CHAPTER 17
BORROWING COSTS
PAS 23
TECHNICAL KNOWLEDGE
To know the concept of qualifying asset for purposes of capitalization of
borrowing costs.
To understand the proper accounting treatment of borrowing costs.
To distinguish specific borrowing and general borrowing in relation to
capitalization of borrowing costs.
BORROWING COSTS
Under PAS 23, paragraph 5, borrowing costs are defined as interest and other
costs that an entity incurs in connection with borrowing of funds.
In other words, as the term suggests, borrowing costs are interest costs
incurred as a result of borrowings from banks and other fir’ancial institutions.
Borrowing can be classified as specific borrowing and general borrowing.
A specific borrowing is intended specifically in acquiring a qualifying asset.
A general borrowing is intended partly in acquiring a qualifying asset and
partly for general or working capital purposes.
Qualifying asset
A qualifying asset is an asset that necessarily takes a substantial period of
time to get ready for the intended use or sale.
Examples include the following:
a. Manufacturing plant
b. Power generation facility
c. Intangible asset
d. Investment property
PAS 23 requires that borrowing costs incurred in connection with acquisition
of a qualifying asset should be capitalized as cost of the qualifying asset.
Excluded from capitalization
PAS 23 does not require capitalization of borrowing costs relating to the
following assets not considered as qualifying asset:
a. Asset measured at fair value, such as biological asset
b. Inventory that is manufactured in large quantity on a repetitive basis,
such as maturing whisky, even if it takes a substantial period of time to
get ready for sale
c. Asset that is ready for the intended use or sale when acquired
Accounting for borrowing cost
PAS 23, paragraph. 8, mandates the following rules on borrowing cost:
1. If the borrowing is directly attributable to the acquisition, construction
or production of a qualifying asset, the borrowing cost is required to be
capitalized as cost of the asset.
In other words, the capitalization of borrowing cost is mandatory for a
qualifying asset.
2. All other borrowing costs shall be expensed as incurred.
In other words, if the borrowing is not directly attributable to a qualifying
asset, the borrowing cost is expensed immediately.
Asset financed by specific borrowing
PAS 23, paragraph 12, provides that if the funds are borrowed specifically for
the purpose of acquiring a qualifying asset, the amount of capitalizable
borrowing cost is the actual borrowing cost incurred during the period less
any investment income from the temporary investment of those borrowings.
Asset financed by general borrowing
PAS 23, paragraph 14, provides that if the funds are borrowed generally and
used for acquiring a qualifying asset, the amount of capitalizable borrowing
cost is equal to the average carrying expenditures on the asset during the
period multiplied by a capitalization rate or average interest rate.
However, the capitalizable borrowing cost shall not exceed the actual
interest incurred.
The capitalization rate or average interest rate is equal to the total annual
borrowing cost divided by the total general borrowings outstanding during
the period.
No specific guidance is provided for general borrowing with respect to
investment income.
Accordingly, any investment income from general borrowing is not deducted
from capitalizable borrowing cost.
The fraction Is developed from the number of months the expenditures are
outstanding from the date of expenditure to the end of the year.
The January 1 expenditures are outstanding for 12 months, the March 31
expenditures are outstanding for 9 months, the June 30 expenditures are
outstanding for 6 months and the September 30 expenditures are
outstanding for 3 months.
The capitalization rate is computed by dividing the total annual borrowing
cost by the total general borrowings.
Thus, P760,000 divided by P8,000,000 equals 9.5%.
The amount of capitalizable borrowing cost is the average expenditures on
the building multiplied by the capitalization rate.
Thus, P2,000,000 x 9.5% equals P190,000.
The capitalizable borrowing cost shall not exceed the actual borrowing cost.
The amount of P190,000 is the proper capitalizable borrowing cost because it
is less than the actual borrowing cost of P760,000.
The excess of P760,000 over P190,000 or P570,000 is charged to interest
expense
Asset financed both by specific and general borrowing
At the beginning of the current year, an entity borrowed P1,500,000 at an
interest of 10% specifically for the construction of a new building. The actual
borrowing cost on this loan is P150,000.
The entity had also outstanding during the year a 5-year 8% general
borrowing of P7,000,000.
The construction of the building started on January 1 and was completed on
December 31 of the current year.
The average expenditures are considered partly arising from specific
borrowing and partly from general borrowing.
The average expenditures are taken first from specific borrowing and the
balance from general borrowing.
Commencement of capitalization
The capitalization of borrowing costs as part of the cost of a qualifying asset
shall commence when the following three conditions are present:
a. When the entity incurs expenditures for the asset.
b. When the entity incurs borrowing costs.
c. When the entity undertakes activities that are necessary to prepare the
asset for the intended use or sale.
Cessation of capitalization
Capitalization of borrowing costs shall cease when substantially all the
activities necessary to prepare the qualifying asset for the intended use or
sale are complete.
An asset is normally ready for the intended use or sale when the physical
construction of the asset is complete even though routine administrative
work might still continue.
Disclosures related to borrowing costs
a. The amount of borrowing costs capitalized during the period.
b. The capitalization rate used to determine the amount of borrowing
costs eligible for capitalization.
Segregation of assets that are “qualifying assets” from other assets in the
statement of financial position is not required to be disclosed.