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.
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.
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:
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.
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:
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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