7.

224 FINANCIAL REPORTING

2. Qualifying asset: Qualifying asset is an asset that necessarily takes a substantial period of
time to get ready for its intended use or sale. Examples of qualifying assets are manufacturing
plants, real estate and infrastructure assets such as bridges and railways etc.
Ind AS 23 does not provide any guidance on what constitutes a 'substantial period of time'. The
specific facts and circumstances should be considered in each case. For example, it is likely
that a period of twelve months or more might be considered 'substantial'.
Depending on the circumstances, any of the following may be qualifying assets:
(a) inventories
(b) manufacturing plants
(c) power generation facilities
(d) intangible assets
(e) investment properties
(f) bearer plants.
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 acquired are not qualifying assets.

Excludes
• Inventories produced
Includes in large quantities on
repititive basis
• Inventories • Assets ready for
Qualifying asset • Manufacturing plant intended use or sale
• Power generation when acquired
• Takes substantial
facilities • Financial assets
period of time to get
ready for its intended • Intangible assets
use or sale. • Bearer plants

Illustration 1
A company deals in production of dairy products. It prepares and sells various milk products like
ghee, butter and cheese. The company borrowed funds from bank for manufacturing operation. The
cheese takes substantial longer period to get ready for sale.
State whether borrowing costs incurred to finance the production of inventories (cheese) that have a
long production period, be capitalised?

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 INDIAN ACCOUNTING STANDARD 23 7.225

Solution

Ind AS 23 does not require the capitalisation of borrowing costs for inventories that are manufactured
in large quantities on a repetitive basis. However, interest capitalisation is permitted as long as the
production cycle takes a ‘substantial period of time’, as with cheese.
*****
Illustration 2
A company is in the process of developing computer software. The asset has been qualified for
recognition purposes. However, the development of computer software will take substantial period
of time to complete.
(i) Can computer software be termed as a ‘qualifying asset’ under Ind AS 23?
(ii) Is management intention considered when assessing whether an asset is a qualifying asset?
Solution
(i) Yes. An intangible asset that takes a substantial period of time to get ready for its intended use
or sale is a ‘qualifying asset’. This would be the case for an internally generated computer
software in the development phase when it takes a ‘substantial period of time’ to complete.
(ii) Yes. Management should assess whether an asset, at the date of acquisition, is ‘ready for its
intended use or sale’. The asset might be a qualifying asset, depending on how management
intends to use it. For example, when an acquired asset can only be used in combination with a
larger group of fixed assets or was acquired specifically for the construction of one specific
qualifying asset, the assessment of whether the acquired asset is a qualifying asset is made
on a combined basis.
*****
Illustration 3
A telecom company has acquired a 3G license. The licence could be sold or licensed to a third party.
However, management intends to use it to operate a wireless network. Development of the network
starts when the license is acquired.
Should borrowing costs on the acquisition of the 3G license be capitalised until the network is ready
for its intended use?
Solution
Yes. The license has been exclusively acquired to operate the wireless network. The fact that the
license can be used or licensed to a third party is irrelevant. The acquisition of the license is the first
step in a wider investment project (developing the network). It is part of the network investment,
which meets the definition of a qualifying asset under Ind AS 23.
*****

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 7.226 FINANCIAL REPORTING

Illustration 4

A real estate company has incurred expenses for the acquisition of a permit allowing the construction
of a building. It has also acquired equipment that will be used for the construction of various
buildings.
Can borrowing costs on the acquisition of the permit and the equipment be capitalised until the
construction of the building is complete?
Solution
With respect to Permit
Yes, since permit is specific to one building. It is the first step in a wider investment project. It is
part of the construction cost of the building, which meets the definition of a qualifying asset.
With respect to Equipment
No, since the equipment will be used for other construction projects. It is ready for its ‘intended use’
at the acquisition date. Hence, it does not meet the definition of a qualifying asset.
*****

4.4 EXCHANGE DIFFERENCE TO BE INCLUDED IN

BORROWING COSTS
The extent to which exchange differences can be considered as borrowing cost depends on the
terms and conditions of the foreign currency borrowing.
The gains and losses that are an adjustment to interest costs include the interest rate differential
between borrowing costs that would be incurred if the entity borrowed funds in its functional currency
and borrowing costs actually incurred on foreign currency borrowings. An entity may borrow funds
in a currency that is not its functional currency e.g. A Company with INR functional currency may
take US dollar loan for financing asset development project in a company.
This may have been done on the basis that, over the period of the development of asset, the
borrowing costs, even after allowing for exchange differences, were expected to be less than the
interest cost of an equivalent INR loan.
Following approach is to be followed for determining the extent to which the exchange difference
should be treated as borrowing costs:
(i) the adjustment should be of an amount which is equivalent to the extent to which the exchange
loss does not exceed the difference between the cost of borrowing in functional currency when
compared to the cost of borrowing in a foreign currency.

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 INDIAN ACCOUNTING STANDARD 23 7.231

Cost of the asset:

Expenditure incurred 10,00,000 20,00,000
Borrowing Costs 72,500 1,45,000
Total 10,72,500 21,45,000

*****
4.5.1.2 General borrowing costs
 All borrowings that are not specific represents general borrowings.
 When funds are borrowed specifically for a qualifying asset, costs in relation to that borrowing are
accounted for as specific borrowing costs until the asset is ready for its intended use or sale; if the
borrowing remains outstanding after the related asset is ready for its intended use or sale, it
becomes part of 'general borrowings'.
Illustration 7
On 1st April, 20X1, A Ltd. took a 8% loan of ` 50,00,000 for construction of building A which is
repayable after 6 years ie on 31st March 20X7. The construction of building was completed on
31st March 20X3. A Ltd. started constructing a new building B in the year 20X3-20X4, for which
he used his existing borrowings. He has outstanding general purpose loan of ` 25,00,000, interest
on which is payable @ 9% and ` 15,00,000, interest on which is payable @ 7%.
Is the specific borrowing transferred to the general borrowings pool once the respective qualifying
asset is completed? Why
Solution
Yes. If specific borrowings were not repaid once the relevant qualifying asset was completed, they
become general borrowings for as long as they are outstanding.
The borrowing costs that are directly attributable to obtaining qualifying assets are those
borrowing costs that would have been avoided if the expenditure on the qualifying asset had not
been made. If cash was not spent on other qualifying assets, it could be directed to repay this
specific loan. Thus, borrowing costs could be avoided (that is, they are directly attributable to
other qualifying assets).
 When general borrowings are used for qualifying assets, Ind AS 23 requires that, borrowing
costs eligible for capitalisation is calculated by applying a capitalisation rate to the
expenditures on qualifying assets.
 The amount of borrowing costs eligible for capitalisation is always limited to the amount of
actual borrowing costs incurred during the period.

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 INDIAN ACCOUNTING STANDARD 23 7.241

TEST YOUR KNOWLEDGE

Questions
1. Marine Transport Limited ordered 3 ships for its fleet on 1st April, 20X0. It pays a down payment
of 25% of the contract value of each of the ship out of long term borrowings from a scheduled
bank. The delivery has to commence from the financial year 20X7. On 1st March, 20X2, the
ship builder informs that it has commenced production of one ship. There is no progress on
other 2 ships. Marine Transport Limited prepares its financial statements on financial year
basis.
Is it permissible for Marine Transport Limited to capitalise any borrowing costs for the financial
year ended 31st March, 20X1 or 31st March, 20X2.
2. X Limited has a treasury department that arranges funds for all the requirements of the
Company including funds for working capital and expansion programs. During the year ended
31st March, 20X2, the Company commenced the construction of a qualifying asset and incurred
the following expenses:
Date Amount (`)
1st July, 20X1 2,50,000
1st December, 20X1 3,00,000
The details of borrowings and interest thereon are as under:

Particulars Average Balance (`) Interest (`)

Long term loan @ 10% 10,00,000 1,00,000
Working capital loan 5,00,000 65,000
15,00,000 1,65,000

Compute the borrowing costs that need to be capitalised.

3. An entity constructs a new head office building commencing on 1st September 20X1, which
continues till 31st December 20X1. Directly attributable expenditure at the beginning of the
month on this asset are ` 100,000 in September 20X1 and ` 250,000 in each of the months of
October to December 20X1.
The entity has not taken any specific borrowings to finance the construction of the asset but
has incurred finance costs on its general borrowings during the construction period. During the
year, the entity had issued 10% debentures with a face value of ` 20 lacs and had an overdraft
of ` 500,000, which increased to ` 750,000 in December 20X1. Interest was paid on the
overdraft at 15% until 1 October 20X1, then the rate was increased to 16%.
Calculate the capitalization rate for computation of borrowing cost in accordance with
Ind AS 23 ‘Borrowing Costs’.

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 7.242 FINANCIAL REPORTING

4. K Ltd. began construction of a new building at an estimated cost of ` 7 lakh on 1st April, 20X1.
To finance construction of the building it obtained a specific loan of ` 2 lakh from a financial
institution at an interest rate of 9% per annum.
The company’s other outstanding loans were:
Amount Rate of Interest per annum
` 7,00,000 12%
` 9,00,000 11%

The expenditure incurred on the construction was:

April, 20X1 ` 1,50,000
August, 20X1 ` 2,00,000
October, 20X1 ` 3,50,000
January, 20X2 ` 1,00,000

The construction of building was completed by 31st January, 20X2. Following the provisions of
Ind AS 23 ‘Borrowing Costs’, calculate the amount of interest to be capitalized and pass
necessary journal entry for capitalizing the cost and borrowing cost in respect of the building
as on 31st January, 20X2.
5. On 1st April, 20X1, entity A contracted for the construction of a building for ` 22,00,000. The
land under the building is regarded as a separate asset and is not part of the qualifying assets.
The building was completed at the end of March, 20X2, and during the period the following
payments were made to the contractor:
Payment date Amount (` ’000)
1st April, 20X1 200
30th June, 20X1 600
31st December, 20X1 1,200
31st March, 20X2 200
Total 2,200

Entity A’s borrowings at its year end of 31st March, 20X2 were as follows:
a. 10%, 4-year note with simple interest payable annually, which relates specifically to the
project; debt outstanding on 31st March, 20X2 amounted to ` 7,00,000. Interest of `
65,000 was incurred on these borrowings during the year, and interest income of ` 20,000
was earned on these funds while they were held in anticipation of payments.
b. 12.5% 10-year note with simple interest payable annually; debt outstanding at
1st April, 20X1 amounted to ` 1,000,000 and remained unchanged during the year; and
c. 10% 10-year note with simple interest payable annually; debt outstanding at
1st April, 20X1 amounted to ` 1,500,000 and remained unchanged during the year.

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 INDIAN ACCOUNTING STANDARD 23 7.243

What amount of the borrowing costs can be capitalized at year end as per relevant
Ind AS?
6. In a group with Parent Company “P” there are 3 subsidiaries with following business:
“A” – Real Estate Company
“B” – Construction Company
“C” – Finance Company
 Parent Company has no operating activities of its own but performs management functions
for its subsidiaries.
 Financing activities and cash management in the group are coordinated centrally.
 Finance Company is a vehicle used by the group solely for raising finance.
 All entities in the group prepare Ind AS financial statements.
The following information is relevant for the current reporting period 20X1-20X2:
Real Estate Company
 Borrowings of ` 10,00,000 with an interest rate of 7% p.a.
 Expenditures on qualifying assets during the period amounted to ` 15,40,000.
 All construction works were performed by Construction Company. Amounts invoiced to
Real Estate Company included 10% profit margin.
Construction Company
 No borrowings during the period.
 Financed ` 10,00,000 of expenditures on qualifying assets using its own cash resources.
Finance Company
 Raised ` 20,00,000 at 7% p.a. externally and issued a loan to Parent Company for general
corporate purposes at the rate of 8%.
Parent Company
 Used loan from Finance Company to acquire a new subsidiary.
 No qualifying assets apart from those in Real Estate Company and Construction Company.
 Parent Company did not issue any loans to other entities during the period.
What is the amount of borrowing costs eligible for capitalisation in the financial statements of
each of the four entities for the current reporting period 20X1-20X2?
Answers
1. As per paragraph 5 of Ind AS 23, a qualifying asset is an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale.

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 7.244 FINANCIAL REPORTING

As per paragraph 17 of Ind AS 23, an entity shall begin capitalising borrowing costs as part of
the cost of a qualifying asset on the commencement date. The commencement date for
capitalisation is the date when the entity first meets all of the following conditions:
(a) It incurs expenditures for the asset.
(b) It incurs borrowing costs.
(c) It undertakes activities that are necessary to prepare the asset for its intended use or sale.
The ship is a qualifying asset as it takes substantial period of time for its construction. Thus
the related borrowing costs should be capitalised.
Marine Transport Limited borrows funds and incurs expenditures in the form of down payment
on 1st April, 20X0. Thus condition (a) and (b) are met. However, condition (c) is met only on
1st March, 20X2, and that too only with respect to one ship. Thus there is no capitalisation of
borrowing costs during the financial year ended 31st March, 20X1. Even during the financial
year ended 31st March, 20X2, borrowing costs relating to the ‘one’ ship whose construction had
commenced from 1st March, 20X2 will be capitalised from 1st March, 20X2 to 31st March, 20X2.
All other borrowing costs are expensed.
2. The capitalisation rate is calculated as below:
Total borrowing costs / Weighted average total borrowings: 1,65,000/15,00,000 = 11%.
Interest to be capitalised is calculated as under:
— On ` 2,50,000 @ 11% p.a. for 9 months = ` 20,625
— On ` 3,00,000 @ 11% p.a. for 4 months = ` 11,000
Total interest capitalised for year ended 31 March 2002 is ` 31,625
3. Since the entity has only general borrowing hence first step will be to compute the capitalisation
rate. The capitalisation rate of the general borrowings of the entity during the period of
construction is calculated as follows:

Finance cost on ` 20 lacs 10% debentures during September – December ` 66,667

20X1
Interest @ 15% on overdraft of ` 5,00,000 in September 20X1 ` 6,250
Interest @ 16% on overdraft of ` 5,00,000 in October and November 20X1 ` 13,333
Interest @ 16% on overdraft of ` 750,000 in December 20X1 ` 10,000
Total finance costs in September – December 20X1 ` 96,250

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 INDIAN ACCOUNTING STANDARD 23 7.245

Weighted average borrowings during period

(20,00,000 × 4) + (500,000 × 3) + (750,000 × 1)
= = ` 25,62,500
4
Capitalisation rate = Total finance costs during the construction period / Weighted average
borrowings during the construction period
= 96,250 / 25,62,500 = 3.756%
4. (i) Calculation of capitalization rate on borrowings other than specific borrowings
Amount of loan (` ) Rate of Amount of
interest interest
(`)
7,00,000 12% = 84,000
9,00,000 11% = 99,000
16,00,000 1,83,000
Weighted average rate of interest = 11.4375%
(1,83,000/16,00,000) x 100
(ii) Computation of borrowing cost to be capitalized for specific borrowings and
general borrowings based on weighted average accumulated expenses
Date of Amount Financed Calculation `
incurrence of spent through
expenditure
1st April, 20X1 1,50,000 Specific 1,50,000 x 9% x 10/12 11,250
borrowing
1st August, 20X1 2,00,000 Specific 50,000 x 9% x 10/12 3,750
borrowing
General 1,50,000 x 11.4375% x
borrowing 6/12 8,578.125
1st October, 20X1 3,50,000 General 3,50,000 x 11.4375% x
borrowing 4/12 13,343.75
1st January, 20X2 1,00,000 General 1,00,000 x 11.4375% x
borrowing 1/12 953.125
37,875
Note: Since construction of building started on 1st April, 20X1, it is presumed that all the
later expenditures on construction of building had been incurred at the beginning of the
respective month.

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 7.246 FINANCIAL REPORTING

(iii) Total expenses to be capitalized for building

`
Cost of building ` (1,50,000 + 2,00,000 + 3,50,000 + 1,00,000) 8,00,000
Add: Amount of interest to be capitalized 37,875
8,37,875
(iv) Journal Entry
Date Particulars ` `
31.1.20X2 Building account Dr. 8,37,875
To Bank account 8,00,0000
To Interest payable (borrowing cost) 37,875
(Being expenditure incurred on
construction of building and borrowing
cost thereon capitalized)

Note: In the above journal entry, it is assumed that interest amount will be paid at the
year end. Hence, entry for interest payable has been passed on 31.1.20X2.
Alternatively, following journal entry may be passed if interest is paid on the date
of capitalization:
Date Particulars ` `
31.1.20X2 Building account Dr. 8,37,875
To Bank account 8,37,875
(Being expenditure incurred on
construction of building and borrowing
cost thereon capitalized)

5. As per Ind AS 23, when an entity borrows funds specifically for the purpose of obtaining a
qualifying asset, the entity should 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 those borrowings.
The amount of borrowing costs eligible for capitalization, in cases where the funds are borrowed
generally, should be determined based on the capitalisation rate and expenditure incurred in
obtaining a qualifying asset. The costs incurred should first be allocated to the specific
borrowings.

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 INDIAN ACCOUNTING STANDARD 23 7.247

Analysis of expenditure:
Date Expenditure Amount allocated Weighted for period
(` ’000) in general outstanding
borrowings (` ’000)
(` ’000)
1st April 20X1 200 0 0
30th June 20X1 600 100* 100 × 9/12 = 75
31st Dec 20X1 1,200 1,200 1,200 × 3/12 = 300
31st March 20X2 200 200 200 × 0/12 = 0
Total 2,200 375
*Specific borrowings of ` 7,00,000 fully utilized on 1st April & on 30th June to the extent of
` 5,00,000 hence remaining expenditure of ` 1,00,000 allocated to general borrowings.
The capitalisation rate relating to general borrowings should be the weighted average of the
borrowing costs applicable to the entity’s borrowings that are outstanding during the period,
other than borrowings made specifically for the purpose of obtaining a qualifying asset.
Capitalisation rate = (10,00,000 x 12.5%) + (15,00,000 x 10%) = 11%
10,00,000 + 15,00,000
Borrowing cost to be capitalized: Amount
(` )
On specific loan 65,000
On General borrowing (3,75,000 × 11%) 41,250
Total 1,06,250
Less: interest income on specific borrowings (20,000)
Amount eligible for capitalization 86,250
Therefore, the borrowing costs to be capitalized are ` 86,250.

6. Following is the treatment as per Ind AS 23:

Finance Company
No expenditure on qualifying assets have been incurred, so Finance Company cannot
capitalise anything.
Real Estate Company
Total interest costs in the financial statements of Real Estate Company is ` 70,000.
Expenditures on qualifying assets exceed total borrowings, so the total amount of interest
can be capitalised.

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 7.248 FINANCIAL REPORTING

Construction Company
No interest expense has been incurred, so Construction Company cannot capitalise anything.
Consolidated financial statements of Parent Company:
Total general borrowings of the group: ` 10,00,000 + ` 20,00,000 = ` 30,00,000
Although Parent Company used proceeds from loan to acquire a subsidiary, this loan cannot
be excluded from the pool of general borrowings.
Total interest expenditures for the group = ` 30,00,000 x 7% = ` 2,10,000
Total expenditures on qualifying assets for the group are added up. Profit margin charged
by Construction Company to Real Estate Company is eliminated:
Real Estate Company – ` 15,40,000/1.1 = ` 14,00,000
Construction Co – ` 10,00,000
Total consolidated expenditures on qualifying assets:
` (14,00,000 + 10,00,000) = ` 24,00,000
Capitalisation rate = 7%
Borrowing costs eligible for capitalisation = ` 24,00,000 x 7% = ` 1,68,000
Total interest expenditures of the group are higher than borrowing costs eligible for
capitalisation calculated based on the actual expenditures incurred on the qualifying assets.
Therefore, only ` 1,68,000 can be capitalised.

© The Institute of Chartered Accountants of India