CHAPTER 25 -BORROWING COSTS

Under PAS 23, paragraph 5, borrowing costs are defined as interest and other costs that an entity incurs in connection
with borrowing of funds.

Paragraph 6 provides that borrowing costs specifically include:

a. Interest expense calculated using the effective interest method.

b. Finance charge with respect to a finance lease.
c. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as an adjustment
to interest cost.

QUALIFYING ASSET

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for the intended use or sale.

Examples include the following:

a. Manufacturing plant
b. Power generation facility
c. Intangible asset
d. Investment property

EXCLUDED FROM CAPITALIZATION

PAS 23 does not require capitalization of borrowing costs relating to the following:

a. Assets measured at fair value, such as biological assets.

b. Inventory manufactured or produced 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.
c. Assets that are ready for their intended use or sale when acquired.

ACCOUNTING FOR BORROWING COST

PAS 23, paragraph 8, mandates the following rules on borrowing cost:

1. If the borrowing is directly attributable to the acquisition, construction or production of a qualifying asset, the
borrowing cost is required to be capitalized as cost of the asset. In other words, the capitalization of borrowing cost is
mandatory for a qualifying asset.

The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are
borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made.

2. All other borrowing costs shall be expensed as incurred. In other words, if the borrowing is not directly attributable to
a qualifying asset, the borrowing cost is expensed immediately.

ASSET FINANCED BY SPECIFIC BORROWING

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

At the beginning of the current year, 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 cost 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 costs 250,000

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

ASSET FINANCED BY GENERAL BORROWING

PAS 23, paragraph 14, provides that if the funds are borrowed
generally and used for acquiring a qualifying asset, the amount
of capitalizable borrowing cost is equal to the average carrying
amount of the asset during the period multiplied by a
capitalization rate or average interest rate.

However, the capitalizable borrowing cost shall not exceed the

actual interest incurred.

The capitalization rate or average interest rate is equal to the

total annual borrowing cost divided by the total general
borrowings outstanding during the period.

No specific guidance is provided for general borrowing with

respect to investment income. Accordingly, any investment
income from general borrowing is not deducted from
capitalizable borrowing cost.

AVERAGE CARRYING AMOUNT OF THE BUILDING

The capitalization rate is computed by dividing the total

annual borrowing cost by the total general borrowings.

Thus, P760,000 divided by P8,000,000 equals 9.5%.

The amount of capitalizable borrowing cost is the average

carrying amount of the building multiplied by the
capitalization rate. Thus, P2,000,000 x 9.5% equals P190,000.
The capitalizable borrowing cost shall not exceed the actual
borrowing cost. The amount of capitalizable borrowing cost is
P190,000 because it is less than the actual borrowing cost of P760,000. The excess of P760,000 over P190,000 or
P570,000 is charged to interest expense.

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 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 January 1 and was completed on December 31 of the current year.
Expenditures on the construction were:
January 1 500,000
April 1 1,000,000
May 1 1,500,000
September 1 1,500,000
December 31 500,000
Total cost 5,000,000

AMOUNT OF AVERAGE EXPENDITURES

Date (a) (b) (a x b)

Expenditures Fraction Average
January 1 500,000 12/12 500,000
April 1 1,000,000 9/12 750,000
May 1 1,500,000 8/12 1,000,000
September 1 1,500,000 4/12 500,000
December 31 500,000 -- 5,000,000

CAPITALIZABLE BORROWING COSTS

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 an, 2021.

Specific construction loan 2,000,000 15%

General loan 15,000,000 12%

The entity began the self-construction of a new building January 1, 2020 and the building was completed on December
31, 2021. The following expenditures were made during 2020 and 2021:
January 1, 2020 2,000,000
July 1, 2020 4,000,000
November 1, 2020 3,000,000
July 1, 2021 1,000,000
10,000,000

More than one year but less than 2 years

Assume the same data in the preceding illustration, except that the building was completed on August 31, 2021. The
capitalizable borrowing cost for 2020 would be the same.

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 building to date – December 31, 2020 9,600,000

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.

Thus, the capitalizable borrowing cost is equal to the average expenditures on the asset multiplied by the average
interest rate.

COMMENCEMENT OF CAPITALIZATION
The capitalization of borrowing costs 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.

These include technical and administrative work prior to the commencement of physical construction, such as drawing
up plans and obtaining permit for a building.

However, merely holding assets 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 interrupts

However, capitalization of borrowing costs is not normally suspended during a period when substantial technical and
administrative work is being carried out.

Capitalization of borrowing costs is not also suspended when a 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 georgraphical 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 RELATED TO BORROWING COSTS

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