DA 3513 – Financial Reporting Standards

ATI- Sammanthurai.
Lecturer in Charge: M.I.M.Feroze.
ACCA (UK), MBA (PIM-UJP), MBA (UCN- Financial Management), BBA (SEUSL), CIMA (UK), CBA (ICASL), Dip in IFRS (UK)

LKAS 23 / IAS 23 - Borrowing Costs

1. Introduction
LKAS 23 looks at the treatment of borrowing costs, particularly where the related borrowings are applied to the
construction of certain assets. These are what are usually called 'self-constructed assets', where an entity builds its
own inventory or non-current assets over a substantial period of time.

2. Definition
• Borrowing costs. Interest and other costs incurred by an entity in connection with the borrowing of funds.
• Qualifying asset. An asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
(LKAS 23)

3. What are the expenses may be included in Borrowing Costs?

• Interest on bank overdrafts and short-term and long-term borrowings
• Amortisation of discounts or premiums relating to borrowings
• Amortisation of ancillary costs incurred in connection with the arrangement of borrowings
• Finance charges in respect of finance leases recognised in accordance with LKAS 17
• Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an
adjustment to interest costs

4. What may be qualifying assets?

Depending on the circumstances, any of the following may be qualifying assets.
• Inventories
• Manufacturing plants
• Power generation facilities
• Intangible assets
• Investment properties

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 purchased are not qualifying assets.

5. Accounting treatment for borrowing Cost (or) Capitalisation of

Borrowing Costs.
Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset can be
capitalised as part of the cost of that asset. Other borrowing cost are recognised as expenses.

The standard lays out the criteria for determining which borrowing costs are eligible for capitalisation.

5.1 Borrowing costs eligible for capitalization

Those borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset must be
identified. These are the borrowing costs that would have been avoided had the expenditure on the qualifying asset not been
made. This is obviously straightforward where funds have been borrowed for the financing of one particular asset.

Difficulties arise, however, where the entity uses a range of debt instruments to finance a wide range of assets, so that there
is no direct relationship between particular borrowings and a specific asset. For example, all borrowings may be made
centrally and then lent to different parts of the group or entity. Judgement is therefore required, particularly where further
complications can arise (eg foreign currency loans).

M.I.M.Feroze - ACCA (UK), MBA (PIM-UJP), MBA (UCN- Financial Management), BBA (SEUSL), CIMA (UK), CBA (ICASL), Dip in IFRS (UK). Page 1 of 3
Once the relevant borrowings are identified, which relate to a specific asset, then the amount of borrowing costs available
for capitalisation will be the actual borrowing costs incurred on those borrowings during the period, less any investment
income on the temporary investment of those borrowings. It would not be unusual for some or all of the funds to be invested
before they are actually used on the qualifying asset.

5.2 Commencement of Capitalization of Borrwing Cost ( Conditions

that should be satisfied to commence Capitalization of Borrwing
Cost)
Three events or transactions must be taking place for capitalisation of borrowing costs to be started.
(a) Expenditure on the asset is being incurred
(b) Borrowing costs are being incurred
(c) Activities are in progress that are necessary to prepare the asset for its intended use or sale

5.3 Suspension of capitalisation of Borrwing Cost

If active development is interrupted for any extended periods, capitalisation of borrowing costs should be suspended for
those periods.

Suspension of capitalisation of borrowing costs is not necessary for temporary delays or for periods when substantial
technical or administrative work is taking place.

5.4 Cessation of capitalisation of Borrwing Cost

Once substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete, then
capitalisation of borrowing costs should cease. This will normally be when physical construction of the asset is completed,
although minor modifications may still be outstanding.

The asset may be completed in parts or stages, where each part can be used while construction is still taking place on the
other parts. Capitalisation of borrowing costs should cease for each part as it is completed. The example given by the standard
is a business park consisting of several buildings.

6. Disclosure
The following should be disclosed in the financial statements in relation to borrowing costs.
(a) Amount of borrowing costs capitalised during the period
(b) Capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation

7. An Illustrative examples
Example -01:

M.I.M.Feroze - ACCA (UK), MBA (PIM-UJP), MBA (UCN- Financial Management), BBA (SEUSL), CIMA (UK), CBA (ICASL), Dip in IFRS (UK). Page 2 of 3
 Example -02:
Apex is a publicly listed supermarket chain. During the current year it started the building of a new store. The directors are
aware that in accordance with LKAS 23 Borrowing costs certain borrowing costs have to be capitalised.
Required:
Explain the circumstances when, and the amount at which, borrowing costs should be capitalised in accordance with LKAS
23.
Answers to Example- 02
‘Qualifying’ borrowing costs are borrowing costs incurred in the construction of qualifying assets. These are assets that
necessarily take a substantial period of time to get ready for intended use or sale. Since the revision of LKAS 23, qualifying
borrowing costs now must be capitalised.

Where funds are borrowed specifically to finance the construction of a qualifying asset, the amount eligible for
capitalisation will be the borrowing costs incurred at the effective rate of interest, less any investment income earned on
the temporary investment of those borrowings.

Where funds are borrowed generally and the borrowings attributable to a particular asset cannot be readily identified, the
amount eligible for capitalisation will have to be estimated by applying a weighted capitalisation rate to the funds used in
constructing the asset.

Capitalisation commences when expenditure and necessary activities begin on the asset and borrowing costs are incurred.
Capitalisation is suspended during any period in which activities on the asset are suspended and it ceases when
substantially all activities necessary to prepare the asset for its intended use or sale are complete.

Example -03:
Details relating to construction of Apex’s new store:
Apex issued a $10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1 April 20X8. The loan is redeemable
at a premium which means the loan has an effective finance cost of 7·5% per annum.

The loan was specifically issued to finance the building of the new store which meets the definition of a qualifying asset in
IAS 23. Construction of the store commenced on 1 May 20X8 and it was completed and ready for use on 28 February 20X9,
but did not open for trading until 1 April 20X9. During the year trading at Apex’s other stores was below expectations so
Apex suspended the construction of the new store for a two month period during July and August 20X8. The proceeds of the
loan were temporarily invested for the month of April 20X8 and earned interest of $40,000.

Required:
Calculate the net borrowing cost that should be capitalised as part of the cost of the new store and the finance cost that
should be reported in profit or loss for the year ended 31 March 20X9. (5 marks)

Question Practice:
HNDA 3102 FR Past Questions - 2018 Q 05 (i) , (ii) , (iii) & (iv) - (13 Marks), 2017 Q 02 (i) , (ii) , & (iii) - (14
Marks), 2015 Q 03 (i),(ii) & (iii) (12 Marks), 2014 Q 01 (iii), (iv) & (v)- (8 Marks).

M.I.M.Feroze - ACCA (UK), MBA (PIM-UJP), MBA (UCN- Financial Management), BBA (SEUSL), CIMA (UK), CBA (ICASL), Dip in IFRS (UK). Page 3 of 3