TUTORIAL 7: Borrowing costs (IAS 23 / MFRS 123)

Question 1
(a)
The concept of qualifying assets is important for the implementation of IAS 23. IAS 23 allows
capitalization of borrowing costs for the qualifying assets.

Qualifying assets are the assets which are being built by an entity and it takes a substantial time to
build them. Assets which are ready for their intended use or sale, when they are acquired, are not
qualifying assets for the purpose of IAS 23.

(i) Inventories which are normally manufactured by an entity on a repetitive basis over a short
period of time are not qualifying assets. But the inventories which take a considerable period
of time to bring to a salable condition, like these log-handling equipment, can be regarded as
qualifying assets. IAS 23R does not mandate the capitalization of borrowing costs for
inventories that are manufactured in large quantities on a repetitive basis. Interest
capitalization is allowed as long as the production cycle takes a ‘substantial period of time’, as
with wine or cheese. The choice to capitalize borrowing costs on those inventories is an
accounting policy choice. Management discloses it when material.

(ii) The customized machine is inventory but a qualifying asset as it is manufactured over an
extended period of time.

(iii) The production facility is part of Alpha’s PPE, so is a qualifying asset.

(b) In IAS 23, borrowing costs includes interest as well as other costs incurred by an entity in
connection with the borrowing of funds. These costs must be directly attributable to the acquisition,
construction or production of a 'qualifying asset' are included in the cost of the asset. It also counts
(i) amortization of premium/discount on debt
(ii) amortization of debt issue costs
(iii) some foreign exchange differences arising from foreign currency borrowings to the extent
that they are regarded as an adjustment to interest costs

(c) Yes. The determination of the amount of borrowing costs to be capitalized in the financial
statements of the constructor are based on the net position of the contract, after taking into account
any customer payments in respect of the contract. Thus, the $50 must be deducted from the cost of
the qualifying asset.

(d) The capitalization rate is the weighted-average interest rate applicable to general borrowings
outstanding during the period. It is calculated as the weighted average general borrowing costs
divided by the total general borrowings.
Question 2

(a)
Interest rate
Principal ($) (loans were outstanding Total Interest
31/12/2022 for the whole year) $
12% Loan Stock 100,000 12% 12,000
10% Term Loan 220,000 10% 22,000
8% redeemable preference shares 80,000 8% 6,400
Total 400,000 40,400

40,400
Capitalization rate = = 10.1%
400,000

Alternative calculation of capitalization rate:

Principal ($) Weighted Interest rate (A)x()
31/12/2022 Average (A) (B) %
12% Loan Stock 100,000 25% 12% 3.0
10% Term Loan 220,000 55% 10% 5.5
8% redeemable preference shares 80,000 20% 8% 1.6
400,000 100% 10.1

Interest rate Total Interest

Principal ($) (loans were outstanding for the year
31/12/2022 for the whole year) $
12% Loan Stock 100,000 12% 12,000
10% Term Loan 220,000 10% 22,000
8% redeemable preference shares 80,000 8% 6,400
Total 400,000 40,400

(b) Interest to be capitalized RM300,000 x 10.1% 30,300

(c) Finance cost 10,100
Total interest cost 40,400
Question 3

(a) Capitalization shall commence when (IAS 23.17)

(1) expenditures for assets are being incurred
(2) borrowing costs are being incurred
(3) activities that are necessary to prepare the asset for its intended use or sale are in progress

Assume construction of the distribution center started on 30 September.

Borrowing costs capitalized = actual costs – any investment income received from the temporary
reinvestment of unutilised borrowings

Weighted
Payment/ expenditure
Date Income Weight $
30 Sep 40 3/12 10.00
2 Dec 50 1/12 4.17
Total weighted expenditures 14.17
Capitalization rate (all specific borrowing) x 10%
Borrowing costs to capitalize ($14.17 x 10%) 1.42
Less interest income on specific borrowings (0.20)
Net borrowing costs to capitalize 1.22

(b) The bank fee would need to be included in cash flows for determining the effective interest rate
(capitalization rate) used in calculating the borrowing costs to capitalize.

Question 4

(a)
Weighted
Debt Interest
Debt $ Weight $ $
8% 8-year $200 loan 200 12/12 200 16.0
10% 12-year $300 bond payable 300 12/12 300 30.0
500 46.0
Capitalization rate: $46.0 ÷ $500 = 9.20%

(b)
Weighted
expenditure
Date Payment/Income Weight $
1 Mar 120 10/12 100.0
30 Apr 150 8/12 10.0
30 Dec 130 0 0.0
Total weighted expenditures 110.0
Borrowing cost to capitalize
(9.20% x $110) $10.12