BORROWING COSTS

PAS 23
BORROWING COSTS
• PAS 23, paragraph 5,
• borrowing costs are defined as “interest and other costs
that an entity incurs in connection with borrowing of
funds”.
• encompasses interest on all types of borrowing including finance
leases and ancillary costs incurred in connection with the
arrangement of borrowing.
 
BORROWING COSTS
• Par 6; 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
• an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale.
• Examples:
1. Manufacturing plant
2. Power generation facility
3. Intangible asset
4. Investment property
Excluded from capitalization
• PAS 23 does not require capitalization of borrowing costs relating to
the following:
1. Assets measured at fair value, such as biological assets.
2. Inventories manufactured or produced in large quantity on a
repetitive basis, such as maturing whisky, even if they take 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, 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.
2. All other borrowing costs shall be expensed as incurred.
Accounting for Borrowing Cost
• 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.
 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
• On January 1 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 its new building. Availments from the loan were
made quarterly in equal amounts. QUALIFYING ASSET
• 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 on December 31 of the current year.
Actual borrowing cost 250,000
Interest income from investment ( 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 capitalizable rate or
average interest rate.
• However, the capitalizable borrowing cost shall not exceed
the actual interest incurred.
 Asset financed by “general
borrowing”
• The capitalization rate or average interest rate is equal to the
total annual borrowing costs divided by the total general
borrowings outstanding during the period.
• No specific guidance is provided for general borrowing with
respect to investment income.
• any investment income from general borrowing is not
deducted from capitalizable borrowing cost.
 Illustration
• An entity had the following borrowings on January 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 note 3,500,000 280,000
8,000,000 760,000
Capitalizable BORROWING COST
= Average Carrying Amount (Borrowings) X Capitalization Rate
CAPITALIZATION Total Borrowing Cost 760,000
RATE
= Total General Borrowings 8,000,000 9.5 %
 AVERAGE CARRYING AMOUNT OF THE BUILDING
The construction of the DATE Expenditures Months Outstanding AMOUNT
building was started on Jan 1 Jan 1 400,000 12 4,800,000
and was completed on Dec 31 Mar 31 1,000,000 9 9,000,000
of the current year. Jun 30 1,200,000 6 7,200,000
Sept 30 1,000,000 3 3,000,000
Expenditures on the building Dec 31 400,000 0 0
were made as follows: 24,000,000
Jan 1 400,000 Average Carrying Amount 2,000,000
Mar 31 1,000,000 Another Approach (24,000,000/12)
June 30 1,200,000 DATE Expenditures Fraction AVERAGE
Jan 1 400,000 12/12 400,000
Sept 30 1,000,000 Mar 31 1,000,000 9/12 750,000
Dec 31 400,000 Jun 30 1,200,000 6/12 600,000
Sept 30 1,000,000 3/12 250,000
TOTAL COST 4,000,000 Dec 31 400,000 0 0
Average Carrying Amount 2,000,000
 CAPITALIZABLE BORROWING COST
AVERAGE CARRYING AMOUNT 2,000,000
Multiply by CAPITALIZATION RATE 9.5 %
Capitalizable BORROWING COST 190,000
The capitalizable borrowing cost shall JOURNAL ENTRY
not exceed the actual borrowing cost. Building 190,000
The amount of capitalizable borrowing Interest Expense 570,000
cost is P190,000 because it is less Cash / Interest Payable 760,000
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 The construction of the building
entity borrowed P1,500,000 at an was started on Jan 1 and was
interest of 10% specifically for the completed on Dec 31 of the
construction of a new building. The current year. Expenditures on
actual borrowing cost on this loan is the building were made as
P150,000.
follows:
• The entity had also outstanding during
the year a 5-year 8% general borrowing Jan 1 500,000
of P7,000,000. Apr 11,000,000
May 1 1,500,000
Sept 1 1,500,000
Dec 31 500,000
TOTAL COST 5,000,000
 Asset financed both by specific and general
DATE borrowing
Expenditures Fraction AVERAGE
Jan 1 500,000 12/12 500,000
Ápr 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 0 0
Average Carrying Amount 2,750,000
Capitalizable BORROWING COST
AVERAGE CARRYING AMOUNT 2,750,000
JOURNAL ENTRY
Less: Specific Borrowing 1,500,000 Building 150,000
General Borrowing 1,250,000 Cash 150,000

Specific Borrowing (1,500,000 * 10%) 150,000 Building 100,000

General Borrowing (1,250,000 * 8%) 100,000
Interest Expense 460,000
Total Capitalizable Borrowing Cost 250,000 Cash 560,000
 CONSTRUCTION PERIOD MORE THAN 1
YEAR
• An entity had the following loans outstanding during 2019 & 2020
Specific construction loan 2,000,000 15% 300,000
General loan 15,000,000 12% 1,800,000 CAPITALIZABLE
BORROWING
Total annual borrowing cost 2,100,000 COST ??
• The entity began the self-construction of a new building on January 1, 2019
and the building was completed on December 31, 2020.
Total Expenditures – 2019 9,000,000
• The following expenditures were made
during 2019 and 2020 . Average expenditures 2019
Jan 1, 2019 2,000,000 12/12 2,000,000
Jul 1, 2019 4,000,000 6/12 2,000,000
Nov 1, 2019 3,000,000 2/12 500,000
Jul 1, 2020 1,000,000 4,500,000
10,000,000
Average expenditures 2019 4,500,000 JOURNAL ENTRY –
Applicable to specific loan 2,000,000 Borrowing Cost
Applicable to general loan 2,500,000 Building 300,000
Interest Payable 300,000
To capitalized borrowing cost
Actual expenditures 2019 9,000,000
ADD: Capitalizable borrowing cost
Building 300,000
Specific (2,000,000 * 15%) 300,000 Interest Expense 1,500,000
General (2,500,000 * 12%) 300,000
1,800,000 Interest Payable 1,800,000
Total Cost of new building 9,600,000 To record accrued interest and
to date – Dec 31, 2019 capitalized borrowing cost
 DATE Expenditures Fraction AVERAGE
COMPUTATION
Jan 1 9,600,000 9,600,000
2020 12/12
Jul 1 1,000,000 6/12 500,000
10,600,000 10,100,000
PAS 23, par 18,
provides that the Average expenditures 2020 10,100,000
average expenditures Less: Applicable to specific loan 2,000,000
during a period shall Applicable to general loan 8,100,000
include the
borrowing cost Actual expenditures 2019 10,600,000
previously ADD: Capitalizable borrowing cost
capitalized. Specific (2,000,000 * 15%) 300,000
General (8,100,000 * 12%) 972,000
Total Cost of new building Dec 31, 2020 11,872,000
If the DATE Expenditures Fraction AVERAGE
building was Jan 1 9,600,000 8/8 9,600,000
completed Jul 1 1,000,000 2/8 250,000
on August 9,850,000
10,600,000
31, 2020
NOTE that the
construction period
Average expenditures 2020 9,850,000
in 2020 is only 8
months because the Less: Applicable to specific loan 2,000,000
building was Applicable to general loan 7,850,000
completed on
August 31, 2020. Actual expenditures 2019 10,600,000
ADD: Capitalizable borrowing cost
Specific (2,000,000 * 15% * 8/12) 200,000
General (7,850,000 * 12% * 8/12) 628,000
Total Cost of new building – Aug 31, 2020 11,428,000
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:
1. When the entity incurs expenditures for the asset.
2. When the entity incurs borrowing costs.
3. When the entity undertakes activities that are necessary to
prepare the asset for the intended use or sale.
“Activities” necessary to
prepare
• encompass more than the physical construction of the
asset
• include technical and administrative work prior to the
commencement of physical construction, such as drawing
up plans and obtaining permit for a building.
• borrowing costs incurred while land is under
development are capitalized during the period in when
development activities are being undertaken.
“Activities” necessary to
prepare
• Merely holding assets for use or development without any
associated development activity does not quality for
capitalization.
• 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
during a period when substantial technical and administrative work
is being carried out.
Suspension of Capitalization
• 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 for 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 its
intended use for sale are complete.
• An asset is normally ready for its 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.
DEMO PROBLEMS
CLASS ACTIVITIES
Try to answer them so can easily be followed during the
discussion and demonstration.
 PROBLEM 27-2 GENERAL BORROWINGS Principal Interest
• On January 1, 2019, Shangrila Company borrowed 10% Bank Loan 3,000,000 300,000
P2,000,000 at an interest rate of 12% specifically 12% Long Term Loan 5,000,000 600,000
for the construction of a new building. 8,000,000 900,000
TOTAL
• The actual interest cost on this specific borrowing
was P240,000 but interest of P100,000 was CAPITALIZATION RATE 11.25 %
earned from the temporary investment of the AVERAGE CARRYING AMOUNT
borrowing proceeds. Jan 1 2,000,000
Actual Borrowing Cost - Specific 230,000 Jun 30 750,000 X
• The construction began on January 1, 2019 and Dec 31 750,000
was completed on December 31, 2019.
EXACTLY 1 YEAR 3,500,000
SPECIFIC BORROWING 2,000,000 1,500,000
• Expenditures on the building were P2,000,000 on
January 1, P1,000,000 on March 31 and Capitalizable Borrowing Cost - General 168,750
P3,000,000 on September 31. Capitalizable Borrowing Cost - Specific 230,000
COST OF 6,000,000
CONSTRUCTION COST OF CONSTRUCTION 6,000,000

• Compute the cost of the building. 

COST OF BUILDING 6,398,750
 PROBLEM 27-1 GENERAL BORROWINGS Principal Interest
• Sulo Company had the following 12% Bank Loan 3,000,000 360,000
borrowings during 2019. The
borrowings were made for general 14% Long Term Loan 5,000,000 700,000
purposes but the proceeds were used to 8,000,000 1,060,000
TOTAL
finance the construction of a new
building. CAPITALIZATION RATE 13.25 %
• The construction began on January 1, AVERAGE CARRYING AMOUNT
2019 and was completed on December
EXACTLY 1 YEAR Jan 1 2,000,000 X
31, 2019. Jun 30 1,000,000
• Expenditures on the building were Dec 31 0 3,000,000
P2,000,000 on January 1, P2,000,000 on
June 30 and P1,000,000 on December CAPITALIZABLE BORROWING COST 397,500
31. COST OF COST OF CONSTRUCTION 5,000,000
5,000,000
CONSTRUCTION 5,397,500
COST OF BUILDING

• Compute the cost of the building. 

On January 1, 2019, Gemini Company contracted with a PROBLEM 27-5
contractor to construct a building for P20,000,000.
Jan 1 2,000,0002,000,000
Gemini is required to make five payments in 2019 with the Mar 31 3,000,0004,000,000
last payment scheduled on the date of completion. The Jun 30
building was completed on December 31, 2019. The entity 3,050,0006,100,000
made the following payments for 2019:  Sep 30 1,100,0004,400,000
R#1 Dec 31 0 3,500,000
The entity had the following debt outstanding
AVERAGE EXPENDITURES 9,150,000 20,000,000
on December 31, 2019: Capitalizable Borrowing Cost INTEREST = Borrowing CostR#2 1,138,750
Capitalizable
• 12% 4-year note dated January 1, 2019, with interest 8,500,000
compounded quarterly, both principal and interest due * 0.1255 8,500,000 1,066,750
on December 31, 2020, relating specifically to the GENERAL 650,000 +
building project. * 11.0769 % 72,000
• The future value of 1 at 3% for 4 periods is 1.1255.
COST OF BUILDING R#3 21,138,750
FUTURE AMOUNT = 8,500,000 * 1.1255 9,566,750
• 10% 10-year note dated December 31, 2018 with INTEREST EXPENSE R#4 1,440,000
simple interest and interest payable annually on – 72,000
December 31 600,000 6,000,000
1,368,000
• 12% 5-year note dated December 31, 2017 with simple
interest and interest payable annually on December 31
840,000 7,000,000
CAPITALIZATION RATE 1,440,000 / 13,000,000 11.0769 %
END