Objective and Scope – Ind AS 23

Objective

• Ind AS 23 “Borrowing Costs” prescribes the accounting treatment of borrowing costs (which are interest and other costs that an entity incurs in connection with the borrowing of funds), the circumstance in which the borrowing cost will be capitalized and when it will be recognized as expense

Scope

• An entity shall apply this Standard in accounting for borrowing costs
• 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 within the scope of Ind AS 41 Agriculture; or
• Inventories that are manufactured or otherwise produced, in large quantities on a repetitive basis
• The Standard also does not deal with the actual or imputed cost of equity, including preferred capital not classified as a liability

Question:

Imputed cost of equity may not be eligible for capitalization as borrowing costs under Ind AS 23? True / False?

Answer

True. Imputed cost of equity has been specifically excluded from the scope of application of Ind AS 23.

Question:

A subsidiary finance a qualifying asset through a capital increase, which is provided by the parent company. Can a notional amount of borrowing costs be capitalized in the separate financial statements of the subsidiary? Yes / No?

Answer

Yes. Notional amount cannot be capitalized as the subsidiary has not incurred any borrowing costs. The standard does not deal with actual or imputed cost of equity.

Core Principle

• Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset
• Other borrowing costs are recognized as an expense

What is a Qualifying Asset?

• It is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale
• We should note here that Ind AS 23 does not mention that it must necessarily be an item of a property, plant and equipment under IAS 16
• It can include some inventories or intangibles, too! What means to be a “substantial period of time” is not defined precisely in Ind AS 23, so here one needs to apply some judgment
• Normally, if an asset takes more than 1 year to be ready, then it would be qualifying but, this may vary depending on the given facts and circumstances
• Management exercises judgment when determining which assets are qualifying assets, taking into account, among other factors, the nature of the asset
• Once management chooses the criteria and type of assets, it applies this consistently to those types of asset
• Management discloses in the notes to the financial statements, when relevant, how the assessment was performed, which criteria were considered, and which types of assets are subject to capitalization of borrowing costs

What can / cannot be a qualifying asset?

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

What is a Borrowing cost?

• Borrowing costs are
• interest and other costs
• that an entity incurs in connection with the borrowing of funds

Question:

An entity has no borrowings and uses its own cash resources to finance the construction of property, plant and equipment. Cash being used to finance the construction could, otherwise have been used to earn interest. Can management capitalize a ‘notional’ borrowing cost representing the opportunity cost of the cash employed in financing the asset’s construction? Yes / No?

Answer

Yes: A ‘notional’ borrowing cost cannot be capitalized. Ind AS 23 limits the amount that can be capitalized to the actual borrowing costs incurred.

 

What are the constituents of Borrowing cost?

• Borrowing costs may include
• interest expense calculated using the effective interest method as described in Ind AS 109, Financial Instruments
• interest in respect of lease liabilities recognized in accordance with Ind AS 116, Leases; and
• exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs
• To understand in depth the third and the last constituent of borrowing cost as illustrated above, we shall learn the manner of arriving at the adjustments with regard to exchange difference to be treated as borrowing costs as follows

Exchange difference as borrowing costs

Manner of arriving at the adjustments with regard to exchange difference to be treated as borrowing costs

• the adjustment should be of an amount which is equivalent to the extent to which the exchange loss does not exceed the difference between the
• cost of borrowing in functional currency when compared to
• the cost of borrowing in a foreign currency.
• where there is an unrealized exchange loss which is treated as an adjustment to interest and subsequently there is a realized or unrealized gain in respect of the settlement or translation of the same borrowing, the gain to the extent of the loss previously recognized as an adjustment should also be recognized as an adjustment to interest
• Crux: If the exchange loss arising due to restatement of foreign liability is less than interest saving amount (Difference between cost of borrowing in functional currency when compared to cost of borrowing in a foreign currency), then the entire amount to be considered as Borrowing cost

Example:

KLM Limited (Indian Company) has imported goods worth $ 1,00,000 from US at the rate of 65 (Year -2018) by taking a foreign currency loan. The interest rate is 8% P.A at the end of the year. An equivalent borrowing in INR would carry an interest rate of 14% P.A. The exchange rates for the years are given below:

March 2019- 1$ – Rs 70

March 2020- 1$ – Rs 64

FY 2018-19

Calculation of Foreign Exchange loss:

Calculation of Interest differential:

Adjustment to Borrowing Cost:

• The adjustment should be of an amount which is equivalent to the extent to which the exchange loss does not exceed the difference between the cost of borrowing in functional currency when compared to the cost of borrowing in a foreign currency

Statement of Profit and Loss Account for FY 2018-19

FY 2019-20

Calculation of Foreign Exchange gain:

Statement of Profit and Loss Account for FY 2019-20

• Where there is an unrealized exchange loss which is treated as an adjustment to interest and subsequently there is a realized or unrealized gain in respect of the settlement or translation of the same borrowing, the gain to the extent of the loss previously recognized as an adjustment should also be recognized as an adjustment to interest