Borrowing Costs
Borrowing costs are interests and other costs incurred by an entity in connection with the borrowing of funds
- These mainly include interest on bank drafts and loans.
- These mainly include amortization of discount or premium on issue of loans or debentures and amortization of other related costs that are incurred on arrangement of borrowings.
IAS 23 sets forth two accounting treatments for these costs:
Qualifying assets:
Qualifying assets are those assets that necessarily take substantial period of time to get ready for their intended use or sale.
- These mainly include the assets, which are used by the enterprise itself like buildings, plant and machinery.
- Otherwise they may be the assets for sale that have been manufactured / produced specifically on order of customers like ships or real estate developments like housing projects or commercial plazas.
Recognition of Borrowing Cost
- An entity shall capitalize borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognize other borrowing costs as an expense in the period in which it incur them.
- Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are included in the cost of that asset. Such borrowing costs are capitalized as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably.
Borrowing costs eligible for capitalization
- The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had no been made.
- To the extent that and entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing during the period less any investment income on the temporary investment of those borrowings.
- Is the funds have been obtained specifically for the financing of qualifying asset, the amount of interest to be capitalized. However, if there have been general borrowings at different rates of interest then capitalization rate should be weighted average rate of borrowing costs applicable to the borrowings of the enterprise.
Example: 1
Suppose a company has obtained following general borrowings:
Principal
|
Interest
| |
₤
|
₤
| |
16% - 4 Years loan
|
500,000
|
80,000
|
14% - 6 Years loan
|
1,000,000
|
140,000
|
10% - 8 Years loan
|
1,200,000
|
120,000
|
Total
|
2,700,000
|
340,000
|
Required: Calculate capitalized rate
Answer:
Capitalized rate:
Loan A / Total Loans * Rate of interest of loan A
|
₤500,000/₤2,700,000*16%
|
= 2.96%
|
Loan B / Total Loans * Rate of interest of loan B
|
₤1,000,000/₤2,700,000*14%
|
= 5.19%
|
Loan C / Total Loans * Rate of interest of loan C
|
₤1,200,000/₤2,700,000*10%
|
= 4.4%
|
The statement of financial position of a company at year ended 31st December 2000 reflects the following status:
Plant under installation
|
₤2,000,000
|
Other assets
|
₤8,000,000
|
Total
|
₤10,000,000
|
Loans:
| |
Bank Loan 18%
|
₤2,000,000
|
Bank Loan 20%
|
₤2,500,000
|
Bank Loan 22%
|
₤1,500,000
|
Total
|
₤6,000,000
|
Shareholder’s equity
|
₤4,000,000
|
Total
|
₤10,000,000
|
Bank loan of 20% was taken on April 1, 2000 . Other loans were brought forward from 1999.
Expenditure incurred on plant under installation:
₤1,000,000
| |
₤700,000
| |
₤300,000
| |
Total
|
₤2,000,000
|
Required: Calculate borrowing cost and total capitalized cost of asset at 2000.
Answer:
Capitalization of borrowing costs:
Date
|
Expenditure incurred (₤)
|
Rate
|
Period
|
Capitalization (₤)
|
1,000,000
|
19.82%
|
2 months
|
33,033
| |
1,700,000
|
19.82%
|
4 months
|
112,313
| |
2,000,000
|
19.82%
|
2 months
|
66,067
| |
Total
|
211,413
|
Capitalized cost of asset:
Original cost
|
₤2,000,000
|
Borrowing cost
|
₤211,413
|
Total cost
|
₤2,211,413
|
Capitalization rate:
₤2,000,000/₤5,375,000*18%=
|
6.70%
|
₤1,875,000/₤5,375,000*20%=
|
6.98%
|
₤1,500,000/₤5,375,000*22%=
|
6.14%
|
Total
|
19.82%
|
Temporary investment income:
- When surplus funds taken for the projects are invested temporarily, the interest income earned should be deducted from borrowing costs capitalized.
Commencement of borrowing costs:
It should commence when:
- Expenditure for the asset is being incurred
- Borrowing costs are being incurred; and
- Activity necessary to prepare the asset is in progress.
Suspension of Capitalization:
- Borrowing cost should not be capitalized during the period in which active development is interrupted. However, if delay is a necessary part of process of getting an asset ready for this intended use or sale, the capitalization should not be suspended.
Cessation of Borrowing Cost Capitalization:
- Capitalization of borrowing cost shall cease when substantially all the activities necessary to prepare the qualifying asset for this intended use or sale are complete.
Disclosure:
Financial statement shall disclose:
- The accounting policy adopted for borrowing cost.
- The amount of borrowing cost capitalized during the period.
- The capitalization rate used to determine the amount of borrowing cost.
Question. 1
On 1-1-20 x6 stream co. borrowed 1.5m to finance the production of two assets, both of which were expected to take a year to build. Work started during 20x6. The loan facility was drawn down and incurred on 1-1-20 x6, and was utilized as follows.
Asset A
|
Asset B
| |
₤250,000
|
₤500,000
| |
₤250,000
|
₤500,000
|
The loan rate was 9% and steam co. can invest surplus fund at 7%
Required:
i) calculate borrowing cost, which may be capitalized for each asset 31-12-20 x6
ii) total cost of each asset at 31-12-20 x6
Answer to Question. 1
Borrowing cost to be capitalized
Asset A
|
Asset B
| |
(₤500,000x9%)
|
₤45,000
| |
(₤1,000,000x9%)
|
₤90,000
| |
Less: Investment Income
| ||
₤(8,750)
|
-
| |
-
|
₤(17,500)
| |
Net borrowing cost
|
₤36,250
|
₤72,500
|
Cost of power generation facilities:
| ||
Total expenditure
|
₤500,000
|
₤1,000,000
|
Total cost
|
₤536,250
|
₤1,072,500
|
Question. 2
Acruni co. had following loans in place at the beginning and end of 20x6
₤ ‘ 000
|
₤ ‘ 000
| |
10% bank loan repayable in 20x8
|
120,000
|
120,000
|
9.5% bank loan repayable in 20x9
|
80,000
|
80,000
|
8.9% bank loan repayable in 20x7
|
-
|
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 1-7-20 x6. On 1-1-20 x6, Acurni Co. began construction of qualifying asset, a piece of machinery for hydro electric plant, using existing borrowings. Expenditure drawn down for the construction was: 30mon 1-1-20 x6 and 20m on 1-10-20 x6.
Required:
i) Calculate borrowing cost can be capitalized for the piece of mining equipment.
ii) Calculate borrowing cost can be capitalized for hydro electric plant.
Answer to Question. 2
i) borrowing cost to be capitalized
₤ ‘ 000
| |
2,205
| |
1,225
| |
Total
|
3,430
|
Working:
Capitalization rate
₤120,000/₤200,000 * 10% + ₤80,000/₤200,000 * 9.5% =
|
9.8%
|
Question. 3
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 to be provided by the bank carried interest @ 18% per annum. The 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 commencement of work by 3 months. The work finally started on Oct 01, 19x1.
In the absence of other good investment opportunity, the management decided to temporarily utilize ₤25m 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
|
₤ Millions
|
October 01, 19x1
|
35
|
January 01, 19x2
|
25
|
May 01, 19x2
|
10
|
₤35 million include initial disbursement made by the bank.
The work on the facilities was stopped from February 01, 19x2 to April 30, 19x2 due to company’s internal problems.
The Company amortized ₤ 5 million from other costs in connection with the borrowing of funds up to June 30, 19x2.
Required:
Compute the cost of power generation facilities as at June 30, 19x2 under IAS 23, Borrowing costs.
Answer to Question. 3
Borrowing cost to be capitalized
₤ Millions
| |
1.6
| |
0.9
| |
-
| |
2.1
| |
Total
|
4.6
|
Add:
| |
Amortization of other costs
|
5.0
|
Total borrowing cost
|
11.6
|
Cost of power generation facilities
| |
Total expenditure (35+25+10)
|
70.0
|
Total cost
|
81.6
|
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