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Financial Accounting and

Reporting
(ACC3206)

IAS 23
Borrowing Costs
Introduction
Borrowing costs are interests and other costs incurred on
funds borrowed.

IAS 23 (MFRS 123) Borrowing Costs deals with borrowing


costs incurred to construct or develop an asset.

The construction of property, plant and equipment or


undertaking of long-term construction may involve large
sums of funds. Therefore, entities may borrow funds to
finance the construction of these assets.
There was controversy to the accounting treatment of
borrowing costs. Some wanted borrowing costs to be
capitalised to become part of the cost of constructing or
developing the assets.
Others wanted it written off as period costs.
Definitions Borrowing Costs

IAS 23 Borrowing Costs defines borrowing costs as interest and


other costs incurred by an entity in connection with borrowing of
funds.

Borrowing costs include the following:

(a) Interests such as on bank overdrafts and both short-term and


long-term borrowings.
(b) Amortisation of discounts or premiums relating to borrowings.
(c) Amortisation of ancillary costs incurred in connection with the
arrangement of borrowings.
(d) Finance charges in respect of finance leases recognised in
accordance with IAS 17 Leases.
Definitions Qualifying assets
The accounting for borrowing costs covered in this standard is
limited to the borrowing to construct or develop qualifying assets.

IAS 23 defines a qualifying asset as an asset that necessarily takes


a substantial period of time to get ready for its intended use or sale.

Qualifying assets include the construction of a building, long-term


construction contracts, research and development, construction of
investment property and production of inventories that take a
considerable period of time to bring to a saleable condition.

However, inventories routinely produced on a repetitive manner


over a short period of time are not qualifying assets. Assets ready
for intended use are not qualifying assets either.

An entity may borrow for other reasons and if they are not in
relation to construction or developing an asset, then those costs are
to be expensed as period costs.
Recognition
Borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset
are to be capitalised as part of cost of the asset provided it is
probable that they will result in future economic benefits to
the entity and the costs can be measured reliably.

Even though an entity can capitalise borrowing costs, IAS


23 has imposed specific limitations to the amount that can
be capitalised. These limitations are as follows:

(a) Funds borrowed are specifically for the purpose of


obtaining a qualifying asset.
(b) The amount eligible for capitalisation should be
determined as the actual borrowing costs incurred on
that borrowing during the period, less any income from
temporary investment of the borrowing.
Recognition
(c) Capitalisation should commence when:
(i) Expenditure for the asset is being incurred;
(ii) Borrowing costs are being incurred; and
(iii) Activities for the intended use or sale are in
progress.

(d) Capitalisation should cease when the asset is ready


for its intended use.

(e) Total costs capitalised should not exceed the future


economic benefits that will accrue to the entity.
Borrowing Costs Eligible for Capitalisation
Costs on funds borrowed specifically for the purpose of
obtaining the qualifying asset less income from temporary
investment of the borrowing are to be capitalised as part
of the cost of the asset.

Income from Temporary Investment

Funds may be directly borrowed for the acquisition,


construction or production of a qualifying asset. In such
cases, the borrowing costs may be capitalised by limited
to actual borrowing costs incurred less any investment
income on the temporary investment of those borrowings.

See Example 1 on the next slide.


Borrowing Costs Eligible for Capitalisation
Income from Temporary Investment
Example 1

An entity borrowed RM39 million for the construction of a


building that is estimated to cost RM45 million. However,
only RM10 million was used and the balance of RM29
million was invested temporarily. Investment income of
RM400,000 was earned on the temporary investments and
interest accrued on the borrowing of RM39 million was
RM2 million.

Required:

Discuss the accounting treatment of the borrowing costs.


Borrowing Costs Eligible for Capitalisation
Income from Temporary Investment
Answer

The borrowing cost on the total borrowing could be


capitalised if the borrowing was to construct a qualifying
asset. As part of the borrowing was invested and the income
earned was RM400,000, the amount of borrowing costs that
can be capitalised is only RM1.6 million. This amount is
added to the construction cost of the building.
Borrowing Costs Eligible for Capitalisation
Central Borrowings
Sometimes, it may be difficult to identify the borrowing that relates
to the acquisition, construction or production of a qualifying asset
specifically.

Borrowing may be done centrally, or the entity might take up


different loan packages with varying interest rates.

Generally, when funds are borrowed, the borrowing cost applicable


to obtaining a qualifying asset is measured by applying a weighted
average interest rate, excluding that borrowed specifically for the
purpose of obtaining a qualifying asset.

The amount of borrowing costs capitalised during a period should not


exceed the actual borrowing costs incurred during that period.
Borrowing Costs Eligible for Capitalisation
Central Borrowings
Example 2

On 1 January x5, May Bhd raised finance amounting to RM400,000.


The borrowing was to finance both a construction of a plant and for
operations. On 31 December x5, the outstanding borrowings were
RM400,000 with no capital repayment in year x5. The borrowings were
mainly used for the construction of the plant at a cost of RM300,000.
May Bhd wants to capitalise borrowing costs on qualifying assets. The
details of the borrowings were as follows:

31/12/x5
RM
12% Loan stock 100,000
10% Term loan 220,000
8% Redeemable preference shares 80,000
Borrowing Costs Eligible for Capitalisation
Central Borrowings
Answer:

Of the borrowings of RM400,000, only the borrowing costs of


RM300,000 is eligible for capitalisation. The borrowings are from
different sources and they differ in interest rates. The weighted average
rate will be used to determine the amount of interest that can be
capitalised.

Capitalisation rate:
Principal (a) (b) (a) x (b)
At 31/12/x5 Weighted Interest %
RM Average Rate
12% Loan stock 100,000 25% 12% 3.0
10% Term loan 220,000 55% 10% 5.5
8% Redeemable 80,000 20% 8% 1.6
preference shares
400,000 100% 10.1%
Borrowing Costs Eligible for Capitalisation
Central Borrowings
Total interest:
Principal Interest Total
At 31/12/x5 Rate Interest
RM RM
12% Loan stock 100,000 12% 12,000
10% Term loan 220,000 10% 22,000
8% Redeemable preference 80,000 8% 6,400
shares
Total 400,000 40,400

RM
Interest that can be capitalised RM300,000 x 10.1% 30,300
Interest that can be charged as expense 10,100
40,400
Borrowing Costs Eligible for Capitalisation
Limitation to Capitalisation
If the carrying amount of an asset or the total cost of the
asset (including borrowing cost) exceeds its recoverable
amount or net realisable value, the asset has to be written
down or written off accordingly.

If it were to be an inventory, it has to be written down to


the net realisable value and for property, plant and
equipment, to the recoverable amount.

These write-downs may be written back in accordance


with the relevant standards.
Borrowing Costs Eligible for Capitalisation
Commencement of Capitalisation
The capitalisation of borrowing costs should commence
when:

(a) Expenditure for the asset is being incurred;


(b) Borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for
its intended use or sale are in progress.

Sometimes, the borrowing may commence before


construction starts. In this case, the borrowing costs
incurred from the date when construction starts can be
capitalised.
Borrowing Costs Eligible for Capitalisation
Suspension of Capitalisation
During periods when active development is interrupted,
the borrowing costs incurred during these interrupted
periods should not be capitalised.

Again, physical activity may not be carried out although


technical work is being carried on. This is not considered
interruption of construction.

Temporary delays which are necessary, or extended


period for inventory to mature, or delays in construction
are not considered interruption of construction.
Borrowing Cost Eligible for Capitalisation
Cessation of Capitalisation
Borrowing costs are not capitalised once the activities
necessary to prepare the qualifying asset for intended use
or sale are completed.

An asset is normally ready for intended use when the


physical construction is complete even though some
administration work or decoration of the asset is not done.

When the construction of a qualifying asset is completed


in parts and each part is ready for use while construction
continues on other parts, capitalisation should cease when
substantially all the activities necessary to prepare that
part for its intended use or sale are completed.
Example 3

Beano Bhd started constructing a building on 1 January x1. The


building was completed on 31 December x3. The useful life of the
building was estimated to be 50 years. Construction costs (excluding
interest) incurred on the building was RM1.5 million.

Beano Bhd secured a loan of RM1 million from Giant Finance Bhd in x1
to finance the construction costs. Interest on the loan was charged at
10% per annum. Repayment period of the loan was five years. Since
Beano Bhd did not need the full amount of the loan in the first year of
construction, it deposited RM600,000 in a fixed deposit which yielded
an interest of 8% per annum. The deposit matured on 31 December x1.

Required:
(a) Calculate the cost of the building.
(b) Show the statements of comprehensive income (extract) for the
years ended 31 December x1 until x4.
Answer:
(a)

Cost of the building RM RM


Construction costs 1,500,000
Interest costs (10% x RM1,000,000 x 3 years) 300,000
Less: Interest income on fixed deposit (8% x (48,000) 252,000
RM600,000)
1,752,000
(b) Statement of Comprehensive Income (extract) for the years ended
31 December
X1 X2 X3 X4
RM RM RM RM
Expenses:
Interest expense - - - 100,000
Depreciation - - - 35,040
Disclosure
The following information should be disclosed in the financial
statements:

(a) The amount of borrowing costs capitalised during the period.


(b) The capitalisation rate used to determine the amount of
borrowing costs eligible for capitalisation.
Capitalisation of borrowing costs

Arguments for:
1) Borrowing costs form part of acquisition
cost
2) Costs included in assets is matched
against revenue of future periods.
3) Results is better comparability between
assets purchased and constructed.
Capitalization of borrowing costs

Arguments against:
1) Attempts to link borrowing costs to a
specific asset is arbitrary.
2) Different financing methods may result in
different amounts capitalized for the same
asset.
3) Expensing borrowing costs causes better
comparable results.
The End

Thank you

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