AS – 16: Borrowing Costs

Take a look at the following love story

The hero of our story is an employee and heroine is a student

studying CA. Everyday evening they both will meet at a spot, the boy usually gives
many gifts. As and when he gives gift, he thinks that it is an investment for
marriage.
A twist in the story, the hero while going in his car watches the girl sitting
with another boy in the restaurant. Our hero’s heart broke into pieces and he
became a mini Devdas. The fact is that the boy with whom the girl was sitting is her
cousin.
------ A break in the Love and Interval for our story -------

The hero has ordered a Diamond ring for his love. Without knowing what has
happened, the jewellery shop owner sent the ring to girl’s house and bill to boy’s
house. Now our hero has to pay the bill. At the time of paying the bill , hero will
certainly think it as a wasteful expenditure.

There should be a good climax, other wise audience wont accept the story.
So, A common friend to hero and heroine enters the scene and makes all the doubts
of hero clear and again they both will be same as before. Again the hero starts
giving gifts. Now he will think it as an investment for marriage.
---------- They both got married -----------

One fine day, sorry one bad day, Our heroine asks his husband for a mobile
(N 97) as the mobile with her which he has gifted is very old (1100). Our hero didn’t
accept for that and heroine starts crying. The hero has no other alternative and
has to buy the mobile. Now he will think it as expenditure. Right???

What is borrowing cost?

When we borrow funds we have to incur costs, like
 Interest charges
 Commitment charges
 Amortization of discounts related to borrowings
 Amortization of premiums related to borrowings
 Amortization of ancillary costs incurred in connection with the arrangement
of borrowings
 Finance charges in respect of assets acquired under finance lease
 Exchange differences arising from foreign currency borrowings to the
extent they are regarded as an adjustment to interest costs
This accounting standard states whether the borrowing costs has to be capitalized
or to be charged to profit & Loss A/C. The following table shows in brief the
accounting treatment.

Particulars Treatment Correlation with our

story
During the development of Capitalize Gifts given will be treated
the Asset as investment for
(Asset as defined under marriage when their love
AS – 16) is developing

Interruption in the Charge it to P&L A/C A break in their love and

development of asset (Revenue Exp.) the diamond ring

When the development of Capitalize The story after interval.

asset again continues Common friend joins hero
and heroine

Asset is completed and Charge it to P&L A/C After marriage and

ready for use. If (Revenue Exp.) quarrel for mobile.
borrowing cost is incurred
after completion

FAQ’s on AS – 16:

1. What is an asset?
Asset under AS – 16 means the qualifying asset which takes substantial
period of time for its intended use or for sale.
Eg: Turnkey projects, Construction, power generation facilities, Investment
properties, Inventories that require substantial period to bring them to saleable
condition, Development of steel plants.

2. What is substantial period of time?

As per the consensus, it is 12 months but may be more or less than 12
months, which depends on the facts and circumstances of each case.

3. When capitalization shall commence, whether from the date of borrowing of

funds or whether from the start of construction of asset or whether at any other
time?
The following conditions has to be satisfied
 (a) Expenditure for the acquisition, Construction or production of a qualifying
asset is being incurred.
(b) Borrowing costs are being incurred on the other hand
(c) Activities necessary to prepare the asset for its intended use or sale is in
progress.

Types of Borrowing

General Borrowing Specific Borrowing

Amount borrowed in general Amount borrowed only for the

and later on used for the qualifying asset.
qualifying asset.

Borrowing cost has to be capitalized

Borrowing cost that has to be capitalized
= Exp. On that asset X Capitalization rate.
Borrowing cost =
Borrowing cost during the period
Capitalization rate = Weighted average
(-) Income from temporary investment of
cost of borrowing
borrowed amount

Note: Borrowing cost capitalized should not

exceed Actual borrowing cost incurred
during the period.

Disclosure under AS – 16:

a) Accounting Policy adopted
b) Amount of borrowing cost capitalized during the accounting period

Problems on AS – 16:

1. A ltd. has taken 5,00,000 for the construction of building for interest
rate @ 10% and the loan was taken in the beginning of the year 2008-09.
The company has to repay the entire amount of loan after 5 years. On the
date of arrangement of loan the company has incurred 30,000 as
 commission and 5,000 as agreement charges. Calculate the borrowing cost
for the 1st year and also pass journal entries.

2. Same as problem 1 and assume that out of borrowed funds of 5,00,000,

the amount utilized for building is only 3,00,000.

3. Calculate the amount of borrowing cost to be capitalized for the year end
2009 -10 from the following information.
Amount borrowed upto 2008-09 = 3,00,000
Expenditure incurred upto 2008-09 on qualifying asset = 5,00,000
Interest cost capitalized for the year 2008-09 @ 13% = 3,00,000 X
13% = 39,000
Expenditure incurred on qualifying asset during 2009-10 = 2,00,000
Progress payments received = 3,50,000
Amount borrowed during 2009-10 = 2,00,000.

4. Narayan Ltd. started constructing manufacturing plant on 1/04/08. During the

year 1,200 crores were evenly incurred for construction of plant. At the beginning
of the year, the company had the following borrowings:
Amount Rate of Interest
Term loan from FI
(Specifically for manufacturing plant) 300 crores 10%
Bank Loans
- Indian Bank 400 crores 11%
- ICICI Bank 400 crores 12%
- SBI 200 crores 12%
What is the amount of interest to be capitalized for the year ended 31/03/09?

5. Amulya Ltd. has taken 10,00,000 @ 15% in the beginning of the year for
construction of building. In addition to above loan, the company has taken multiple
borrowings as follows:
(a) 10% debentures 5,00,000
(b) 20% Term loan 10,00,000
(c) 15% other loans 5,00,000
The above funds have been utilized by the company in the following assets.
1. Building – 25,00,000
2. Furniture – 10,00,000
3. Plant – 40,00,000
4. Factory shed – 15,00,000
Calculate the borrowing cost and also pass journal entries.
6. A company capitalizes interest cost of holding investments and adds to cost of
investment every year, thereby understating interest cost in profit and loss
account. Whether it leads to unusual accounting?

7. X Ltd. has obtained an institutional loan of Rs. 800 lakhs for modernization and
renovation of its machinery. Machinery acquired under the modernization scheme
and installation completed on 31.3.08 amounts to Rs. 600 lakhs. Rs. 80 lakhs has
been advanced to suppliers for additional assets and balance loan of Rs.120 lakhs
has been utilized for working capital purpose. The total interest paid for the above
loan amounted to Rs.80 lakhs during 2007-08.You are required to state how the
interest on the institutional loan is to be accounted in the year 2007-08.

8. On 30.4.2008 MNC Ltd.obtained a loan from the bank for Rs.50 lakhs to be
utilized as under:
(i) Construction of a factory shed Rs.2 crores.
(ii) Purchase of Machinery Rs. 1.5 crores.
(iii) Working Capital Rs. 1 crore.
(iv) Advance for Purchase of truck Rs. 50 lakhs.
In March 2008, construction of shed was completed and machinery installed.
Delivery of truck was not received. Total interest charged by the bank for the year
ended 31.3.08 was Rs.90 lakhs. Show the treatment of interest as per AS-16.

9. Kesava Ltd. took a loan of USD 20,000 at 6% p.a on 1st April, for a specific
capital expansion project. The interest was payable annually. The exchange rate at
the date of the loan was 1 USD = 45. However, the company could have taken a
corresponding rupee loan from banks @ 12% p.a on that date. At the end of the
year, the exchange rate was 1 USD = 48. How would you treat the borrowing costs
and exchange differences in the above case. What would be the accounting
treatment if the rupee loan were to carry interest @ 14% p.a.? What will be the
treatment if the exchange rate at the end of the year were 1 USD = 46?

10. X Ltd. began construction of a new building on 1 st January, 2007. It obtained

Rs.1 lakh special loan to finance the construction of the building on 1 st January,
2007 at an interest rate of 10%. The company’s other outstanding two non-
specific loans were:
Amount Rate of Interest
Rs.5,00,000 11%
Rs.9,00,000 13%
The expenditure that were made on the building project were as follows:
Rs.
January 2007 2,00,000
April 2007 2,50,000
July 2007 4,50,000
December 2007 1,20,000
Building was completed by 31st December, 2007. Following the principles prescribed
in AS-16 ‘Borrowing Cost,’ calculate the amount of interest to be capitalized and
pass one Journal Entry for capitalizing the cost and borrowing cost in respect of
the building.