BORROWING COST

Interest and other costs that an entity incurs in connection with borrowing of funds, which includes:
1. Interest expense calculated using the effective interest method
2. Finance charge with respect to a finance lease
3. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as
an adjustment to interest cost.

Qualifying Asset – as asset that necessarily takes substantial period of time to get ready for the intended
use or sale including:
a. Manufacturing plant c. Intangible asset
b. Power generation facility d. Investment property

EXCLUDED FROM CAPITALIZATION:

1. Assets measured at fair value, such as biological assets
2. Inventory manufactured in large quantity on a repetitive basis, such as maturing whisky, even if it
takes a substantial period of time to get ready for sale
3. Assets that are ready for their intended use or sale when acquired

ACCOUNTING FOR BORROWING COST

PAS 23, par. 8 mandates the following rules:

1. If directly attributable to the acquisition, construction or production of a qualifying asset, the
borrowing cost is required to be capitalized as the cost of the asset
2. All other borrowing costs shall be expensed as incurred

I. Asset financed by specific borrowing

PAS 23, par. 12 provides that if the funds are borrowed specifically for the purpose of acquiring a
qualifying asset, the amount of capitalizable borrowing cost is actual borrowing cost incurred during the
period less any investment income from the temporary investment of these borrowings

Illustration: On Jan. 1, an entity obtained a loan of P4,000,000 at an interest rate of 10%, specifically to
finance the construction of a new building. Availments from the loan were made quarterly in equal
amounts. Total borrowing costs incurred amounted to P250,000 for the current year.

Prior to their disbursement, the proceeds of the borrowing were temporarily invested and earned interest
income of P40,000. The building was completed at the current year-end.

Actual borrowing cost P250,000

Interest income from investment of proceeds (40,000)
Capitalizable borrowing cost 210,000

II. Asset financed by general borrowing

PAS 23, par 14: amount capitalizable is equal to average carrying amount of the asset during the period
multiplied by a capitalization rate or average interest rate. However, capitalizable borrowing costs shall
not exceed the actual interest incurred.

Capitalization rate – total annual borrowing cost divided by total general borrowings outstanding during
the period
Illustration: An entity had the following borrowings on Jan. 1 of the current year. The borrowings were
made for general purposes and the proceeds were partly used to finance the construction of a new
building.
Principal Borrowing Cost
10% bank loan 3,000,000 300,000
12% short-term note 1,500,000 180,000
8% long-term loan 3,500,000 280,000
8,000,000 760,000

The construction of the building was started on Jan. 1 and was completed on Dec. 31 of the current year.
Expenditures on the building were:
Jan. 1 400,000
Mar. 31 1,000,000
June 30 1,200,000
Sept. 30 1,000,000
Dec. 31 400,000
Total Cost 4,000,000

Average carrying amount of the building:

Date Expenditures (a) Months Outstanding (b) Amount (a x b)
Jan. 1 400,000 12 4,800,000
Mar. 31 1,000,000 9 9,000,000
June 30 1,200,000 6 7,200,000
Sept. 30 1,000,000 3 3,000,000
Dec. 31 400,000 0 -
24,000,000

Average carrying amount (24,000,000 / 12) 2,000,000

Another approach
Date Expenditures (a) Fraction (b) Amount (a x b)
Jan. 1 400,000 12/12 400,000
Mar. 31 1,000,000 9/12 750,000
June 30 1,200,000 6/12 600,000
Sept. 30 1,000,000 3/12 250,000
Dec. 31 400,000 0 -
2,000,000

Capitalization rate = 760,000/ 8,000,000 = 9.5%

Capitalizable borrowing cost = 2,000,000 x 9.5% = 190,000
Interest expense = 760,000 – 190,000 = 570,000
III. Asset Financed both by specific and general borrowing
At the beginning of the current year, an entity borrowed P1,500,000 at an interest of 10%
specifically for the construction of a new building. The actual borrowing cost on this loan is P150,000. The
entity had also outstanding during the year a 5-year 8% general borrowing of P7,000,000.

The construction of the building started on Jan. 1 and was completed on Dec. 31 of the current year.
Expenditures on the construction were:
Jan. 1 500,000
Apr. 1 1,000,000
May 1 1,500,000
Sept. 1 1,500,000
Dec. 31 500,000
Total Cost 5,000,000

Amount of average expenditures

Date Expenditures (a) Fraction (b) Average (a x b)

Jan. 1 500,000 12/12 500,000
Apr. 1 1,000,000 9/12 750,000
May 1 1,500,000 8/12 1,000,000
Sept. 1 1,500,000 4/12 500,000
Dec. 31 500,000 - -
2,750,000

Capitalizable borrowing cost:

Average Expenditures 2,750,000

Specific borrowing -1,500,000
General borrowing 1,250,000

Specific borrowing (10% x 1,500,000) 150,000

General borrowing (8% x 1,250,000) 100,000
Total Capitalizable borrowing cost 250,000

Construction period more than one year

An entity had the following loans outstanding during 2020 and 2021:
Specific construction loan 2,000,000 15%
General loan 15,000,000 12%

The entity began the self-construction of a new building on Jan. 1, 20202 and the building was
completed on Dec. 31, 2020. The following expenditures were made during 2020 and 2021:

2020 Jan. 1 2,000,000

Jul. 1 4,000,000
Nov. 1 3,000,000
2021 Jul. 1 1,000,000
10,000,000
Computation for 2020: The average and capitalizable borrowing cost for 2020 are determined as follows:

Expenditures Fraction Average

Jan. 1, 2020 2,000,000 12/12 2,000,000
Jul. 1, 2020 4,000,000 6/12 2,000,000
Nov. 1, 2020 3,000,000 2/12 500,000
9,000,000 4,500,000

Average expenditures in 2020 4,500,000

Applicable to specific loan -2,000,000
Applicable to general loan 2,500,000

Actual expenditures in 2020 9,000,000

Capitalizable borrowing cost in 2020:
Specific (2,000,000 x 15%) 300,000
General (2,500,000 x 12%) 300,000
Total cost of new building as of Dec. 31, 2020 9,600,000

Computation for 2021: The average and capitalizable borrowing cost for 2021 are determined as follows:

Expenditures Fraction Average

Jan. 1, 2021 9,600,000 12/12 9,600,000
Jul. 1, 2021 1,000,000 6/12 500,000
10,600,000 10,100,000

PAS 23, par. 18, provides that the average expenditures during a period shall include the borrowing cost
previously capitalized.

Average expenditures in 2021 10,100,000

Applicable to specific loan -2,000,000
Applicable to general loan 8,100,000

Cumulative actual expenditures in 2021 10,600,000

Capitalizable borrowing cost in 2021:
Specific (2,000,000 x 15%) 300,000
General (8,100,000 x 12%) 972,000
Total cost of new building as of Dec. 31, 2021 (Completion date) 11,872,000
Specific borrowing for asset used for general purposes
If the asset is financed by specific borrowing but a portion is used for working capital purposes,
the borrowing shall be treated as a general borrowing in determining capitalizable borrowing cost, which
is the cost is equal to the average expenditures on the asset multiplied by the average rate.

Commencement of Capitalization
The capitalization of borrowing as part of the cost of a qualifying asset shall commence when the following
three conditions are present:
a. When the entity incurs expenditures for the asset.
b. When the entity incurs borrowing costs.
c. When the entity undertakes activities that are necessary to prepare the asset for the
intended use or sale

Activities necessary to prepare

The activities necessary to prepare the asset for the intended use or sale encompass more than
the physical construction of the asset. It includes technical and administrative work prior to the
commencement of construction, such as drawing up plans and obtaining permit for a building.

However, merely holding for use or development without any associated development activity
does not qualify for capitalization. For example, borrowing costs incurred while land is under development
are capitalized during the period in which development activities are being undertaken. But borrowing
costs incurred while land acquired for building purposes is held without any associated development
activity do not qualify for capitalization.

Suspension of capitalization
Capitalization of borrowing costs shall be suspended during extended periods in which active
development is interrupted.

However, capitalization of borrowing costs is not normally suspended:

a. During a period when substantial technical and administrative work is being carried out.
b. When temporary delay is a necessary part of the process of getting an asset ready for its
intended use or sale.

For example, capitalization continues during the extended period that high water levels
delay the construction of a bridge, if such high-water levels are common during the
construction period in the geographical region involved.

Cessation of capitalization
Capitalization of borrowing costs shall cease when substantially all the activities necessary to
prepare the qualifying asset for the intended use or sale are complete.

As asset is normally ready for the intended use or sale when the physical construction of the asset
is complete even though routine administrative work might still continue.
 DISCLOSURES
a. The amount of borrowing costs capitalized during the period
b. The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

Segregation of assets that are "qualifying assets" from other assets in the statement of financial
position is not required to be disclosed.