Borrowing Cost

IAS - 23
Definition
IAS 23 requires that borrowing costs associated with the acquisition, construction or
production of a qualifying asset are be capitalised as part of the cost of that asset.
Borrowing costs are defined as:
◦ “interest and other costs that an entity incurs in connection with the borrowing of funds.”

A qualifying asset is defined as:

◦ “an asset that necessarily takes a substantial period of time to get ready for its intended use or
sale.”
Standard list
The standard lists what may be included in borrowing costs.
◦ Interest on bank overdrafts and short-term and long-term borrowings
◦ Amortisation of discounts or premiums relating to borrowings
◦ Amortisation of ancillary costs incurred in connection with the arrangement of borrowings
◦ Exchange differences arising from foreign currency borrowings to the extent that they are regarded
as an adjustment to interest costs
Qualifying assets
Depending on the circumstances, any of the following may be qualifying assets.
◦ Inventories
◦ Manufacturing plants
◦ Power generation facilities
◦ Intangible assets
◦ Investment properties

Financial assets and inventories that are manufactured, or otherwise produced over a short
period of time are not qualifying assets. Assets that are ready for their intended use or sale
when purchased are not qualifying assets.
Borrowing costs eligible for
capitalisation
Those borrowing costs directly attributable to the acquisition, construction or production of
a qualifying asset must be identified. These are the borrowing costs that would have been
avoided had the expenditure on the qualifying asset not been made. This is obviously
straightforward where funds have been borrowed for the financing of one particular asset.
Difficulties arise, however, where the entity uses a range of debt instruments to finance a
wide range of assets, so that there is no direct relationship between particular borrowings
and a specific asset.
Specific and general borrowings
Where borrowings are made 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.

Where funds for the project are taken from general borrowings:
◦ The weighted average cost of general borrowings is taken.
Example
If a company had a $10million 6% loan and a $2million 8% loan, the weighted average cost
of borrowing would be:
◦ ($10m × 6%) + ($2m × 8%)/$12m = 6.33%
◦ The amount to be capitalised would be the amount spent on the asset multiplied by 6.33%.
Commencement of capitalization
Capitalisation of borrowing costs should commence when all of the following conditions are
met:
◦ expenditure for the asset is being incurred
◦ borrowing costs are being incurred
◦ activities that are necessary to prepare the asset for its intended use or sale are in progress.
Example
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.
Solution
Interest to be capitalized $000
Interest related to construction period ($10 million × 6% × 11/12) 550,000
Less: Investment Income during construction period ($2 million × 3% × 5/12) (25000)
Capitalised Amount 525,000

Statement of Profit or Loss

Finance Cost ($10 million × 6% × 1/12) (50,000)
Investment Income ($2 million × 3% × 1/12) 5000
Suspension of capitalisation
If active development is interrupted for any extended periods, capitalisation of borrowing
costs should be suspended for those periods.
Suspension of capitalisation of borrowing costs is not necessary for temporary delays or for
periods when substantial technical or administrative work is taking place.
Cessation of capitalisation
Once substantially all the activities necessary to prepare the qualifying asset for its intended
use or sale are complete, then capitalisation of borrowing costs should cease. This will
normally be when physical construction of the asset is completed, although minor
modifications may still be outstanding.
The asset may be completed in parts or stages, where each part can be used while
construction is still taking place on the other parts. Capitalisation of borrowing costs should
cease for each part as it is completed. The example given by the standard is a business park
consisting of several buildings.
Example
On 1 January 20X5, Sainsco began to construct a supermarket which had an estimated
useful life of 40 years. It purchased a leasehold interest in 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.
Solution
Total amount to be included in property, plant and equipment at 31 December 20X5:

$m
Lease 25,000
Building 9,000
Fittings 6,000
Interest capitalised (40,000 × 10% × 9/12) 3,000
43,000
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.
Example
MurphyCo commences building a new head office on 1 May 20X7. The project is anticipated
to cost $400,000 which MurphyCo believes can be financed from reserves. On 1 October
20X7 it becomes apparent that a loan is required to finance the project and $350,000 is
advanced from the Northern Bank at a rate of 4%. Half of this is invested in an interest
bearing account at a rate of 2.5% until it is required on 1 May 20X8.
Building commences throughout the year ended 31 December 20X8, although work is
forced to stop temporarily for the month of February due to inclement weather. At 31
December 20X8, it is anticipated that there are a further two months of work before the
building is complete.
What borrowing costs must be capitalised in the years ended 31 December 20X7 and 20X8?
Solution
$000
Year ended 31 December 20X7
$350,000 x 4% x 3/12 3,500
Investment income $175,000 x 2.5% x 3/12 (1,094)
Capitalised borrowing costs 2,406
Year ended 31 December 20X8
$350,000 x 4% x 11/12 12,833
Investment income $175,000 x 2.5% x 3/12* (1,094)
Capitalised borrowing costs 11,739

* Investment income relating to February is not relevant, as interest costs relating to this
month are ineligible for capitalisation.
Example
On 1 January 20X1, Hi-Rise obtained planning permission to build a new office building.
Construction commenced on 1 March 20X1. To help fund the cost of this building, a loan for
$5 million was taken out from the bank on 1 April 20X1. The interest rate on the loan was
10% per annum.
Construction of the building ceased during the month of July due to an unexpected shortage
of labour and materials.
By 31 December 20X1, the building was not complete. Costs incurred to date were $12
million (excluding interest on the loan).
Required:
Discuss the accounting treatment of the above in the financial statements of Hi-Rise for
the year ended 31 December 20X1.
Solution
The new office building is a qualifying asset because it takes a substantial period of time to
get ready for its intended use.
Hi-Rise should start capitalising borrowing costs when all of the following conditions have
been met:
◦ It incurs expenditure on the asset – 1 March 20X1.
◦ It incurs borrowing costs – 1 April 20X1.
◦ It undertakes activities necessary to prepare the asset for intended use – 1 January 20X1.

The total borrowing costs to be capitalised are $333,333 ($5m × 10% × 8/12). These will be
added to the cost of the building, giving a carrying amount of $12,333,333 as at 31
December 20X1. The building is not ready for use, so no depreciation is charged.
Disclosures
IAS 23 requires the following disclosures:
◦ the value of borrowing costs capitalised during the period
◦ the capitalisation rate.