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ACCOUNTING STANDARD 16
BORROWING COST
BORROWING COSTS:
Borrowing costs are interest and other costs incurred by an enterprise in connection with the
borrowing of funds.
As per Para 4 of AS 16 on Borrowing Costs, borrowing costs may include:
(a) Interest and commitment charges on borrowings.
(b) Amortisation of discounts on issue of debenture or bond but not shares.
(c) Amortisation of premiums on redemption of debenture or bond.
(d) Amortisation of ancillary costs incurred in connection with borrowings e.g., fees to CA for
arranging loans;
(e) Exchange differences arising from foreign currency borrowings to the extent that they are
regarded as an adjustment to interest costs.
Note:
1 Borrowing cost does not include the actual or imputed cost of owners’ capital (i.e, equity
&preference share capital.
2 Prepayment fee paid for liquidating high cost debt and availing low cost debt is not borrowing
cost.
Examples – borrowing costs
Ex 1 An entity incurs interest at the fixed rate of 5 per cent per year on a Rs. 100,000loan from a
local bank.
Ans: The 5 per cent interest on the loan is a borrowing cost.
Ex 2 An entity issued a Rs. 100,000 debenture to a local bank. The debenture contract requires the
entity to pay the local bank Rs. 134,010 to redeem the debenture (ie Rs. 100,000 repayment
of capital and Rs. 34,010 premium) at the end of the sixth year. The debenture has a coupon
of zero (ie it is ‘interest-free’).
Ans: The amortisation of the redemption premium is a borrowing cost.
Ex 3 An entity incurred Rs. 1,000 legal fees to raise a Rs. 100,000 loan that bears interest at the
fixed rate of 5 per cent per year. The principal of the loan is repayable at the end of the sixth
year.
Ans: The interest on the loan is a borrowing cost. Furthermore, the amortisation of the legal fees
(ancillary cost incurred to arrange the borrowing) is a borrowing cost.

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TREATMENT OF BORROWING COSTS:

Recognition
Principle 1: An entity shall capitalise borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset as part of the cost of that asset.
Principle 2: An entity shall recognise other borrowing costs as an expense in the period in which it
incurs them.

Borrowing costs

Directly attributable to the

- acquisition,
- construction or Other borrowing osts
- production
of a Qualifying Asset

Capitalised to the cost of qualifying Recognised as an expense in the

assets period in which they are incurred

Directly attributable costs are those costs that would have been avoided if the expenditure on the
qualifying assets had not been made.
Qualifying Asset:
Qualifying Asset is an asset that necessarily takes a substantial period of time to get ready
 for its intended use { Fixed assets or Investment properties } or
 for its sale { Inventory }
Substantial Period of Time:
What constitutes a substantial period of time primarily depends on the facts and circumstances of
each case. However, ordinarily, a period of twelve months is considered as substantial period of time
unless a shorter or longer period can be justified on the basis of facts and circumstances of the case.
In estimating the period, time which an asset takes, technologically and commercially, to get it ready
for its intended use or sale should be considered.

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The following assets ordinarily take twelve months or more to get ready for intended use or sale
unless the contrary can be proved by the enterprise:
1. Assets that are constructed or otherwise produced for an enterprise’s own use, e.g., assets
constructed under major capital expansions.
2. Assets intended for sale or lease that are constructed or otherwise produced as discrete
projects (for example, ships or real estate developments).
In case of inventories, substantial period of time is considered to be involved where time is the major
factor in bringing about a change in the condition of inventories. Those inventories that are routinely
manufactured or otherwise produced in large quantities on a repetitive basis over a short period of
time, are not qualifying assets. For example, liquor is often required to be kept in store for more than
twelve months for maturing. Assets that are ready for their intended use or sale when acquired also
are not qualifying assets.

COMMENCEMENT, SUSPENSION & CESSATION OF CAPITALISATION

Commencement of Capitalisation:
The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when
all the following conditions are satisfied:
(a) expenditure for the acquisition, construction or production of a qualifying asset is being
incurred;
(b) borrowing costs are being incurred; and
(c) activities that are necessary to prepare the asset for its intended use or sale are in progress.
Note: The activities necessary to prepare the asset include technical and administrative work prior
to the commencement of physical construction, such as obtaining permits prior to the
commencement of the physical construction.
For example,
a) borrowing costs incurred while land is under development are capitalised during the period
in which activities related to the development are being undertaken.
b) borrowing costs incurred while land acquired for building purposes is held without any
associated development activity do not qualify for capitalisation.
Suspension of Capitalisation of Borrowing Cost:
Capitalisation of borrowing cost should be suspended during the extended period in which active
development is interrupted.
Exception:
1. An entity does not normally suspend capitalising borrowing costs during a period when it
carries out substantial technical and administrative work.

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2. An entity also does not suspend capitalising borrowing costs when a temporary delay is a
necessary part of the process of getting an asset ready for its intended use or sale.
For example: Capitalisation continues during the extended period that high water levels delay
construction of a bridge, if such high water levels are common during the construction period
in the geographical region involved.
Cessation of capitalisation: [Nov 2002]
Capitalisation of borrowing costs should cease when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete.
Note: When the construction of a qualifying asset is completed in parts and a completed part is
capable of being used while construction continues for the other parts, capitalisation of borrowing
costs in relation to a part should cease when substantially all the activities necessary to prepare that
part for its intended use or sale are complete.

AMOUNT OF BORROWING COST ELIGIBLE FOR CAPITALISATION

Specific Borrowing: 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 capitalisation as the actual borrowing costs incurred on
that borrowing during the period less any investment income on the temporary investment of those
borrowings.
Calculation of borrowing cost to be capitalised
Actual borrowing cost incurred during the period XXX
Less: Income on temporary investment of Borrowed Funds XXX
Borrowing cost to be capitalised XXX
General Borrowing: 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 capitalisation by applying a capitalisation rate to the expenditures on that asset.
The capitalisation rate shall be the weighted average of the borrowing costs applicable to the
borrowings of the entity that are outstanding during the period, other than borrowings made
specifically for the purpose of obtaining a qualifying asset.
Calculation of borrowing cost to be capitalised
Borrowing cost to be capitalised = Capitalisation Rate X Expenditure on QA

Where, Capitalisation Rate = x 100

Note: Amount of borrowing cost capitalised during the period should not exceed the amount of
borrowing cost incurred during the period.

DISCLOSURE REQUIREMENTS AS PER AS-16:

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(1)The accounting policy adopted for borrowing costs; and

(2)The amount of borrowing costs capitalised during the period.

INTERPRETATION OF PARAGRAPH 4(e) OF AS 16

ISSUE: Paragraph 4 (e) of AS 16, ‘Borrowing Costs’, provides that borrowing costs may include
“exchange differences arising from foreign currency borrowings to the extent that they are regarded
as an adjustment to interest costs”. The issue is which exchange differences are covered under
paragraph 4 (e) of AS 16.
CONSENSUS: Paragraph 4 (e) of AS 16 covers exchange differences on the amount of principal of the
foreign currency borrowings to the extent of difference between interest on local currency
borrowings and interest on foreign currency borrowings.
For this purpose, the interest rate for the local currency borrowings should be considered as that rate
at which the enterprise would have raised the borrowings locally had the enterprise not decided to
raise the foreign currency borrowings. If the difference between the interest on local currency
borrowings and the interest on foreign currency borrowings is equal to or more than the exchange
difference on the amount of principal of the foreign currency borrowings, the entire amount of
exchange difference is covered under paragraph 4 (e) of AS 16.

QUESTIONS FROM ICAI SM

Q1 On 20.04.2003 JLC Ltd. obtained a loan from the Bank for Rs.50 lakhs to be utilized as under:
Construction of a shed Rs 20 lakh
Purchases of Machine Rs 15 lakh
Working Capital Rs 10 lakh
Advance for Purchases of Truck Rs.5 lakh
In March, 2004 construction of shed was completed and machinery installed. Delivery of truck
was not received. Total interest charged by the bank for the year ending 31.3.2004 was Rs 9
lakh. Show the treatment of interest under AS -16.
[Nov 2004; May 2011, Nov 2011, May 2014]
Ans: As per AS 16, borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset should be capitalized. A qualifying asset is an asset that
necessarily takes a substantial period of time (usually 12 months or more) to get ready for its
intended use or sale.
If an asset is ready for its intended use or sale at the time of its acquisition then it is not treated
as a qualifying asst for the purposes of AS-16.
Treatment of interest as per AS-16

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Particulars Nature Interest to be Interest to be charged to

capitalized profit and loss account

Construction Qualifying (Rs.9 lakhs x Rs 20 lakhs)

of a shed Assets /Rs.50 lakhs = 3.60 lakhs
Purchase of Not a qualifying (Rs 9 lakhs x Rs 15 lakhs) /Rs
machinery Assets (See 50 lakhs = Rs 2.70 lakhs
Note below)

Working Not qualifying (Rs 9 1akhs x Rs 10 lakhs)/Rs

Capital Assets 50 lakhs = Rs 1.80 lakhs

Advance for Not a qualifying (Rs 9 lakhs x Rs 5 lakhs)

purchase of Assets /Rs 50 lakhs = Rs 0.90 lakhs
trucks
Total Rs 3.60 lakhs Rs 5.40 lakhs

Note: On the basis that machinery is ready for its intended use at the time of its acquisition/
purchase.
Q2 The company has obtained Institutional Term Loan of Rs 580 lakhs for modernisation and
renovation of its Plant & Machinery. Plant & Machinery acquired under the modernisation
scheme and installation completed on 31st March, 2006 amounted to Rs 406 lakhs, Rs 58
lakhs has been advanced to suppliers for additional assets and the balance loan of Rs 116
lakhs has been utilised for working capital purpose. The Accountant is on a dilemma as to how
to account for the total interest of Rs 52.20 lakhs incurred during 2005-2006 on the entire
Institutional Term Loan of Rs 580 lakhs.
Ans: As per para 6 of AS 16 ‘Borrowing Costs’, borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset should be capitalized as part of
the cost of that asset. Other borrowing costs should be recognized as an expense in the period
in which they are incurred. Borrowing costs should be expensed except where they are
directly attributable to acquisition, construction or production of qualifying asset.
A qualifying asset is an asset that necessary takes a substantial period of time* to get ready
for its intended use or sale.
The treatment for total interest amount of Rs 52.20 lakhs can be given as:

Purpose Nature Interest to be Interest to be

Capitalized charged to P/L

[Link] Qualifying asset **52.20 × 406/580

= 36.54

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and renovation of plant

and machinery
[Link] to Qualifying asset **52.20 × 58/580
supplies for additional = 5.22
assets

[Link] Capital Not a Qualifying 52.20 × 116/58

asset =10.44

41.76 10.44

* Accounting Standards 16 deals with the meaning of expression ‘substantial period of time’. A
substantial period of time primarily depends on the facts and circumstances of each case.
However, ordinarily, a period of twelve months is considered as substantial period of time
unless a shorter or longer period can be justified on the basis of the facts and circumstance
of the case.
** It is assumed in the above solution that the modernization and renovation of plant and
machinery will take substantial period of time (i.e. more than twelve months). Regarding
purchase of additional assets, the nature of additional assets has also been considered as
qualifying assts. Alternatively, the plant and machinery and additional assets may be assumed
to be non-qualifying assets on the basis that the renovation and installation of additional
assets will not take substantial period of time. In that case, the entire amount of interest, Rs.
52.20 lakhs will be recognized as expense in the profit and loss account for year ended
31stMarch, 2006. [Nov 2016]
Q 3: Rainbow Limited borrowed an amount of Rs.150 crores on 1.4.2008 for construction of boiler
plant @ 11% p.a. The plant is expected to be completed in 4 years. Since the weighted average
cost of capital is 13% p.a., the accountant of Rainbow Ltd. capitalized Rs.19.50 crores for the
accounting period ending on 31.3.2009. Due to surplus fund, out of Rs.150 crores, an income
of Rs.3.50 crores was earned and credited to profit and loss account. Comment on the above
treatment of accountant with reference to relevant accounting standard.
Ans: AS 16 ‘Borrowing Costs’ states, “to the extent that funds are borrowed specifically for the
purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for
capitalisation on that asset should be determined as the actual borrowing costs incurred on
that borrowing during the period less any income on the temporary investment of those
borrowings.” The capitalisation rate should be the weighted average of the borrowing costs
applicable to the borrowings of the enterprise that are outstanding during the period, other
than borrowings made specifically for the purpose of obtaining a qualifying asset. Hence, in
the above case, treatment of accountant of Rainbow Ltd. is incorrect. The amount of
borrowing costs capitalized for the financial year 2008-2009 should be calculated as follows:
Actual interest for 2008-2009 (11% of Rs.150 crores) Rs.16.50 crores
Less: Income on temporary investment from specific borrowings Rs 3.50 crores

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Borrowing costs to be capitalized during year 2008-2009 Rs 13.00 crores

Q 4: Paras Ltd. had the following borrowings during a year in respect of capital expansion.
Plant Cost of Asset (Rs) Remarks
Plant P 100 lakhs No specific borrowings
Plant Q 125 lakhs Bank loan of Rs 65 lakhs at 10%
Plant R 175 lakhs 9% Debentures of Rs 125 lakhs were issued.
In addition to the specific borrowings stated above, the Company had obtained term loans
from two banks
(1) Rs 100 lakhs at 10% from Corporation Bank and
(2) Rs 110 lakhs at 11.50% from State Bank of India, to meet its capital expansion
requirements.
Determine the amount of borrowing costs to be capitalized in each of the above Plants, as per
AS-16.
Ans:
1. Computation of Actual Borrowing Costs incurred during the year
Source Loan Amount Interest Rate Interest Amount
Rs. in lakhs Rs. in lakhs
Bank Loan 65.00 10% 6.50
9% Debentures 125.00 9% 11.25
Term Loan from Corporation Bank 100.00 10% 10.00
Term Loan from State Bank of India 110.00 11.5% 12.65
Total 400.00 40.40
Specific Borrowings included in 190.00 17.75
above

2. Weighted Average Capitalisation Rate for General Borrowings

= x 100=22.65/210 x 100 = 10.79%

3 Capitalisation of Borrowing Costs under AS-16 will be as under:

Plant Borrowing Loan Amount Interest Rate Interest Amount Cost Asset
Rs. in lakhs Rs. in lakhs Rs. in lakhs Rs. in lakhs
P General 100 10.79% 10.79 110.79
110.79
Q Specific 65 10.00% 6.50 71.50
General 60 10.79% 6.47 66.47
137.97
R Specific 125 9.00% 11.25 136.25
General 50 10.79% 5.39 55.39
191.64

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Total 400 40.40 440.40

Note: The amount of borrowing costs capitalized should not exceed the actual interest cost.
Q 5: X Ltd. began construction of a new building on 1 stJanuary, 2007. It obtained Rs.1 lakh special
loan to finance the construction of the building on 1stJanuary, 2007 at an interest rate of 10%.
The company’s other outstanding two non–specific loans were:
Amount Rs.
Rs.5,00,000 11%
Rs.9,00,000 13%
The expenditure that were made on the building project were as follows:
Rs.
January 2007 2,00,000
April 2007 2,50,000
July 2007 4,50,000
December 2007 1,20,000
Building was completed by 31st December, 2007. Following the principles prescribed in AS–
16 ‘Borrowing Cost,’ calculate the amount of interest to be capitalized and pass one Journal
Entry for capitalizing the cost and borrowing cost in respect of the building.
Ans:
(i) Computation of average accumulated expenses
Rs.2,00,000 x 12 / 12 = 2,00,000
Rs. 2,50,000 x 9 / 12 = 1,87,500
Rs. 4,50,000 x 6 / 12 = 2,25,000
Rs. 1,20,000 x 1 / 12 = 10,000
6,22,500
(ii) Calculation of average interest rate other than for specific borrowings
Amount of loan (in Rs.) Rate of Amount of
interest interest (in
Rs.)
5,00,000 11% 55,000
9,00,000 13% 1,17,000
14,00,000 1,72,000
Weighted average rate of interest = (1,72,000/14,00,000)*100 = 12.285% (approx)
(iii) Interest on average accumulated expenses
Specific borrowings (Rs. 1,00,000 X 10%) = 10,000
Non-specific borrowings (Rs. 5,22,500* X 12.285%) = 64,189
Amount of interest to be capitalized = 74,189
*(Rs. 6,22,500 – Rs. 1,00,000)
(iv) Total expenses to be capitalized for building

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Cost of building Rs.(2,00,000 + 2,50,000 + 4,50,000 + 1,20,000) 10,20,000

Add: Amount of interest to be capitalised 74,189
10,94,189
(v) Journal Entry
Date Particulars Dr. (Rs.) Cr. (Rs.)
31.12.2007 Building account Dr. 10,94,189
-To Bank account
(Being amount of cost of
building and borrowing cost
thereon capitalized)

Q 6: XYZ Ltd. has taken a loan of USD 10,000 on April 1, 20X3, for a specific project at an interest
rate of 5% p.a., payable annually. On April 1, 20X3, the exchange rate between the currencies
was Rs. 45 per USD. The exchange rate, as at March 31, 20X4, is Rs. 48 per USD. The
corresponding amount could have been borrowed by XYZ Ltd. in local currency at an interest
rate of 11 per cent per annum as on April 1, 20X3. Calculate borrowing cost and exchange
loss. What will be your answer if interest rate on local currency borrowings is assumed to be
13%
Ans: The following computation would be made to determine the amount of borrowing costs for
the purposes of paragraph 4(e) of AS 16:
Interest for the period = USD 10,000 x 5%x Rs. 48/USD = Rs. 24,000/-
Increase in the liability towards the principal amount = USD 10,000 x (48-45) = Rs. 30,000/-
Interest that would have resulted if the loan was taken in Indian currency
= USD 10000 x 45 x 11%). = Rs. 49,500
Difference between interest on local currency borrowing and foreign currency borrowing
= Rs. 49,500 - Rs. 24,000 = Rs. 25,500
Therefore, out of Rs. 30,000 increase in the liability towards principal amount, only Rs. 25,500
will be considered as the borrowing cost. Thus, total borrowing cost would be Rs. 49,500 being
the aggregate of interest of Rs. 24,000 on foreign currency borrowings (covered by paragraph
4(a) of AS 16) plus the exchange difference to the extent of difference between interest on
local currency borrowing and interest on foreign currency borrowing of Rs. 25,500. Thus, Rs.
49,500 would be considered as the borrowing cost to be accounted for as per AS 16 and the
remaining Rs. 4,500 would be considered as the exchange difference to be accounted for as
per Accounting Standard (AS) 11, The Effects of Changes in Foreign Exchange Rates.
In the above example, if the interest rate on local currency borrowings is assumed to be 13%
instead of 11%, the entire exchange difference of Rs. 30,000 would be considered as
borrowing costs, since in that case the difference between the interest on local currency
borrowings and foreign currency borrowings (i.e., Rs. 34,500 (Rs. 58,500 - Rs. 24,000) is more
than the exchange difference of Rs. 30,000. Therefore, in such a case, the total borrowing cost
would be Rs. 54,000 (Rs. 24,000 + Rs. 30,000) which would be accounted for under AS 16 and
there would be no exchange difference to be accounted for under AS 11.

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Q 7: Take Ltd. has borrowed Rs. 30 lakhs from State Bank of India during the financial year 2016-
2017. The borrowings are used to invest in shares of Give Ltd., a subsidiary company of Take
Ltd., which is implementing a new project, estimated to cost Rs. 50 lakhs. As on 31st March,
2017, since the said project was not complete, the directors of Take Ltd. resolved to capitalise
the interest accruing on borrowings amounting to Rs. 4 lakhs and add it to the cost of
investments. Comment.
Ans: As per AS 13 (Revised) "Accounting for Investments", the cost of investment includes
acquisition charges such as brokerage, fees and duties. In the present case, Take Ltd. has used
borrowed funds for purchasing shares of its subsidiary company Give Ltd. Rs. 4 lakhs interest
payable by Take Ltd. to State Bank of India cannot be called as acquisition charges, therefore,
cannot be constituted as cost of investment.
Further, as per para 3 of AS 16 "Borrowing Costs", a qualifying asset is an asset that necessarily
takes a substantial period of time to get ready for its intended use or sale. Since, shares are
ready for its intended use at the time of sale, it cannot be considered as qualifying asset that
can enable a company to add the borrowing cost to investments. Therefore, the directors of
Take Ltd. cannot capitalise the borrowing cost as part of cost of investment. Rather, it has to
be charged to the Statement of Profit and Loss for the year ended 31st March, 2017.
Q8 On 1st April, 2009, Amazing Construction Ltd. obtained a loan of Rs 32 crores to be utilized as
under:
(i) Construction of sealink across two cities: (work was held up totally
for a month during the year due to high water levels): Rs 25 crores
(ii) Purchase of equipments and machineries : Rs 3 crores
(iii) Working capital: Rs 2 crores
(iv) Purchase of vehicles: Rs 50,00,000
(v) Advance for tools/cranes etc.: Rs 50,00,000
(vi) Purchase of technical know-how: Rs 1 crores
(vii) Total interest charged by the bank for the year ending 31.03.2010: Rs. 80 lacs
Show the treatment of interest by Amazing Construction Ltd. [Nov 2010]
Ans: According to para 3 of AS 16 ‘Borrowing costs’, qualifying asset is an asset that necessarily
takes substantial period of time to get ready for its intended use. As per para 6 of the
standard, borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset should be capitalised as part of the cost of that asset. Other
borrowing costs should be recognised as an expense in the period in which they are incurred.
The treatment of interest by Amazing Construction Ltd. can be shown as:

Qualifying Interest to Interest to be

Asset be capitalized charged to P/L A/c

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1 Construction of sea-link Yes 62,50,000

(80,00,000*(25/32
2 Purchase of equipments and No 7,50,000
machineries (80,00,000*(3/32)

3 Working capital No 5,00,000

(80,00,000*(2/32)
4 Purchase of vehicles No 1,25,000
(80,00,000*(.5/32)
5 Advance for tools, cranes etc. No 1,25,000
(80,00,000*(.5/32)
6 Purchase of technical know- No 2,50,000
how (80,00,000*(1/32)
Total 62,50,000 17,50,000

QUESTIONS FROM OTHER SOURCES

Q9 In May, 2004 Speed Ltd. took a bank loan to be used specifically for the construction of a new
factory building. The construction was completed in January, 2005 and the building was put
to its use immediately thereafter. Interest on the actual amount used for construction of the
building till its completion was Rs.18 lakh, whereas the total interest payable to the bank on
the loan for the period till 31st March, 2005 amounted to 25 lakh. Can Rs.25 lakh be treated
as part of the cost of factory building and thus be capitalized on the plea that the loan was
specifically taken for the construction of factory building?
Ans: AS 16 clearly states that capitalization of borrowing costs should cease when substantially all
the activities necessary to prepare the qualifying asset for its intended use are completed.
Therefore, interest on the amount that has been used for the construction of the building
upto the date of completion (January, 2005) i.e. Rs 18 lakhs alone can be capitalized. It cannot
be extended to Rs 25 lakhs.
Q 10 An industry borrowed Rs 40,00,000 for purchase of machinery on 1.6.2007. Interest on loan
is 9% per annum. The machinery was put to use from 1.1.2008. Pass journal entry for the year
ended 31.3.2008 to record the borrowing cost of loan as per AS 16. [May 2008]
Ans:
Interest upto 31.3.2008 (40,00,000 * 9% * (10/12) months) 3,00,000
Less: Interest relating to pre-operative period 3,00,000 x 7/10 2,10.000
Amount to be charged to P&L A/c 90.000
Pre-operative interest to be capitalized 2,10.000

Journal Entry
(i) Machinery A/c Dr. 2,10,000
To Loan A/c 2,10,000

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(Being interest on loan for pre-operative period

capitalized)
(ii) Interest on loan A/c Dr. 90,000
To Loan A/c 90,000
(Being the interest on loan for the post-operative
period)
(iii) Profit and Loss A/c Dr. 90,000
To Interest on loan A/c 90,000
(Being interest on loan transferred to P&L A/c)

Q 11 Shan Builders Limited has borrowed a sum of US $ 10,00,000 at the beginning of Financial
Year 2014-15 for its residential project at LIBOR + 3 %. The interest is payable at the end of
the Financial Year. At the time of availment, exchange rate was Rs.56 per US $ and the rate as
on 31st March, 2015 Rs. 62 per US $. If Shan Builders Limited borrowed the loan in India in
Indian Rupee equivalent, the pricing of loan would have been 10.50%. Compute Borrowing
Cost and exchange difference for the year ending 31stMarch, 2015 as per applicable
Accounting Standards. (Applicable LIBOR is 1%). [Nov 2015]
Ans:
(i) Interest for the period 2014-15= US $ 10 lakhs x 4% × Rs. 62 per US $ = Rs. 24.80 lakhs
(ii) Increase in the liability towards the principal amount=US $ 10 lakhs × Rs. (62 - 56)=Rs. 60 lakhs
(iii) Interest that would have resulted if the loan was taken in Indian currency= US $ 10 lakhs × Rs.
56 x 10.5% = Rs. 58.80 lakhs
(iv) Difference between interest on local currency borrowing and foreign currency borrowing =
Rs. 58.80 lakhs - Rs. 24.80 lakhs = Rs. 34 lakhs.
Therefore, out of Rs. 60 lakhs increase in the liability towards principal amount, only Rs. 34
lakhs will be considered as the borrowing cost. Thus, total borrowing cost would be Rs. 58.80
lakhs being the aggregate of interest of Rs.24.80 lakhs on foreign currency borrowings plus
the exchange difference to the extent of difference between interest on local currency
borrowing and interest on foreign currency borrowing of Rs. 34 lakhs. Hence, Rs. 58.80 lakhs
would be considered as the borrowing cost to be accounted for as per AS 16 “Borrowing
Costs” and the remaining Rs.26 lakhs (60 - 34) would be considered as the exchange difference
to be accounted for as per AS 11 “The Effects of Changes in Foreign Exchange Rates”.
Q 12: Y Ltd. made the following borrowings:
Borrowing Date of Amount Related exp
Borrowing (Rs. in lacs) Purpose (Rs. in lacs)
14.8% Debentures 1-1-2001 400 General 1.0
14.5 Term Loan 1-7-2001 200 Specific to 2.0
acquisition of machinery
14.2 Term Loan 1-9-2001 300 General 2.5

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14.8% Debentures and 14.2% Term Loans were raised for the entire project and 14.5% Term
Loans were raised for financing plant and machinery. Qualifying assets for borrowings are:
Rs. in lacs
Factory Shed 100
Plant & Machinery 900
Other Fixed Assets 100
1100
Assume that project is ready for commercial production as on 1-1-2002.
Assume year ended on 31.12.2002
Ans: Specific borrowing cost to be capitalized against plant and machinery is shown below:
Rs. In lacs
Specific borrowing cost(Interest (1-7-2001 to 31-12-2001) 14.5
Related expenses 2.0
Total 16.5

Weighted average borrowing cost for general purpose borrowed funds:

Type of Loans Outstanding Bal. Interest Expenses Related Exp Total Costs
14.8% Debentures 400 59.2 1.0 60.2
14.2% Term Loan 300 14.2 2.5 16.7
Total 700 76.9
General Borrowing rate is 10.99%

General borrowed fund needs to be allocated at a capitalization rate as shown below:

Item of Asset (net of specific Net 10.99% Allocated
borrowing) Borrowing Costs
Factory shed 100 10.99 8.54
Plant & Machinery 700 76.90 59.81
Other Fixed Assets 100 10.99 8.54
98.87 76.90

Q 13: XYZ Ltd., has undertaken a project for expansion of capacity as per the following details:
Plan Actual
Rs. Rs.
April, 2006 2,00,000 2,00,000
May, 2006 2,00,000 3,00,000
June, 2006 10,00,000 –
July, 2006 1,00,000 –
August, 2006 2,00,000 1,00,000

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September, 2006 5,00,000 7,00,000

The company pays to its bankers at the rate of 12% p.a., interest being debited on a monthly
basis. During the half year company had Rs. 10 lakhs overdraft upto 31st July, surplus cash in
August and again overdraft of over Rs. 10 lakhs from 01-09-2002. The company had a strike
during June and hence could not continue the work during June. Work was again commenced
on 1st July and all the works were completed on 30th September. Assume that expenditure
were incurred on 1st Day of each month. Calculate:
1. Interest to be capitalized.
2. Give reasons wherever necessary.
Assume:
a. Overdraft will be less, if there is no capital expenditure.
b. The Board of Directors based on facts and circumstances of the case has decided that any
capital expenditure taking more than 3 months as substantial period of time. [May 2003]
Ans:
Month Actual Expense on Interest to be capitalized Remark
Qualifying Assets
April 2002 200,000x3/12x12/100 6,000 April, May, July
May 2002 300,000x2/12x12/100 6,000 May, July
June 2002 - - -
July 2002 - - -
August 2002 100,000 Nil -
Sept. 2002 700,000x1/12x12/100 7,000 September
13,00,000 19,000

Q 14: X Limited began construction of a new plant on 1st April 2011 and obtained a special loan of
8 lakhs to finance the construction of the plant. The rate of interest on loan was 10 per cent
per annum.
The expenditure that was made on the project of plant construction was as follows: Rs.
1-4-2011 10,00,000
1-8-2011 24,00,000
1-1-2012 4,00,000
The Company’s other outstanding non-specific loan was Rs. 46,00,000 at an interest of 12
percent per annum.
The construction of the plant was completed on 31-3-2012. You are required to calculate the
amount of interest to be capitalized as per the provision of AS 16 of the borrowing cost
(including cost).
Ans:

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(i) Computation of average accumulated expenses Rs.

Rs. 10,00,000 x 12 / 12 = 10,00,000
Rs. 24,00,000 x 8 / 12 = 16,00,000
Rs. 4,00,000 x 3 / 12 = 1,00,000
27,00,000
(ii) Non-specific Borrowings
Non-specific Borrowings = Average accumulated capital expenses – Specific borrowings
= Rs. 27,00,000 – Rs. 8,00,000 = Rs. 19,00,000
(ii) Interest on average accumulated expenses Rs.
Specific borrowings (Rs. 8,00,000 X 10%) = 80,000
Non-specific borrowings (Rs. 19,00,000 × 12%) = 2,28,000
Amount of interest to be capitalized = 3,08,000
(iii) Total expenses to be capitalized for Plant Rs.
Cost of plant Rs. (10,00,000 + 24,00,000 + 4,00,000) 38,00,000
Add: Amount of interest to be capitalised 3,08,000
Total cost of plant 41,08,000

Q 15: In May, 2016, Capacity Ltd. took a bank loan to be used specifically for the construction of a
new factory building. The construction was completed in January, 2017 and the building was
put to its use immediately thereafter. Interest on the actual amount used for construction of
the building till its completion was Rs. 18 lakhs, whereas the total interest payable to the
bank on the loan for the period till 31st March, 2017 amounted to Rs. 25 lakhs.
Can Rs. 25 lakhs be treated as part of the cost of factory building and thus be capitalized on
the plea that the loan was specifically taken for the construction of factory building? Explain
the treatment in line with the provisions of AS 16.
Ans: AS 16 clearly states that capitalization of borrowing costs should cease when substantially all
the activities necessary to prepare the qualifying asset for its intended use are completed.
Therefore, interest on the amount that has been used for the construction of the building up
to the date of completion (January, 2017) i.e. Rs. 18 lakhs alone can be capitalized. It cannot
be extended to Rs. 25 lakhs.

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