Wednesday, March 10, 2010

International Accounting Standard 23


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%





Example 2:
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:

May 01, 2000
₤1,000,000
July 01, 2000
₤700,000
November 01, 2000
₤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  (₤)
1-5-00 to 30-06-00
1,000,000
19.82%
2 months
33,033
  1-7-00 to 31-1-00
1,700,000
19.82%
4 months
112,313
1-11-00 to 31-12-00
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 1-1-20x6 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 1-1-20x6, and was utilized as follows.


Asset A
Asset B
1-1-20x6
₤250,000
₤500,000
1-7-20x6
₤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 31-12-20x6
ii)                   total cost of each asset at 31-12-20x6


Answer to Question. 1

Borrowing cost to be capitalized
                                                                                   

Asset A
Asset B
1-1-20x6 to 31-12-20x6


(₤500,000x9%)
₤45,000

(₤1,000,000x9%)

₤90,000
Less: Investment Income



1-1-20x6 to 30-6-20x6 (₤250,000 x 7% x 6/12)
₤(8,750)
 -
1-1-20x6 to 30-6-20x6 (₤500,000 x 7% x 6/12)
 -
₤(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                                                                      



1-1-20x6
31-12-20x6

₤ ‘ 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 1-7-20x6. On 1-1-20x6, 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 1-1-20x6 and 20m on 1-10-20x6.

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
1-7-20x6 to 30-9-20x6 (₤30,000 x 9.8% (w-1) x 9/12)
2,205
1-10-20x6 to 31-12-20x6 (₤50,000 x 9.8% (w-1) x 3/12)
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

1-10-19x1 to 31-12-19x1 (₤35m x 18% x 3/12)
1.6
1-1-19x2 to 31-1-19x2 (₤60m x 18% x 1/12)
0.9
1-2-19x2 to 30-4-19x2 (Suspended)
-
1-5-19x2 to 30-6-19x2 (₤70m x 18% x 2/12)
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

           
                           
                                                           
                                                                                                                                   
                                                                                    

0 Comments: