IAS 23 Question 12

QUESTION 12 – IAS 23 Borrowing Costs (ICAP C6 S07)

White Limited is engaged in the construction of small townships. It announced a new township
with a name and style of ‘Ashiyana’.

The estimated cost of the project is as under:

Land Rs. 180 million
Construction Rs. 100 million

The company planned to finance the project through shareholders’ equity, bank loans and down
payments to be received from buyers. The land required for the project was in the possession of
the company and had been acquired in 2003. The construction started on January 01, 2006 and
completed on November 30, 2006.

Details of costs incurred are as follows:

Date of Bills Particulars Rs. in million
Feb 16, 06 Documentation 2.50
Mar 16, 06 Land preparation 13.50
May 16, 06 Structure 50.00
Dec 16, 06 Finishing 38.50

All the above bills were paid on the same dates except for Rs. 15 million included in finishing cost,
which was paid in January 2007.

Funds were arranged as under:

Date Source Rs. million Finance cost
Mar 01, 06 Shareholders equity 10.00 Yield required is 30%
Mar 01, 06 Bank Loan-A 30.00 Carry markup @ 12% p.a.
Mar 01, 06 Bank Loan-B 40.00 Carry markup @ 18% p.a.
Dec 16, 06 Down payments 24.50 No financial cost

Required:
Determine the amount of borrowing cost that can be capitalized by the company under IAS 23
(Borrowing Costs). (15)

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IAS 23 Question 12

ANSWER 12 – IAS 23 Borrowing Costs (ICAP C6 S07)

Time Funds Expenditure Interest rate Period Rs.

Feb 16, 06 Equity 2,500,000 NA NA 0
Mar 16, 06 Equity 7,500,000 NA NA 0
Mar 16, 06 General 6,000,000 15.43% W1 8.5/12 655,775
May 16, 06 General 50,000,000 15.43% W1 6.5/12 4,178,958
Borrowing costs to be capitalised 4,834,733

N1 It has been assumed that the loans were general borrowings in the light of examiner comments
and the fact that question did not mention any temporary investments of material unused amount
which is assumed to be used for other business purposes.

W1
8,100,000
Capitalisation rate = X 100 = 15.43%
52,500,000

Weighted Borrowings Borrowing

Loans Principal Rate Weight
outstanding costs incurred
Rs. % Rs. Rs.
Bank Loan A 30,000,000 12% 9/12 22,500,000 2,700,000
Bank Loan B 40,000,000 18% 9/12 30,000,000 5,400,000
52,500,000 8,100,000

Examiner Comments
Most of the students could not attempt this question correctly and made many mistakes. Some of
the common mistakes were as follows:
 Shareholders equity and down payments from buyers were included in the calculation of
weighted average rate of financing.
 According to the given scenario, documentation cost of 2.5 million and a portion of the cost of
land preparation i.e. 7.5 million was financed through shareholders equity and carried no
financing costs. Most students incorrectly applied the weighted average rate of borrowing on
the above costs also.
 Capitalization of financing cost should commence from the date the payment was made or the
date on which finance was obtained, whichever was later.
 Most candidates computed the cost of borrowing from the dates the loans were obtained.
 The capitalization should have stopped, on November 30, 2006 i.e. the date of completion of
the project. Most candidates computed the same, till the end of the year i.e. December 31,
2006.

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