Borrowing costs must be capitalised as part of the cost of an asset if

that asset is a qualifying asset (one which 'necessarily takes a

substantial period of time to get ready for its intended use or
sale.

Commencement of capitalisation

IAS 23 states that capitalisation of borrowing costs should commence when all
of the following conditions are met:
Cases
• expenditure for the asset is being incurred Con 1/1/2020
Loan 1/1/2020
• borrowing costs are being incurred
1/1/2020
• activities that are necessary to prepare the asset for its intended use or
sale are in progress

The rate of interest to be taken

Where funds are borrowed specifically to acquire a qualifying asset, borrowing

costs which may be capitalised are those actually incurred, less any investment
income on the temporary investment of the borrowings during the capitalisation
period

Question Grimtown took out a $10 million 6% loan on 1 January 20X1 to build a
new football stadium. Not all of the funds were immediately required so
$2 million was invested in 3% bonds until 30 June 20X1.
Construction of the stadium began on 1 February 20X1 and was
completed on 31 December 20X1.
Calculate the amount of interest to be capitalised in respect of the
football stadium as at 31 December 20X1

Answer Interest should only be capitalised from 1 February 20X1, when the
construction begins.

The total interest cost for the year is $600,000 ($10 million × 6%). Of this, 10000000
January's interest should be expensed as it was incurred before the 600000
building was underway. Therefore $550,000 (11/12) relates to the asset, 550000
with $50,000 (1/12) being shown as a finance cost in the statement of 50000
profit or loss.
 In relation to the income earned, a similar situation applies. January's
interest is earned before construction begins. Therefore this is taken as
finance income to the statement of profit or loss, with the other 5 months
relating to the asset.
Interest earned = $30,000 ($2 million × 3% × 6/12) 30000
Of this, $5,000 (1 month) is taken to the statement of profit or loss, with 5
the other $25,000 (5 months) relating to the asset. 1

The total that can be capitalised is the net interest incurred during the 525000
construction period, which will be: 50000
$550,000 – $25,000 = $525,000 5000

The statement of profit or loss will include:

Finance cost 50000 Investment 5000

Where funds for the project are taken from general borrowings the weighted
average cost of general borrowings is taken

Question If an entity had a $10 million 6% loan and a $2 million 8% loan, the
weighted average cost of borrowing would be:

(10*6%)+(2*8%) / 12 m
760/12 5000000
6.33% 6m
6.33%
The amount to be capitalised would be the amount spent on the asset 158250
multiplied by 6.33% per annum.

Cessation of capitalisation

Capitalisation of borrowing costs should cease when either:

• 'substantially all the activities necessary to prepare the qualifying asset for
its intended use or sale are complete' (IAS 23, para 21), or

• construction is suspended, e.g. due to industrial disputes.

Question On 1 January 20X5, Sainsco began to construct a supermarket which
had an estimated useful life of 40 years. It purchased the site for $25
million. The construction of the building cost $9 million and the fixtures
and fittings cost $6 million. The construction of the supermarket was
completed on 30 September 20X5 and it was brought into use on 1
January 20X6.
Sainsco borrowed $40 million on 1 January 20X5 in order to finance this
project. The loan carried interest at 10% pa. It was repaid on 30 June
20X6.
Required:
Calculate the total amount to be included at cost in property, plant and
equipment in respect of the development at 31 December 20X5

Answer Total amount to be included in property, plant and equipment at

31 December 20X5:

Site 25000
Building 9000
Fittings 6000
Interest capitalised (40,000 × 10% × 9/12) 3000
43000

Only nine months’ interest can be capitalised, because IAS 23 states that
capitalisation of borrowing costs must cease when substantially all the
activities necessary to prepare the asset for its intended use or sale are
complete.
 1/1/2020 1/2/2020
1/2/2020 1/1/2020

1/2/2020 1/2/2020

(Specific borrowing)

Total
11 Capitalizes
1 PL
 25000 Deduct frpm Capitalzatopn
5000 PL Income

Capitalizaton
Pl Dr
PL Credit

(General borrowing)
Question During the year to 30 September 20X3 Hudson built a new mining facility
to take advantage of new laws regarding on-shore gas extraction. The
construction of the facility cost $10 million, and to fund this Hudson took
out a $10 million 6% loan on 1 October 20X2, which will not be repaid
until 20X6. The 6% interest was paid on 30 September 20X3.

Construction work began on 1 October 20X2, and the work was

completed on 31 August 20X3. As not all the funds were required
immediately, Hudson invested $3 million of the loan in 4% bonds from 1
October 20X2 until 31 January 20X3. Mining commenced on 1
September 20X3 and is expected to continue for 10 years.
As a condition of being allowed to construct the facility, Hudson is
required by law to dismantle it on 1 October 20Y3. Hudson estimated that
this would cost a further $3 million.

As the equipment is extremely specialised, Hudson invested significant

resources in recruiting and training employees. Hudson spent $600,000
on this process in the year to 30 September 20X3, believing it to be
worthwhile as it anticipates that most employees will remain on the
project for the entire 10 year duration.
Hudson has a cost of capital of 6%.

Required:
Show, using extracts, the correct financial reporting treatment for the
above items in the financial statements for Hudson for the year ended
30 September 20X3.

Answer Statement of profit or loss for the year ended 30 September 20X3

Depreciation (W3) 100753

Staff recruitment and training 600000
Finance costs ($50,000 (W1) + $94,822 (W2) 144822

Statement of financial position as at 30 September 20X3

Non-current assets:
Property, plant and equipment (W3) 11989610
Non-current liabilities:
Provision ($1,580,363 + $94,822 (W2)) 1675185
Loan 1000000
(W1) Borrowing costs

The interest should be capitalised from 1 October to 1 September,

net of the income earned from the temporary investment of the
$3 million for the 4 months.

Interest payable: $10 million × 6% = $600,000 × 11/12 = $550,000

Interest income earned: $3 million × 4% = $120,000 × 4/12 = 40000

Amount to be capitalised = $550,000 – $40,000 = $510,000

Also, as the asset was completed on 1 September, the interest for

September needs to be charged to the statement of profit or loss as
an expense ($600,000 × 1/12 = $50,000).

(W2) Provision for dismantling

The $3 million should be initially discounted to present value using

Hudson’s cost of capital of 6% and capitalised. $3 million payable in
11 years' time (from October 20X2 to October 20Y3):

$3,000,000 × 1/1.06^11 = $1,580,363

The discount on the provision must also be unwound over the year.
$1,580,363 × 6% = $94,822 to be added to finance costs and to the
closing provision.

(W3) Property, plant and equipment

Construction cost 10,000,000

Borrowing costs capitalised (W1) 510,000
Present value of dismantling costs (W2) 1,580,363
Total to be capitalised 12,090,363

This should be depreciated over the useful life of 10 years. As

mining begins on 1 September, depreciation should begin from this
date.

Depreciation = $12,090,363/10 × 1/12 = $100,753

Carrying amount = $12,090,363 – $100,753 = $11,989,610
1 An entity purchased a property 15 years ago at a cost of $100,000
and have been depreciating it at a rate of 2% per annum, on the
straight line basis. The entity have had the property professionally
revalued at $500,000.
What is the revaluation surplus that will be recorded in the
financial statements in respect of this property?
A $400,000
B $500,000
C $530,000
D $430,000

3 On 1 April 20X0 Slow and Steady Co held non-current assets that

cost $312,000 and had accumulated depreciation of $66,000 at this
 date. During the year ended 31 March 20X1, Slow and Steady Co
disposed of non-current assets which had originally cost $28,000
and had a carrying amount of $11,200.

Slow and Steady Co’s policy is to charge depreciation of 40% on the

reducing balance basis, with no depreciation charged in the year of
disposal.

What is the depreciation charge to the statement of profit or

loss for the year ended 31 March 20X1?
$ _________

4 A building contractor decides to construct an office building to be

occupied by his own staff. Tangible non-current assets are initially
measured at cost.

Which TWO of the following expenses incurred by the building

contractor cannot be included as a part of the cost of the office
building?

A Interest incurred on a specific loan taken out to pay for the

construction of the new offices
B Direct building labour costs
C A proportion of the contractor’s general administration costs
D Hire of plant and machinery for use on the office building site
E Additional design work caused by initial design errors
F Delivery costs in getting the raw materials onto site

5 The purpose of depreciation is to:

A Allocate the cost less residual value on a systematic basis
over the asset’s useful economic life
B Write the asset down to its realisable value each period
C Accumulate a fund for asset replacement
D Recognise that assets lose value over time

6 An entity uses funds from its general borrowings to build a new

production facility. Details of the entity's borrowings are shown
below:
– $10 million 6% loan
– $6 million 8% loan
The entity used $12 million of these funds to construct the facility,
which was under construction for the entire year.
 How much interest should be capitalised as part of the cost of
the asset?
$ _________

7 A manufacturing entity is entitled to a grant of $3 million for creating

50 jobs and maintaining them for three years. $1.5m is received
when the jobs are created and the remaining $1.5m is receivable
after three years, provided that the 50 jobs are still in existence. The
entity creates 50 jobs at the beginning of year one and there is
reasonable assurance that this level of employment will be
maintained.
What is the deferred income balance at the end of the first
year?
$ _________

8 On 1 January 20X1, Sly received $2m from the local government on

the condition that they employ at least 100 staff each year for the
next 4 years. On this date, it was virtually certain that Sly would
meet these requirements. However, on 1 January 20X2, due to an
economic downturn and reduced consumer demand, Sly no longer
needed to employ 100 staff. The conditions of the grant required full
repayment.
What should be recorded in the financial statements?
A Reduce deferred income balance by $1,500,000
B Reduce deferred income by $1,500,000 and recognise a loss
in the financial statements of $500,000
C Reduce deferred income by $2,000,000
D Reduce deferred income by $2,000,000 and recognise a gain
in the financial statements of $500,000

9 An entity purchased an investment property on 1 January 20X3 for a

cost of $3.5m. The property had an estimated useful life of 50 years,
with no residual value, and at 31 December 20X5 had a fair value of
$4.2m. On 1 January 20X6 the property was sold for net proceeds
of $4m.
Calculate the profit or (loss) on disposal under both the cost
and fair value (FV) model.
A Cost: $0.71m FV: ($0.2m)
B Cost: $0.2m FV $0.2m
C Cost $0.5m FV ($0.2m)
D Cost $0.71m FV: $0.5m
10 10 An investment property with a useful life of 10 years was purchased
by Akorn on 1 January 20X9 for $200,000. By 31 December 20X9
the fair value of the property had risen to $300,000. Akorn measures
its investment properties under the fair value model.
What values would go through the statement of profit or loss in
the year?
A Gain: $100,000 and Depreciation $30,000
B Gain: $0 and Depreciation of $30,000
C Gain: $100,000 and Depreciation of 0
D Gain: $120,000 and Depreciation of $20,000