Recognition – Ind AS 23

  • 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
  • Such borrowing costs are capitalized as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably
  • An entity shall recognize other borrowing costs as an expense in the period in which it incurs them

Borrowing costs eligible for capitalization:

  • The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made
  • When an entity borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that qualifying asset can be readily identified

Question:

As per Ind AS 23, Borrowing Costs are always capitalized, when they are directly attributable to the acquisition, construction or production of any asset as part of the cost of that asset. True / False?

Answer

True: Per Ind AS 23, The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset and not any asset are those borrowing costs which are eligible for capitalization.

Question:

As per Ind AS 23 Borrowing Cost, an entity has an option to treat as an expense Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset. True / False?

Answer

True: Per Ind AS 23, It is not an option but the mandate to capitalize the borrowing cost pertaining to the acquisition, construction or production of a qualifying asset.

Ind AS 23 differentiates between capitalizing borrowing costs on general borrowings and specific borrowings as follows:

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Direct correlation between borrowings and qualifying assets difficult to establish:

  • There may be circumstances where it may be difficult to identify a direct relationship between particular borrowings and qualifying assets
  • Such circumstances may include the following
  • Financing activity of an entity is coordinated centrally
  • When a group uses a range of debt instruments to borrow funds at varying rates of interest and lends those funds to other entities in the group
  • When entity uses loans denominated in or linked to foreign currencies, when the group operates in highly inflationary economies and high fluctuations in exchange rates arises
  • As a result, the determination of the amount of borrowing costs that are directly attributable to the acquisition of a qualifying asset is difficult and the exercise of judgment is required

Funds borrowed specifically:

  • To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings

Temporary investment of funds borrowed for a qualifying asset:

  • The financing arrangements for a qualifying asset may result in an entity obtaining borrowed funds and incurring associated borrowing costs before some or all of the funds are used for expenditures on the qualifying asset
  • In such circumstances, the funds are often temporarily invested pending their expenditure on the qualifying asset
  • In determining the amount of borrowing costs eligible for capitalization during a period, any investment income earned on such funds is deducted from the borrowing costs incurred

Example:  Financing through specific borrowings

On 1st May 2019, XYZ took a loan of Rs. 50 lacs from a bank at an annual interest rate of 11%. The purpose of this loan was to finance a construction of a production building.

The construction started on 1 June 2019. XYZ temporarily invested Rs.40 lacs borrowed money during the months of June and July 2019 at the rate of 5% p.a.

What borrowing cost can be capitalized in 2019-20? (Assume all interest was paid).

Answer:

Although the funds were withdrawn on 1st May, the capitalization can start only on 1st June 2019 when all criteria were met (the construction had not started until 1st June).

Working:

  • Interest expense: Rs. 50 lacs x 11% x 10/12 = Rs. 458,333
    Less investment income: Rs. 40 lacs x 5% x 2/12 = Rs. 33,333
  • Total borrowing cost to capitalize in 2019-20: Rs. 425,000

We should keep in mind that the borrowing cost in May 2019 is expensed in statement of profit and loss, as the capitalization criteria were not met in that period.

Funds borrowed generally:

  • To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization by applying a capitalization rate to the expenditures on that asset
  • The capitalization rate shall be the weighted average of the borrowing costs applicable to all borrowings of the entity that are outstanding during the period
  • However, an entity shall exclude from this calculation borrowing costs applicable to borrowings made specifically for the purpose of obtaining a qualifying asset until substantially all the activities necessary to prepare that asset for its intended use or sale are complete
  • Because, once an asset is ready for its intended use, it more remains a qualifying asset and hence, it does not remain eligible for the capitalization of the borrowing costs
  • The amount of borrowing costs that an entity capitalizes during a period shall not exceed the amount of borrowing costs it incurred during that period
  • General borrowings are those funds that are obtained for various purposes and they are used (apart from these other purposes) also for the acquisition of a qualifying asset
  • In this case, you need to apply so-called capitalization rate to the borrowing funds on that asset, calculated as the weighted average of the borrowing costs applicable to general pool

Example – Financing through general borrowings

PQR Corp. finances the construction of its new headquarters through funds it borrows generally. The average outstanding balances of these general borrowings for the year are:

  • Rs. 5,000M at 4% per annum; and
  • Rs. 3,000M at 5% per annum.

PQR incurs Rs. 350M of interest expense (Rs. 5,000M × 4% + Rs. 3,000M × 5%) for the year.

The capitalization rate is the weighted average of borrowing costs divided by the total general borrowings: 4.375% (Rs. 350M / Rs. 8,000M).

Expenditure on the building starts April 1, 2019 and is not complete at year-end i.e. March 31, 2020, and the average carrying amount of the building during the year (i.e. general borrowed funds used for building purpose) is Rs. 4,000M.

XYZ therefore capitalizes Rs. 175M (Rs. 4,000M × 4.375%) of borrowing costs for the year.

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