

OVERVIEW

IAS 23 Borrowing Costs requires that borrowing costs directly attributable to the acquisition,
construction or production of a 'qualifying asset” are included in the cost of the asset.

Borrowing cost are interests & other costs that are incurred when funds are borrowed. IAS23
emphasized on borrowing costs incurred on funds borrowed to construct/develop an asset.
These are the “self-constructed assets”, where an entity builds its own inventory or NCA over
a substantial period of time.

OBJECTIVE

IAS 23 specifically mentions 3 types of borrowing costs that can be capitalized:

(a) Interest expenses (refer to the effective interest method under IFRS 9);

(b) Finance charges on finance leases under IFRS 16; and

(c) Exchange differences on borrowings in foreign currencies, but only those representing
the adjustment to interest costs.

QUALIFYING ASSET

Definition

An asset that necessarily takes a substantial period of time to get ready for its intended
use/sale.

But what is a “substantial period of time”? It was not defined in IAS 23, so here you need to
apply some judgment. Normally, if an asset takes more than 1 year to be ready, then it would
be qualifying.

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Example:
(a) Inventories
(b) Manufacturing plants
(c) Power generation facilities
(d) Intangible assets
(e) Investment properties
(f) Production of inventories that take a considerable period of time to bring to a saleable
condition.

Exclusion of qualifying assets

(a) Qualifying assets measured at FV, such as biological assets accounted for under IAS
41 Agriculture.

(b) Inventories that are manufactured, or otherwise produced, in large quantities on a

repetitive basis and that take a substantial period to get ready for sale (for example,
maturing whisky)

(c) Assets that are ready for their intended use/sale when acquired.

(d) Investments other than investment properties.

RECOGNITION

Under the revised treatment, all eligible borrowing costs must be capitalized.

Borrowing cost that directly attributable to the acquisition, construction/production of a

qualifying asset may be capitalized as part of the cost of the asset provided:

(1) It is probable that they will result in future economic benefits to the entity and

(2) The costs can be measured reliably.

Other borrowing costs are recognised as an expense.

Directly attributable to the cost

of qualifying assets? NO

YES

Probable resulting in future

economic benefits? NO

YES

Can be measure reliably? NO

YES

Capitalised Expensed

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MEASUREMENT

WA borrowing costs x
capitalisation rate

Specific borrowings

Where funds are borrowed specifically, costs eligible for capitalisation are the actual costs
incurred less any income earned on the temporary investment of such borrowings.

General borrowings

General borrowings are those funds that are obtained for various purposes and they are used
(apart from these other purposes) also for the acquisition of a qualifying asset.

In this case, you need to apply so-called capitalization rate to the borrowing funds on that
asset, calculated as the weighted average of the borrowing costs applicable to general pool.

Borrowing costs capitalized

RM
Borrowing costs incurred X
Investment income on temporary investment of those borrowing (X)
X

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Question 1

At 31/12/x9, outstanding borrowing = RM400,000.

The amount used for construction of the plant = RM300,000.

Detail of borrowing at 31/12/x9:

RM
12% loan stock 100,000
10% term loan 220,000
8% redeemable preference shares 80,000
400,000

Required:

Compute the capitalization rate & amount of interest qualifies for capitalization as at YE
31/12/x9.

Answer:

WA interest rate

Total interest

Apportionment of Interest

RM
Capitalized as plant

Charged as expense in IS

Total interest

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COMMENCEMENT, SUSPENSION AND CESSATION OF CAPITALISATION

NO
Incurred expenditure for the qualifying assets

YES

NO
Incurs borrowing costs

YES

Undertakes activities necessary to prepare the NO

qualifying asset for its intended use or sales

YES

Commencement of Do not commence

Capitalisation capitalization

Suspend capitalization for Cease capitalization when susbstantially all

extended inactive development the above necessary activities are complete

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COMMENCEMENT OF CAPITALISATION

3 events or transactions must be taking place for capitalization of borrowing costs to be

started:

(a) Expenditure for the asset is being incurred.

(b) Borrowing cost being incurred.

(c) Activities that are necessary to prepare the asset for its intended use/sale are in
progress.

Explanation:

(a) Expenditure must result in the payment of cash, transfer of other assets or
assumptions of interest-bearing liabilities.

Deductions from expenditure will be made for any progress payments or grants
received in connection with the asset.

(b) Borrowing costs incurred from the date when construction starts can be capitalized.

(c ) Activities necessary to prepare the asset for its intended sale or use include:

(1) the physical construction of the asset; and

(2) technical & administration work prior to commencement of construction (eg

obtaining permits, prepare construction plan or getting government approval)
is consider as “construction work”.

However, such activities exclude the holding of an asset when no production or

development that changes the asset’s condition is taking place.

Question 2

Bluberry Bhd. construct scientific medical equipment for its own use, at a cost of RM100
million, and considers it as a qualified asset. Borrowing costs capitalized under IAS 23
amount to RM7 million. It also receives a government grant of RM20 million on that asset.

Required:

Discuss whether the government grant received can be recognized as part of the expenditure
on a qualifying asset?

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Answer:

Yes, in accordance with IAS 23, borrowing cost is considered as an expenditures on a

qualifying asset:

(a) Include only those expenditures that have resulted in payment of cash, transfers of
other assets or the assumption of interest-bearing liabilities; and

(b) Are reduced by any progress payments received and grants received in connection
with the asset.

SUSPENSION OF CAPITALISATION

If active development is interrupted for any extended period, capitalization of borrowing

costs should be suspended for those periods.

Any entity may incur borrowing costs during an extended period in which it suspends the
activities necessary to prepare an asset for its intended use or sale. Such costs are costs of
holding partially completed assets and do not qualify for capitalization.

Situations not considered as interruption of construction:

(a) Physical activity may not be carried on though technical work is being carried on.

(b) Temporary delays which are necessary

(c) Extended period for inventory to mature

(d) Delays in construction.

Exp:

A temporary delay is a necessary part of the process of getting an asset ready for its intended
use or sale in the following cases:

(a) During the extended period needed for inventories to mature;

(b) 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 geographical
region involved.

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CESSATION OF CAPITALISATION

An entity ceases capitalizing borrowing costs when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete.

If minor modifications, such as decoration of a property to the purchase’s or user’s

specification, are all that outstanding, this indicates that substantially all the activities are
complete. Borrowing costs are not allowed to be capitalized.

Where construction is completed in stages, which can be used while construction of the other
parts continues, capitalisation 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
even though routine administrative work might still continue. Capitalisation of borrowing
costs should cease for each part as it is completed.(eg: a business park consisting of several
buildings).

Question 3

Construct a building on 1.1x1, completed on 31/12/x3.

Construction cost (exclude interest) = RM1.5m

Start Completed
3 yrs

1.1x1 31/12/x3

Loan = RM1 million

Interest rate = 10% p.a. (Repayment 5 years)

1st year deposited RM600k in FD & yielded interest of 8% p.a. (matured on 31/12/x1)

1 yr

1.1x1 31/12/x1

Building useful life = 50 years.

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Answer:

Cost of building
RM’000
Construction cost

Interest cost

Interest income from FD

SOPL (extract)

X1 X2 X3 X4
RM’000 RM’000 RM’000 RM’000
Interest expense

Dep

Question 4

Zion Bhd. (Zion) is a developer. On 1 April 2019, Zion raised mezzanine finance amounting
to RM2,500,000 to finance its capital and operating expenditure of the company. Zion
expects to utilise RM1,700,000 to finance the construction of a new bridge in Sipadan Island.
The construction commenced on 1 October 2019 and is expected to be completed by 30
September 2022.

Loan Start YE 1 YE 2 Completion

1/4/19 1/10/19 31/3/20 31/3/21 30/9/22

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Details of the mezzanine finance as at 1 April 2019, 31 March 2020 and 31 March 2021 are
as follows:

WA int rate
1 April 31 March 31 March
2019 2020 2021
RM RM RM
9% loan stock 1,250,000 1,250,000 1,000,000
10% fixed interest bank loan 750,000 600,000 500,000
8% redeemable preference shares 500,000 500,000 500,000
2,500,000 2,350,000 2,000,000

Amount of loan spend on the construction 1,500,000 1,700,000

Total construction cost incurred to date 1,880,000 2,300,000

Since Zion does not need the full amount of the loan in the first two years of the construction,
the loan was invested in money market instruments. The interest income gained from the
investment are as follows:

Investment period RM
1 July 2019 – 31 March 2020 (9 mths) 110,000

1 April 2020 – 31 March 2021 (1 yr) 45,000

The balance of the mezzanine loan will be repaid in one lump-sum on 1 December 2022. The
company’s practice is to capitalise the loan interest as part of its qualifying assets.

Required:

Compute the carrying amount of the new bridge as at 31 March 2020 and 31 March 2021.
(9 marks)
Answer:

Working
2020
WA interest rate
(1,250/2,350 x 9%) + (600/2,350 x 10%) + (500/2,350 x 8%)

= 9.04%

2021
WA interest rate

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Carrying amount of the new bridge
2020 2021
RM RM
Construction cost incurred todate

Capitalised of interest cost in office building

Interest income from investment

Question 5

Dragonfly Bhd. (Dragonfly) secured a term loan of RM27 million to part-finance the
development of three blocks of medium cost apartments at Fraser Hill. The loan carried an
interest rate of 9% per annum and was fully drawn down on 1 April 2015. The term of the
loan is three years, and Dragonfly will settle the full amount of loan cum interest cost in one-
lump sum payment on the due date.

Loan Construction Start End

1/4/15 1/10/15 1/8/16 31/10/16 31/7/17

The construction of the apartments commenced on 1 October 2015 and was completed on 31
July 2017. Costs incurred on the project (excluding interest cost) totalled RM48 million.

The construction work was stopped for 3 months from 1 August 2016 to 31 October 2016 due
to damage caused by a typhoon on 1 August 2016.

Charged out as interest cost (IS) =

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Pending to their requirements, surplus funds from the loan were invested in money market
instruments to generate interest income as follows:

Period of investment
RM'000
From 1 April 2015 to 31 October 2015 750
From 1 November 2015 to 31 December 2016 540
From 1 January 2017 to 31 October 2017 100
1,390

The financial year end of Dragonfly Bhd. is on 31 August.

Required:

(a) In accordance with IAS 23, calculate the amount of interest that shall be included in
the costs of the three-apartment project and determine the revised carrying amount of
the project upon completion on 31 July 2017. (3.5 marks)

(b) Calculate the amount of finance cost and finance income that should be reported in
the statement of profit or loss for the year ended 31 August 2017. (1.5 mark)

Answer:

(a) Carrying amount of project on completion

RM'000 RM'000
Costs incurred on project

Capitalisation of interest cost

1/10/15 - 31/7/17

Suspension of capitalization
1/8/16 - 31/10/16

Interest income
1/10/15 - 31/10/15
1/11/15 - 31/12/16
1/1/17 - 31/7/17

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 (b)
Dragonfly Bhd.
Statement of profit or loss (extract) for the year ended 31 August 2017
RM'000
Finance income

Finance cost

CARRYING AMOUNT EXCEEDS RECOVERABLE AMOUNT

CA or the expected ultimate cost of the qualifying asset exceeds its RA or net realisable value,
the CA is written down or written off in accordance with the requirements of other Standards.

Disclosure

(a) Amount of borrowing cost capitalised during the period

(b) Capitalisation rate used

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SPECIAL ISSUES

Source: https://www.ifrsbox.com/capitalize-borrowing-costs-ias-23/

Question #1: Can you capitalize interest cost in the cost of inventories?

It depends.

In most cases, inventories do not take a substantial period to get ready and in this case no,
you cannot capitalize.

But here, there are some examples of inventories that can take a substantial period to
complete:

(a) Wine, cheese or whiskey that matures in bottle or cask for a long period of time;

(b) Large items of equipment, such as aircraft, ships etc.

In this case, you can capitalize borrowing cost, but it’s up to you if you will or won’t.

While you have no choice for PPE (you have to capitalize), you have a choice for inventories:
either you capitalize, or expense in profit or loss.

Question #2: Can you capitalize foreign exchange loss on specifically borrowed money
in a foreign currency?

No, you cannot.

Yes, IAS 23 says that exchange differences on foreign currency borrowings are a borrowing
cost to the extent that they are regarded as an adjustment of interest cost.

(a) You can capitalize the difference between the interest on the foreign currency loan and
the hypothetical interest expense in your own (functional currency), because that’s
regarded as borrowing cost;

(b) You cannot capitalize the foreign exchange gain/loss on the liability (loan) itself,
because that’s NOT a borrowing cost. You need to realize here, that your loan is a
financial liability that must be subsequently measured under IAS 39/IFRS 9.

Question #3: Can you capitalize interest cost on intercompany loan for qualifying assets?

Yes, in the separate financial statements of the borrowing company.

However, be a bit careful about the consolidated financial statements, because based on the
intercompany relationship (subsidiary or associate?), the intercompany loan might be
eliminated.

Also, let me point out one more issue in relation to intercompany loans: often, they are
provided interest-free.

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Under IFRS 9, you should recognize almost all financial instruments at their fair
value (sometimes plus transaction cost) and if a subsidiary gets an interest-free loan from a
parent, it’s nominal amount is not at fair value.

Therefore, a subsidiary needs to set the fair value of the loan received using the market
interest rates and book the difference between the loan’s fair value and the cash received in
profit or loss (based on the substance of a transaction).

Then, interest expense calculated by the effective interest method is capitalized.

This might sound odd: the loan is interest-free, but you still need to capitalize some
borrowing cost on it.

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