Session 10

IAS 23 Borrowing Costs

FOCUS
This session covers the following content from the ACCA Study Guide.

B. Accounting for Transactions in Financial Statements

1. Tangible non-current assets
a) Define and compute the initital measurement of a non-current asset (including
a self-constructed asset and borrowing costs).

Session 10 Guidance
Know how to describe and identify qualifying assets as defined in IAS 23 (s.3.1).
Learn the advantages and disadvantages to expensing and capitalising interest (s.1.2).
Calculate the amount of interest which should be capitalised under IAS 23 (s.3).

(continued on next page)

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VISUAL OVERVIEW
Objective: To describe the accounting treatment of borrowing costs.

IAS 23
Issue
Arguments
Scope
Terminology

ACCOUNTING TREATMENT
Recognition
Disclosure

CAPITALISATION ISSUES
Qualifying Assets
Borrowing Costs Eligible
Commencement
Suspension
Cessation

Session 10 Guidance
Comprehend that "Borrowing Costs" is a relatively straightforward topic. Some borrowing costs
may be capitalised as a direct cost of constructing a qualifying asset that is then accounted for
under IAS 16 (see Session 9).

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Session 10 IAS 23 Borrowing Costs F7 Financial Reporting

1 IAS 23

1.1 Issue
Companies borrow to finance their activities. Companies pay
interest (finance charges) on the amounts borrowed.
How should such debits for interest be recognised in the
financial statements: *Capitalising an asset
always as an expense; or defers recognition in
the profit or loss to a
are there circumstances which justify capitalisation as
later period.
an asset?*

1.2 Arguments

CAPITALISATION OF INTEREST
Arguments for
Accruals: Better matching
of cost (interest) to benefit
(use of asset).
Comparability is improved.
Better comparison between
companies which buy the
assets and those which
construct.
Consistency: Interest
treated as any other costs.
Arguments against
Accruals: Benefit is use of
money. Interest should be
reflected in profit or loss
in the period for which the
company has the use of the
cash.
Comparability is distorted.
Similar assets at different
costs depending on the
method of finance.
Consistency: Interest
treated differently from
period to period.
Reported profit distorted.

1.3 Scope
IAS 23 is applied to account for borrowing costs.
The standard does not apply to qualifying assets which are
measured at fair value (e.g. under IAS 41 Agriculture).
Any inventories manufactured in large quantities and on a
repetitive basis are not qualifying assets. IAS 41 is examinable
with effect from
December 2014 (see
Session 7).

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F7 Financial Reporting Session 10 IAS 23 Borrowing Costs

1.4 Terminology

Borrowing costsinterest and other costs incurred by an entity in

connection with the borrowing of funds.
Qualifying assetan asset which necessarily takes a substantial
period of time to get ready for its intended use or sale.

The following may fall within the definition of borrowing

costs:
Interest expense calculated using the effective interest
method (IAS 39), which may include:
amortisation of discounts or premiums related to
borrowings; or
amortisation of any directly attributable costs related
to borrowings.
Finance charges with respect to finance leases (IAS 17).
Exchange differences arising from foreign currency
borrowings to the extent they are regarded as an
adjustment to interest costs (IAS 21).
Preference dividend when preference capital is classed
as debt.

2 Accounting Treatment

2.1 Recognition

Borrowing costs which relate to a qualifying asset must be

capitalised as part of the cost of that asset.

All other borrowing costs must be recognised as an expense in

the period in which they are incurred.

2.2 Disclosure
The amount of borrowing costs capitalised in the period.
The capitalisation rate used.

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Session 10 IAS 23 Borrowing Costs F7 Financial Reporting

3 Capitalisation Issues

3.1 Qualifying Assets

Borrowing costs which are directly attributable to the acquisition,

construction or production of a qualifying asset are capitalised as part
of the cost of that asset.

The amount of borrowing costs eligible for capitalisation is

determined in accordance with IAS 23.
A qualifying asset is an asset which necessarily takes a
substantial period of time to get ready for its intended use or
sale.

3.1.1 Examples of qualifying assets: 3.1.2 Examples of assets which do

Inventories which require a substantial
period of time to bring them to a
saleable condition (e.g. whisky)
Manufacturing plant
Power generation facilities
Investment properties.
not qualify:
Inventories routinely manufactured or
otherwise produced in large quantities
on a repetitive basis over a short period
of time.
Assets ready for their intended use or
sale when acquired.

3.2 Borrowing Costs Eligible for Capitalisation

3.2.1 Specific Borrowings
When an entity borrows specifically for the purpose of Directly attributable
funding an asset the identification of the borrowing costs is borrowing costs
straightforward: costs which would
the amount capitalised is the actual borrowing costs; less have been avoided if
the expenditure on the
any income earned on the temporary investment of those
qualifying asset had
borrowings. not been made.
3.2.2 Establishing a Direct Relationship
It is sometimes difficult to establish a direct relationship
between asset and funding.*
For example:
when financing activity is coordinated centrally;
*Judgement is
when a range of debt instruments with varying interest therefore required.
rates are used by a group company and lent to other
members of the group; or
when borrowings are in a foreign currency in a high-
inflation economy.

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F7 Financial Reporting Session 10 IAS 23 Borrowing Costs

3.2.3 Funds Borrowed Generally

The amount of borrowing costs eligible for capitalisation is

determined by applying a capitalisation rate to the expenditures
on that asset.

The capitalisation rate is the weighted average borrowing

cost for the entity's borrowings during the period, excluding
specific borrowing.* *The amount
In some circumstances, it is appropriate to include all capitalised during a
period clearly cannot
borrowings of the parent and its subsidiaries when computing
exceed the amount
a weighted average of the borrowing costs; in other
incurred.
circumstances, it is appropriate for each subsidiary to use a
weighted average of the borrowing costs applicable to its own
borrowings.

Example 1 Capitalisation Rates

An entity has three sources of borrowing in the period.

Outstanding liability Interest charge

$000 $000
7-year loan 8,000 1,000
25-year loan 12,000 1,000
Bank overdraft 4,000 (average) 600

Required:
(a) Calculate the appropriate capitalisation rate if all of the borrowings
are used to finance the production of qualifying assets but none of the
borrowings relate to a specific qualifying asset.
(b) If the seven-year loan is an amount which can be specifically identified
with a qualifying asset, calculate the rate which should be used on the
other assets.
Solution
(a) Capitalisation rate =

(b) Capitalisation rate =

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Session 10 IAS 23 Borrowing Costs F7 Financial Reporting

3.3 Commencement of Capitalisation

Capitalisation commences:
expenditures for the asset are being incurred;
borrowing costs are being incurred; and
activities which are necessary to prepare the asset for its
intended use or sale are in progress.
Expenditures on a qualifying asset include only:
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.
The average carrying amount of the asset during a period,
including borrowing costs previously capitalised, is normally
a reasonable approximation of the expenditures to which the
capitalisation rate is applied in that period.

Activities Included Activities Excluded

Physical construction of the Holding an asset when

asset.
Technical and administrative
work before physical
construction commences
(e.g. obtaining planning
permission).
there is no production or
development which changes
its condition (e.g. land
acquired and held without
any associated development
activity).

3.4 Suspension of Capitalisation

Capitalisation is suspended during extended periods in which
active development is interrupted.
Capitalisation is not normally suspended:* *For example,
during a period when substantial technical and capitalisation continues
during the extended
administrative work is being carried out; or
period needed
when a temporary delay is a necessary part of the process for inventories to
of getting an asset ready for its intended use or sale. mature or where high
water levels delay
construction of a
bridge, if high waters
are common during
the construction period
in the geographic
region involved.

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F7 Financial Reporting Session 10 IAS 23 Borrowing Costs

3.5 Cessation of Capitalisation

Capitalisation ceases when "substantially all" the activities necessary

to prepare the qualifying asset for its intended use or sale are
completed.

An asset is normally ready for its intended use or sale when

the physical construction of the asset is complete even
though routine administrative work might still continue.
If minor modifications are all that are outstanding (e.g.
interior decoration of a property to the purchaser's or user's
specification), this indicates that substantially all the activities
are complete.
When a construction is completed in parts and each part is
capable of being used while construction continues on other
parts, capitalisation ceases when substantially all the activities
necessary to prepare each part are completed.

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 Summary
Compliance with IAS 23 is not mandatory for:
qualifying assets measured at fair value (e.g. IAS 41); or
"mass produced" inventories.
Borrowing costs include:
interest expense calculated by the effective interest method (IAS 39);
nance charges (IAS 17); and
exchange differences on foreign currency borrowings.
A "qualifying asset" takes a substantial amount of time to be ready for its intended use or
sale. Includes "made-to-order" inventories.
Borrowing costs directly attributable to a qualifying asset must be capitalised. Other
borrowing costs are expensed when incurred.
For specific funds, costs eligible for capitalisation are actual costs incurred less any income
from temporary investment.
For general funds, apply a capitalisation rate (weighted average borrowing cost) to
expenditures.
Capitalisation:
commences when expenditure, borrowing and activities are in progress;
is suspended when active development is interrupted; and
ceases when substantially all activities are complete.

Session 10 Quiz
Estimated time: 10 minutes

1. Define a qualifying asset in accordance with IAS 23. (1.4)

2. Specify what would be included within the definition of borrowing costs. (1.4)

3. Describe the type of borrowing costs which may be capitalised according to the standard.
(3.1, 3.2)

4. State when the capitalisation of borrowing costs should commence. (3.3)

5. Assume that a company is required to capitalise borrowing costs relating to the acquisition or
construction of a qualifying asset; state the point in time at which the borrowing costs can no
longer be capitalised. (3.5)

Study Question Bank

Estimated time: 35 minutes

Priority Estimated Time Completed

MCQs - Session 10 20 minutes

Q24 Dawes 15 minutes

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 Session 10

EXAMPLE SOLUTION

Solution 1Capitalisation Rates

(a) Capitalisation rate
1,000,000 + 1,000,000 + 600,000
= 10.8%
8,000,000,+ 12,000,000 + 4,000,000

(b) Capitalisation rate

1,000,000 + 600,000
= 10%
12,000,000 + 4,000,000

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