Wednesday, August 3, 2016

IAS 23 –Borrowing Costs






Financing the activities of a business has always been an important part of almost all entities, especially with respect to the issue of acquiring, constructing or producing assets that will be employed in the business, so as to increase its production capacity and generate more income.

Obtaining loan, bank overdrafts or even issuing bonds are some of the various means that entities employ in generating funds. When such funds are acquired, it is almost certain that interests will be paid on the principal sum. These interests are referred to as the cost incurred by the entity in making such borrowings. Hence, the word –borrowing cost.


Should the cost of borrowing be expensed in Statement of Profit or Loss (SPL) or capitalized as an asset in the Statement of Financial Position (SOFP)? 

OBJECTIVE
To set guidance on the circumstances under which borrowing costs are to be capitalized as part of the cost of qualifying assets.

Wait! Don’t get it twisted
Borrowing costs regulates the extent to which entities are allowed to capitalize borrowing costs incurred on money borrowed to finance the acquisition of certain assets. These costs are not treated as an expense item but rather added as part of the cost of the asset to be capitalized in the SOFP.

SCOPE
An entity is not required to apply the standard to borrowing costs directly attributable to the acquisition, construction or production of:
·       A qualifying asset measured at fair value, for example a biological asset; or
·       Inventories that are manufactured or otherwise produced, in large quantities on a repetitive basis.
·   IAS 23 does not deal with the actual or imputed cost of equity, including preferred capital not classified as a liability.

Wait! Don’t get it twisted
Borrowing costs are only capitalized as part of the cost of an asset, if that asset is one which necessarily takes a substantial time to get ready for its intended use or sale. Costs of borrowing on the above stated items are not considered within the scope of IAS 23. Hence, such costs are not capitalized.

DEFINITIONS
Borrowing Costs
These are interest and other costs that an entity incurs in connection with the borrowing of funds.
Qualifying Assets
These are assets that necessarily takes a substantial period of time to get ready for its intended use or sale.

Wait! Don’t get it twisted
Examples of Borrowing Costs are:
-  Interest on bank overdrafts and short-term and long-term borrowings (including intercompany borrowings).
-      Amortization of discounts or premiums relating to borrowings.
-      Amortization of ancillary costs incurred in connection with the arrangement of borrowings
-      Finance charges in respect of finance leases
-      Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Examples of Qualifying Assets are:
-      Inventories (that are not produced over a short period of time)
-      Manufacturing plants
-      Power generation facilities
-      Intangible assets
-      Investment properties

Financial assets, and inventories that are manufactured, or otherwise produced, over a short
period of time, are not qualifying assets. Also, assets that are ready for their intended use or sale when acquired are not qualifying assets.

RECOGNITION
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 when:
ü  It is probable that they will result in future economic benefits, and
ü  The costs can be measured reliably
An entity shall recognize other borrowing costs as an expense in the period in which it incurs them.

MEASUREMENT
Capitalization of Borrowing Costs
Only borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset must be capitalized as part of the cost of that asset. All other borrowing costs are recognized as an expense in the period in which they are incurred.
Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset are those that would have been avoided if the expenditure on the qualifying asset had not been made.
Borrowing costs include the costs associated with either specific loans or general borrowings taken to fund the production or purchase of an asset.

Wait! Don’t get it twisted
Funds specifically borrowed to obtain a qualifying asset
When a specific loan is taken in order to obtain a qualifying asset, the borrowing costs eligible for capitalization are the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
General funds used for the purpose of obtaining a qualifying asset.
When general borrowings are used, the amount of borrowing costs eligible for capitalization is obtained by applying a capitalization rate to the expenditures on that asset.
The capitalization rate is the weighted average of the borrowing costs applicable to the borrowings that are outstanding during the period except for borrowings made specifically for the purpose of obtaining a qualifying asset.
General borrowings are included because if an asset were not being constructed it stands to reason that there would have been a lower need for cash.


Note that when computing the borrowing cost for an asset funded with specific borrowing, such borrowing cost will not be pro-rated, regardless of when the payment (spending of the fund) is made. It will only be prorated if the amount was incurred during the year (that is, less than twelve months).
Pro-ration of borrowing cost is made on assets funded by general borrowings as payment (spending of the fund) is made to fund the assets.

The amount of borrowing costs capitalized cannot exceed the amount of borrowing costs an entity incurred during a period.


Commencement of Capitalization
Capitalization of borrowing costs shall commence when:
Ø  Expenditures for the asset are being incurred;
Ø  Borrowing costs are being incurred; and
Ø  Activities necessary to prepare the asset for its intended use or sale are in progress.

Suspension of Capitalization
Capitalization shall be suspended during extended periods in which active development is interrupted. Unless that period is a necessary part of the process for the production of the asset. For example, capitalization would be suspended during an interruption to the construction of a bridge during very high water levels, which are common in the area where construction is taking place.
However, capitalization of borrowing costs should not be suspended when there is only a temporary delay that is caused by certain expected and anticipated reasons, such as while an asset is getting ready for its intended use.

Cessation of Capitalization
Capitalization should cease when:
Ø  The asset is materially ready for its intended use or sale; or
Ø  Construction is completed in part and the completed part can be used independently.

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