Borrowing cost AS 16

Prashant M Maharishi

Application

Applies to accounting period commencing on or after 1/4/2000. Mandatory in nature Relevant Para 9.2 of AS 10 of financing cost treatment is withdrawn Relevant part of Para 20 related to Finance cost is also withdrawn Does not apply to actual or imputed cost of owners equity including preference share capital not classified as liability Other ASI 1 Substantial period of time, ASI 10 interpretation of Para 4 (e),

Need for standard

Huge borrowing cost are incurred by the company in putting up Infrastructure for which no guidance available existence of AS 10 Some of the corporate also capitalized interest in inventory valuation which was not fair- existence of AS 2

What is borrowing cost

It

is interest and other cost Incurred by an enterprise In connection with borrowing of funds.

Borrowing cost may include

a)

b)

c)

d)

e)

Interest & commitment charges Amortization of discounts or premium on borrowing Amortization of ancillary cost for arrangement of borrowing Finance charges on assets acquired on finance lease Exchange difference on FCB as an adjustment to interest cost

What is a qualifying asset?

It is an asset. It may be tangible or intangible It may be current assets fixed assets It applies to Investment properties That necessarily takes

Substantial period of time To get ready for its intended use or sale

Recognition
a)

a)

BC directly attributable to be capitalized if probable future economic benefits to the enterprise Bc can be measured reliably. Other BC are to be expensed in the period of incurring

Capitalization of BC

BC that would have been avoided if exp on qualifying assets is not made is cost directly attributable to QA In complex situation, exercise your judgment in recognizing for determine BC Temporary income of funds borrowed specifically should be adjusted from BC General borrowing apply weighted average cost of borrowing

Capitalization of BC

IF carrying amount of QA<recoverable amount/NRV write off is permissible as per requirement of other AS. AS 28 Impairment

Commencement & Suspension of capitalization

Capitalization on satisfaction of :

Exp on QA for acquisition/ construction / production incurred. Borrowing cost is incurred Activities for preparing QA intended use or sale in progress Total amt of exp incurred including BC shall be the amount on which capitalization rate is applied Period of No activity in which QAs condition does not change is excluded.

Suspension of capitalization

BC capitalization suspended during extended periods in which active development is interrupted. Such cost are cost of partially developed QA No suspension allowed during temporary delay which is a necessary part of process of getting QA ready.

Cessation of Capitalization of BC

Substantially all activities are complete Pending routine administrative matters does not allow capitalization of BC Part completion when part is capable of use independently, provision should be applied as if it is an independent QA

Disclosure
A.

B.

Accounting policy adopted for borrowing cost The amount of borrowing cost capitalized during the period

Auditors Checklist

C:\Documents and Settings\pmm\Desktop\Checklist for Auditor Accounting standard 16 borrowing Costs.doc

Issues

Whether BC of preference share capital can be capitalized? Treatment of fees paid for prepayment of loan Restructuring of loans and interest payable thereon whether eligible for capitalization? BC on working capital finance can be capitalized? What happens to waiver of Interest already capitalized? Interest payments on Inventory can be included in the valuation of closing stock? Addition of Interest to the cost of investments is possible? What is substantial period of time? ASI 1 - says 12 months time.

Practical issues
1.

2.

R ltd has borrowed Rs.25 crores from financial institution during the financial year 2001-02. these borrowings are used to invest in shares of A Ltd, a subsidiary company, which is implementing a new project estimated to cost 50 crores. As on 31st March, 2002 since the said project was not yet complete, the Directors of R Ltd, resolved to capitalize the interest on the borrowings amounting to Rs. 3 crores and add it to the cost of investments. As statutory auditor, please comment. A fast food chain takes about 6 months to open a new retail outlet. Can it capitalize borrowing cost incurred in connection with setting up the new outlet?

Practical issues ASI 10

3.

XYZ Ltd. has taken a loan of USD 10,000 on April 1, 20X3 for a specific project at an interest rate of 5% p.a. payable annually. On April 1, 20X3, the exchange rate between the currencies was Rs. 45 per USD. The exchange rate, as at March 31, 20X4, is Rs.48 per USD. The corresponding amount could have been borrowed by XYZ Ltd. in local currency at an interest rate of 11 percent per annum as on April 1, 20X3. The following computation would be made to determine the amount of borrowing costs for the purposes of paragraph 4(e) of AS 16; Interest for the period = USD 10,000 x 5% x Rs. 48/USD = Rs. 24,000/Increase in the liability towards the principal amount = USD 10,000 x (48-45) = Rs. 30,000/Interest that would have resulted if the loan was taken in Indian currency = USD 10000 x 45 x 11%) = Rs. 49,500 Difference between interest local currency borrowing and foreign currency borrowing = Rs.49,5000 Rs.24,000 = Rs. 25,500

Practical issues
4.

A Refinery started erecting in June 1997. Till 2001 erection work continued. In 2001 work was suspended because of financial crunches. In 2005 work was restarted. In September 2006 refinery started its operation in part and selling refined petrol etc. However it could refine only sweet crude till may 2007 because of one unit of refinery could not be set up. It is contended by Company that Till May 2007 all production and sales is trial run of the company. Huge borrowing cost are incurred by the company during the period 1997 to 2007. Till now all expenses including interest cost is debited in expenditure during construction period. Please advise :What will happen to Interest cost a) from 1997 to 2001 b) 2001 to 2005 c) September 2006 to march 2007 d) March 2007 to May 2007.

Practical Issues
5.

On April 1, 2005, MGH constructions undertook construction of a factory building for expansion purpose. Total cost of project was Rs. 3,00,00,000. The Building was completed by end of March 2006 and during the period following payments were made: Payment made 1 April 2005 20,00,000 , 30 June 2005 60,00,000 , 31 December 2005 1,80,00,000 and 31 March 2006 40,00,000 Total 3,00,00,000 MGH constructions borrowings as at March 31, 2006 were as follows; 9% term loan amounting to Rs.80,00,000 taken on December 31, 2004. Simple interest is payable annually. Amount outstanding as at March 31, 2005 and during 05-06 is Rs.80,00,000. the loan was taken specifically for the project. 11% debentures issued on March 31, 2004 with simple interest payable annually. Amount outstanding for the year 05-06 is rs.1,50,00,000. 10% bonds issued on December 31,2003 amounting to Rs.1,70,00,000. simple interest payable at annual rest. Amount outstanding for the year 0506 is rs.1,60,00,000. How much borrowing cost should be capitalized for construction of the building as per AS-16 borrowing Cost?

Practical issues
6.

A company obtained term loan during the year ended 31st March, 2002 to the extent of Rs. 650 lakhs for modernization and development of its factory. Buildings worth Rs. 120 lakhs were completed and Plant and Machinery worth Rs. 350 lakhs were installed by 31st March, 2002. A sum of Rs. 70 lakhs has been advanced for assets, the installation of which is expected in the following year. Rs. 100 lakhs has been utilized for Working Capital requirements. Interest paid on the loan of Rs. 650 lakhs during the year 2001-2002 amounted to Rs. 25.50 lakhs. How should the interest amount be treated in the Accounts of the Company?