IAS 23 - Borrowing Costs

Question 1

What does IAS 23 borrowing costs (essentially) say?

Answer 1

That borrowing costs attributable to the acquisition, construction, or production of a qualifying asset should be capitalised as part of the cost of the asset.

Question 2

What is the definition of borrowing costs?

Answer 2

Borrowing costs are interest and; other costs that an entity incurs in connection with the borrowing of funds.

Question 3

Which types of borrowing costs form part of the cost of the asset?

Answer 3

Borrowing costs that are directly attributable to the acquisition, construction or production of an qualifying asset form part of the cost of the asset. Other borrowing costs are recognised as an expense.

Question 4

what is a capatalised cost?

Answer 4

This is an expense that is added to the cost basis of a fixed asset on a companies balance sheet.

Question 5

What is the definition of a qualifying asset?

Answer 5

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for it intended use or sale. Examples include : - PP&E, Investment properties under construction, inventories that take a long time to produce etc.

Question 6

1. when is it easy to identify borrowing costs for an asset?
2. when is it hard to identify borrowing costs for an asset?

Answer 6

1. it is easy to identify borrowing costs for an asset when the borrowing costs have been borrowed specifically for an asset. The borrowing costs eligible for capatalisation are the actual borrowing costs incurred on the borrowed funds during the period of capitalisation.
2. It is hard to identify borrowing costs for an asset when the funds for an asset have been taken from a pool of borrowings for the asset.

Question 7

How is the amount of borrowing costs to be capitalised calculated where SPECIFIC FUNDS are raised, and some of the borrowings are invested while the others are capitalised.

Answer 7

If the specific funds raised are not all required immediately, and some are invested, the borrowing costs capitalised should be reduced by the investment income received on the excess funds that have been invested. So you offset the investment income you receive from the surplus funds invested with the borrowing cost from the amount used.

make sure you remember to time apportion these.

EXAMPLE : - Borrowed £1m @ 7.5% to finance construction of a new building which will take 12 months. Stage payments are made on construction with surplus invested gaining interest of £35,000. Borrowing cost to be capitalised = (£1,000,000 @ 7.5%) = £75,000 - £35,000 = £40,000

Question 8

How is the amount of borrowing costs to be capitalised calculated where GENERAL FUNDS are raised?

Answer 8

The amount of borrowing costs to be capitalised should be calculated with a capitalisation rate. This is the weighted average cost of the general borrowings during the period of capitalisation.

Question 9

How do you work out the period of capitalisation (i.e. the capitalisation period)

i.e. when does the capitalisation period begin? And;

when does the capitalisation period end?

Answer 9

Capatitalisation period begins when the following conditions are met:

1. expenditure is being incurred on the asset
2. borrowing costs are being incurred on the asset
3. activities are in progress that are necessary to prepare the asset for its intended use.

Capitalisation period for the asset ends when substantially all of the activities necessary to prepare the asset for its intended use are complete.

Question 10

How do you calculate a capatalisation rate, and therefore calculate the amount of fund to be capatalised from a pool of general funds?

Answer 10

Steps to get capitalisation rate:

1. Find the interes payable for each loan that exists. and then add up these figure to get the total amount of interest payable.
2. divide the total amount of interest payable by the total value of funds available in the pool i.e. if you have 3 loans all adding to 20m, divide the total interest payable on these 3 loans by 20m. This gives you the capatalisation rate.

Steps to capitalise costs:

1. Multiply the expenditure on the qualifying asset by the capitalisation rate calculated above. If there are more than one expenditures, multiply both by the capitalisation rate and add the results.
2. Work out the asset cost. this can be done by adding the expenditure calculated using the capitalisation rate in 1 to the cost of the asset.

EXAMPLE : - An entity has the following loans in place:

£1m of 6% loan finance

£2m of 8% loan finance.

Entity constructed a new factory at a cost of £600,000 and took 8 months to complete.

Weighted average cost of loans = (1m x 6%) + (2m x 8%)/3m = 7.33% Borrowing costs to be capitalised = £600,000 x 7.33% x8/12 = £29,320

Question 11

When should capitalisation of borrowing costs commence?

Answer 11

Capitalisation should commence when the entity meets ALL of the following three conditions : - 1) It incurs expenditures for the asset 2) It incurs borrowing costs 3) It undertakes activities that are necessary to prepare the asset for its intended use or sale (i.e construction, drawing up plans, obtaining planning permission)

Question 12

When should suspension of capitalisation of borrowing costs occur?

Answer 12

If the entity suspends active development of a qualifying asset for an extended period the capitalisation of borrowing costs should be suspended and recognised as an expenses in the p&l

Question 13

When should the cessation of capitalisation on borrowing costs take place?

Answer 13

The entity should cease capitalising borrowing costs when substantially all the activities necessary to get the asset ready for its intended use or sale are complete. Minor activities such as decoration of an investment property do not form part of substantial activity.

Question 14

What disclosures should be made under IAS 23?

Answer 14

The entity should disclose :

1) The borrowing costs which have been capitalised in the current period
2) The capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation

Question 15

What judgements are required in relation to IAS 23?

Answer 15

Judgements are required due to the vague definitions of the following :

• > ‘a substantial period of time to get ready’ which is a central part of the definition of a qualifying asset.

> The borrowing costs which are ‘directly attributable’ to work on the qualifying asset.

• attributable costs arise as a result of the expense on the asset.

> ‘Activities necessary to prepare the qualifying asset’

> ‘An extended period’ where active development has been suspended

> When ‘substantially all the necessary activities are complete’

Question 16

What are the comparisons for IAS 23 & FRS 15 under UK GAAP?

Answer 16

UNDER FRS 15 : - Entities are allowed the choice of whether to capitalise borrowing costs or to recognise them as an expense as incurred UNDER IAS 23 : - Capitalisation is required UNDER FRS 15 : - The amount capitalised is limited to the finance costs incurred on the EXPENDITURE incurred. UNDER IAS 23 : - The amount capitalised is limited to the BORROWING costs on the total related funds less the investment income from any temporary investment.