Commencement of capitalization – Ind AS 23
When to begin capitalization
- An entity shall start capitalizing borrowing costs as part of the cost of a qualifying asset on the commencement date
- The commencement date for capitalization is the date when the entity first meets all of the following conditions
- it incurs expenditures for the asset
- it incurs borrowing costs; and
- it undertakes activities that are necessary to prepare the asset for its intended use or sale
Example: Borrowing cost to be capitalized
On April 1, 2019, Compassionate Inc. began construction of homes for those families that were hit by the Typhoon and were homeless. The construction is expected to take 3.5 years. It is being financed by issuance of bonds for $7 million at 12% per annum. The bonds were issued at the beginning of the construction. The project is also financed by issuance of share capital with a 14% cost of capital. Compassionate Inc. has opted under IND AS 23 to capitalize borrowing costs. Compute the borrowing costs that need to be capitalized under IND AS 23 as at March 31, 2020.
Since these homes are “qualifying assets,” as per Ind AS 23, borrowing costs can be capitalized and are computed as follows:
nterest on $7 million bond = $7,000,000 × 12% = $840,000
Borrowing cost to be capitalized = $840,000
Actual or imputed cost of equity is out of the scope of Ind AS 23 and hence, it is irrelevant.
What expenditures are considered for cost of qualifying assets?
- Expenditures on a qualifying asset include only those expenditures that have resulted in payments of cash, transfers of other assets or the assumption of interest-bearing liabilities
- Expenditures are reduced by any progress payments received and grants received in connection with the asset (see Ind AS 20, Accounting for Government Grants and Disclosure of Government Assistance)
- The average carrying amount of the asset during a period, including borrowing costs previously capitalized, is normally a reasonable approximation of the expenditures to which the capitalization rate is applied in that period
Activities eligible for a Qualifying asset for the capitalization purpose:
- The activities necessary to prepare the asset for its intended use or sale encompass more than the physical construction of the asset
- They include technical and administrative work prior to the commencement of physical construction, such as the activities associated with obtaining permits prior to the commencement of the physical construction
- Such activities exclude the holding of an asset when no production or development that changes the asset’s condition is taking place
Activity leading to eligible borrowing cost for capitalization purpose:
- Borrowing costs incurred while land is under development are capitalized during the period in which activities related to the development are being undertaken.
Activity leading to ineligible borrowing cost for capitalization purpose:
- Borrowing costs incurred while land acquired for building purposes is held without any associated development activity do not qualify for capitalization.