Borrowing costs

IAS 23 Borrowing Costs requires that borrowing costs directly attributable to the acquisition, construction or production of a ‘qualifying asset’ (one that necessarily takes a substantial period of time to get ready for its intended use or sale) are included in the cost of the asset. Other borrowing costs are recognised as an expense.

Scope

IAS 23 shall be applied in accounting for borrowing costs but it does not deal with the actual or imputed cost of equity, including preferred capital not classified as a liability.

The standard does not apply to borrowing costs directly attributable to acquisition, construction or production of:

  • a qualifying asset measured at fair value, e.g. a biological asset; or 
  • inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis

IAS 23 decision tree – summary

How do you determine the amount of borrowing costs to be capitalised? The purpose of the following diagram is to summarise the main requirements of the standard and to illustrate the route which preparers need to follow to determine the treatment of borrowing costs.

Borrowing costs

Definitions

Borrowing costs

Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing of funds.

Borrowing costs may include:

  • Interest on bank overdrafts and short-term and long-term borrowings (including intercompany borrowings).
  • Amortisation of discounts or premiums relating to borrowings.
  • Amortisation of ancillary costs incurred in connection with the arrangement of borrowings.
  • Finance charges in respect of finance leases.
  • Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

How do you determine the amount of borrowing costs to be capitalised?

Once the entity has determined it has both qualifying assets (that are not scoped out) and borrowing costs, the entity needs to work out how much to capitalise. In this section we look at how to determine the amount of borrowing costs to capitalise. The application of IAS 23 in this area can be difficult and often requires the use of judgement.

The basic principle is that ‘directly attributable’ borrowing costs are those costs that would have been avoided if the expenditure on the qualifying asset had not been made. To put this principle into practice, it is usually necessary to determine:

  • one or more capitalisation rates,
  • the applicable expenditures on qualifying assets to which to apply these rates, and
  • the total amount of borrowing costs in each period.

An important distinction is made between specific and general borrowings. Entities may wish to borrow funds generally rather than for specific qualifying assets. In those situations it becomes more difficult to identify a relationship between the loan and the qualifying asset. Therefore some judgement is often necessary to determine what to include in borrowing costs and how much to capitalise. This section answers common questions in this area, and also considers whether borrowing costs may include derivative gains or losses, exchange differences and other items that may be viewed as finance-related.

Qualifying asset

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

Examples include:

  • Inventories (that are not produced over a short period of time).
  • Manufacturing plants.
  • Power generation facilities.
  • Intangible assets.
  • Investment properties.

Qualifying asset – Example

Property acquired for development

A property developer acquires a property, which management intends to develop into luxury apartments. Alternatively, the property could be sold or leased immediately after its acquisition.

Should management’s intention be taken into account?

Yes. Assessing whether an asset is a qualifying asset takes into consideration its intended use. The property is determined to be a qualifying asset because management intends to develop the asset over a substantial period of time. This is not changed by the fact that the property could alternatively be sold immediately.

Recognition and measurement

Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset are capitalised.

These are costs that would have been avoided if the expenditure on the qualifying asset had not been made. Other borrowing costs are recognised as an expense in the period in which the entity incurs them. 

Specific borrowings

When an entity borrows funds specifically for a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of these borrowings.

Non-specific borrowings

However, where the borrowed funds are centrally co-ordinated or borrowed generally (e.g. use of a range of debt instruments which incur different rates of interest and lends those funds to other entities within the group), and used for a qualifying asset, the amount eligible for capitalisation shall be determined by applying a capitalisation rate to the expenditures of that asset.

The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs that an entity capitalises during a period shall not exceed the amount of borrowing costs incurred during that period. 

The amount of the borrowing costs capitalised during the period cannot exceed the amount of borrowing costs incurred during the period.

Commencement of capitalisation

Suspension of capitalisation

Cessation of capitalisation

Capitalisation of borrowing costs commences when:

  • expenditures for the qualifying asset are incurred,
  • borrowing costs are incurred, and
  • activities that are necessary to prepare the asset for its intended use or sale are undertaken.

Borrowing costs shall not be capitalised during extended periods in which an entity suspends active development of a qualifying asset.

Borrowing costs are no longer capitalised when substantially all the activities necessary to prepare the qualifying assets for its intended use or sale are complete.

When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, borrowing costs are no longer capitalised when the entity substantially completes all the activities necessary to prepare that part for its intended use or sale.

Investment property under construction measured at fair value What is capitalization of borrowing cost?

An entity develops property that will be investment property. In accordance with the amended version of IAS 40 Investment Property the entity can choose to measure the property under construction at fair value with gains and losses recognised in profit or loss. At the end of the reporting period the fair value of the property is CU 1,000. Costs incurred at the end of the reporting period amount to CU 900, including borrowing costs of CU 50.

Scenario 1: Entity does not capitalise borrowing costs What is capitalization of borrowing cost?

The entity recognises borrowing costs directly attributable to the property in profit or loss. The cost of the property excluding borrowing costs is CU 850. The entity recognises a fair value gain in the income statement of CU 150. The total effect on profit or loss is CU 100 (fair value gain of CU 150 less borrowing costs of CU 50). Borrowing costs

Scenario 2: Entity capitalises borrowing costs 

The entity capitalises borrowing costs directly attributable to the property as part of the cost of the asset. The cost of the property at the end of the period is CU 900. The entity recognises a fair value gain in profit or loss of CU 100. The total effect on profit or loss is CU 100. 

The asset is measured at CU 1,000 in both scenarios. The effect on profit or loss is CU 100 in both scenarios. If the entity elects to capitalise borrowing costs, the only effect is a reallocation between interest expense and the fair value gain.

Owner-occupied property under construction measured at fair value in accordance with the revaluation model of IAS 16

An entity constructs a property that is intended for own-use as its head office building. It chooses to measure the property at revalued amount being its fair value, in accordance with IAS 16 Property, Plant and Equipment.

At the end of the reporting period the fair value of the property is CU 1,000. Costs incurred at the end of the reporting period amount to CU 900, including borrowing costs of CU 50.

Scenario 1: Entity does not capitalise borrowing costs What is capitalization of borrowing cost?

The entity recognises borrowing costs directly attributable to the property in profit or loss. The cost of the property excluding borrowing costs is CU 850. The entity recognises a fair value gain in other comprehensive income of CU 150. The total effect is an interest expense in profit or loss of CU 50 and a fair value gain in other comprehensive income of CU 150.

Scenario 2: Entity capitalises borrowing costs What is capitalization of borrowing cost?

The entity capitalises borrowing costs directly attributable to the property as part of the cost of the asset. The cost of the property at the end of the period is CU 900. The entity recognises a fair value gain in other comprehensive income of CU 100. The borrowing cost of CU 50 is excluded from the interest expense in profit or loss.

The asset is measured at CU 1,000 in both scenarios. The accounting policy choice affects profit or loss and other comprehensive income. Total comprehensive income is unaffected.

Capitalisation of borrowing costs for inventories 

Main rule for all inventories

If the inventory is a qualifying asset, the entity is generally required to capitalise borrowing costs (IAS 23 7(a) and IAS 23 8).

Exception for certain inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis:

This is an accounting policy choice (IAS 23 4(b)). Entities can elect not to capitalise borrowing costs – but only for those inventories within the scope of the exemption.

Disclosure

IFRS

Disclosure requirements

IAS 23 26

The entity has disclosed:

  1. the amount of borrowing costs capitalised during the period; and
  2. the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation

See also: The IFRS Foundation

Borrowing costs

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