IAS 23 Borrowing Cost

Overview

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.
IAS 23 was reissued in March 2007 and applies to annual periods beginning on or after 1
January 2009.

Summary of IAS 23

Objective of IAS 23
The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing
costs include interest on bank overdrafts and borrowings, finance charges on finance leases and
exchange differences on foreign currency borrowings where they are regarded as an
adjustment to interest costs.

Key definitions
Borrowing cost may include: [IAS 23.6]
 interest expense calculated by the effective interest method under IAS 39,
 finance charges in respect of finance leases recognised in accordance with IAS 17
Leases, and
 exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs
This standard does not deal with the actual or imputed cost of equity, including any preferred
capital not classified as a liability pursuant to IAS 32. [IAS 23.3]
A qualifying asset is an asset that takes a substantial period of time to get ready for its intended
use or sale. [IAS 23.5] That could be property, plant, and equipment and investment property
during the construction period, intangible assets during the development period, or "made-to-
order" inventories. [IAS 23.6]
Scope of IAS 23
Two types of assets that would otherwise be qualifying assets are excluded from the scope of
IAS 23:

 qualifying assets measured at fair value, such as biological assets accounted for under
IAS 41 Agriculture
 inventories that are manufactured, or otherwise produced, in large quantities on a
repetitive basis and that take a substantial period to get ready for sale (for example,
maturing whisky)

Accounting treatment
Recognition
Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset form part of the cost of that asset and, therefore, should be capitalised. Other
borrowing costs are recognised as an expense. [IAS 23.8]
Measurement
Where funds are borrowed specifically, costs eligible for capitalisation are the actual costs
incurred less any income earned on the temporary investment of such borrowings. [IAS 23.12]
Where funds are part of a general pool, the eligible amount is determined by applying a
capitalisation rate to the expenditure on that asset. The capitalisation rate will be the weighted
average of the borrowing costs applicable to the general pool. [IAS 23.14]

Capitalisation should commence when expenditures are being incurred, borrowing costs are
being incurred and activities that are necessary to prepare the asset for its intended use or sale
are in progress (may include some activities prior to commencement of physical production).
[IAS 23.17-18] Capitalisation should be suspended during periods in which active development
is interrupted. [IAS 23.20] Capitalisation should cease when substantially all of the activities
necessary to prepare the asset for its intended use or sale are complete. [IAS 23.22] If only
minor modifications are outstanding, this indicates that substantially all of the activities are
complete. [IAS 23.23]

Where construction is completed in stages, which can be used while construction of the other
parts continues, capitalisation of attributable borrowing costs should cease when substantially
all of the activities necessary to prepare that part for its intended use or sale are complete. [IAS
23.24]

Disclosure [IAS 23.26]

 amount of borrowing cost capitalised during the period
 capitalisation rate used

Specific Borrowing:
Illustration 1
Wasif & Co. commenced the construction of an item of Property, Plant and Equipment on 1 st March
2015 and funded it with a Rs. 10 M Bank Loan. The rate of interest of borrowing was 12%. Due to strike
no construction took place between 1st October and 1st November.

Required: Calculate the amount on interest to be capitalized as part of Non-Current Assets.

Solution:
Bank Loan = Rs. 1,00,00,000
Interest Rate = 12 %
Amount of Interest to be Capitalized= 1,00,00,000 x 12/100 x 9/12 = Rs. 900,000

Illustration 2
On 1st May 20X1, Mubashar Ltd. took a loan of Rs. 10,00,000 from a bank at the annual interest rate of
5%. The purpose of this loan was to finance a construction of a production hall.
The construction started on 1 June 20X1. Mubashar Ltd. temporarily invested Rs. 800, 000 borrowed
money during the months of June and July 20X1 at the rate of 2% p.a.

Required: What borrowing cost can be capitalized in 20X1? (Assume all interest was paid).

Solution:

Although the funds were withdrawn on 1st May, the capitalization can start only on 1st June 20X1 when
all criteria were met (the construction had not started until 1st June).
Calculation:
Interest expense: Rs. 10,00,000 x 5% x 7/12 = Rs. 29 167
Less investment income: Rs. 800, 000 x 2% x 2/12 = Rs. 2 667
Total borrowing cost to capitalize in 20X1: Rs. 26 500

Note: the borrowing cost in May 20X1 is expensed in profit or loss, as the capitalization criteria were not
met in that period.

General Borrowing:

Illustration 3

Farooq & co. had the following bank loans in issue during 2015.
4% Bank Loan Rs. 25 M
3% Bank Loan Rs. 40 M
Farooq commenced the construction of an item of plant, property and equipment on 1 st January 2015
for which it used its existing borrowing Rs. 10 M of expenditures was used in 1 st January and Rs. 15 M
was used in 1st July.

Required: Calculate the amount on interest to be capitalized as part of Non-Current Assets.

Solution:
Calculation of weighted average Rate/ Capitalization Rate:
Amount of Loan Interest Rate Amount of Interest
25,00,000 4% 100,000
40,00,000 3% 120,000
65,00,000 220,000
Weighted Average:
= Amount of Interest/ Amount of Loan x 100
= 220,000/65,00,000 x 100= 3.385%
Amount of Interest to be Capitalized=
= Rs. 10,00,000 x 3.385 = Rs. 3,38,500
= Rs. 15,00,000 x 3.385 x 6/12 = Rs. 2,53,875
Total amount of interest = Rs. 592,375

Illustration 4

KLM had the following loans in place at the beginning and end of 20X1:
Description 1 January 20X1 31 December 20X1
Bank loan, 6% p.a. 0 200 000
Bank loan, 8% p.a. 130 000 130 000
Debenture stock, 5.5% p.a. 50 000 50 000

The bank loan at 6% p.a. was taken in July 20X1 to finance the construction of a new production hall
(construction began on 1 March 20X1).
The bank loan at 8% p.a. and debenture stock were taken for no specific purpose and KLM used them to
finance general spending and the construction of a new machinery.
KLM used Rs. 60 000 for the construction of the machinery on 1 February 20X1 and Rs. 25 000 on 1
September 20X1.
Required: What borrowing cost should be capitalized for the new machinery?
Answer:

You ignore bank loan at 6% p.a., because it is a specific borrowing for another asset.
Only general borrowings relate to the financing of the new machinery and therefore, we need to
calculate the capitalization rate:
Calculation of weighted average Rate/ Capitalization Rate:
Amount of Loan Interest Rate Amount of Interest
130,000 8% 10,400
50,000 5.5% 2750
180,000 13,150
Weighted Average Rate:
= Amount of Interest/ Amount of Loan x 100
= 13,150/180,000 x 100= 7.306%
Amount of Interest to be Capitalized=
= Rs. 60,000 x 7.306% x 11/12= Rs. 4,018.3
= Rs. 25,000 x 7.306% x 4/12 = Rs. 586.33
Total amount of interest = Rs. 4604,63

Practice Questions

Question # 1
Suppose a company has obtained following general borrowings:
16% - 4 Years loan Rs. 500,000
14% - 6 Years loan Rs. 1000,000
10% - 8 Years loan Rs. 1200,000

Required: Calculate Capitalized rate.

Question # 2
The statement of financial position of a company at year ended 31 st December 2000 reflects the
following status:
Amount (Rs.)
Plant under installation 2000,000
Other assets 8000,000
10,000,000
Loans
Bank Loan 18% 2,000,000
Bank Loan 20% 2,500,000
Bank Loan 22% 1,500,000
6,000,000
Shareholder’s Equity 4,000,000
10,000,000

Bank loan of 20% was taken on April 1, 2000. Other loans were brought forward from 1999.
Expenditures incurred on plant under installation:
May 01, 2000 1,000,000
July 01, 2000 700,000
November 01, 2000 300,000
2,000,000

Required: Calculate borrowing cost and total capitalized cost of asset at 2000.

Question # 3
On 1-1-2006 Stream co. borrowed Rs.1.5 million to finance the production of two assets, both of which
were expected to take a year to build. Work started during 2006. The loan facility was drawn down and
incurred on 1-1-2006, and was utilized as follows.
Asset A (Rs.) Asset B (Rs.)
1-1-2006 250,000 500,000
1-7-2006 250,000 500,000
The loan rate was 9% and Steam co. can invest surplus fund at 7%.

Required: (a). Calculate borrowing cost, which may be capitalized for each asset 31-12-2006
(b).Total cost of each asset at 31-12- 2006.

Question # 4
An entity borrowed Rs. 5 million to fund the construction of a new building. Interest is payable on the
loan at 8%. Stage payments were due throughout the construction period and therefore excess funds
were reinvested during that period. By the end of the project investment income of Rs.150,000 had
been earned and the construction took twelve months to complete.

Required: Calculate the borrowing costs that can be capitalised and the total cost of the building.

Question # 5
Acruni Co. had following loans in place at the beginning and end of 2006.
1-1-2006 31-12-2006
10% Bank loan repayable in 2008 120,000 120,000
9.5% Bank loan repayable in 2009 80,000 80,000
8.9% debentures repayable in 2007 ---- 150,000
The 8.9% debenture was issued to fund the construction of qualifying asset a piece of mining
equipment, construction of which began on 1-7-2006.
On 1-1-2006, Acruni Co, began construction of a qualifying asset, a piece of machinery for hydroelectric
plant, using existing borrowings. Expenditure drawn down for the construction was: Rs.30 Millions on 1-
1-2006 and Rs.20 Millions on 1-10-2006.
Required:
a) Calculate borrowing cost can be capitalized for the piece of mining equipment
b) Calculate borrowing cost can be capitalized for hydroelectric plant.

Question # 6
The management of Power Limited decided to establish power facilities of its own. The period of
completion of facilities was estimated to be two years. For this purpose, a bank agreed to finance the
project and initially disbursed Rs.25 million on July 01, 2001. The total finance to be provided by the
bank carried interest @ 18% per annum. The bank agreed to disburse the balance of funds as and when
the cost was to be incurred.
The management of the company revised its plan and changed location of power generation facilities
that delayed the commencement of work by 3 months. The work finally started on 1-10-2001.
In the absence of other good investment opportunity, the management decided to temporarily utilize
Rs.25 million to reduce existing overdraft obtained to meet working capital requirement on which
company paid interest @ 20% per annum. Funds were borrowed and used as follows.

Date RS. Millions

October 01, 2001 35
January 01, 2002 25
May 01, 2002 10
Rs.35 million include initial disbursement made by the bank.
The work on the facilities was stopped from February 01, 2002 to April 30, 2002 due to company’s
internal problems.

Required: Compute the cost of power generation facilities as at June 30, 2002.

Question # 7
PEL limited wants to construct a plant, which will cost Rs.110 Million. BOD decided to utilize the
available funds for the construction of the plant. Company has the following loans taken, four years
before from different banks at different rates.
Banks Name Amount in Rs Rate
HBL 80 Million 8.5%
UBL 60 Million 9.7%
MCB 40 Million 13.2%
Construction of the plant was started on 1 st Oct 2006 and funds were used by the company as follows,
Date Amount in Rs
1.10.2006 45 Million
1.05.2007 30 Million
1.11.2007 35 Million
Construction was completed on 31st March 2008.
Required:
a) Calculate borrowing cost to be capitalized
b) Total cost of Plant.

Question # 8

Umar Construction has three sources of borrowings:

Average Loan                             Interest Expenses

7 Years Loan                                                          Rs.  8,000,000                 Rs.  800,000
10 Years Loan                                                        10,000,000                        900,000
Bank Overdraft                                                       10,000,000                        900,000

The 7-year loan has been specifically raised to fund the building of a qualifying asset.

The company has incurred the following expenditure on a project funded from general borrowings for
the year 31st December 2014:

Date Incurred                                                    Amount

31st March                                                        Rs. 1,000,000
31st July                                                            1,200,000
30th October                                                         800,000
                
Required: Determine the weighted average and the amount that will be capitalized.