Borrowing Costs Flashcards
Under ASPE there is no Handbook Section on Borrowing Costs. Does the Handbook however prescribe whether one should capitalize interest under ASPE?
ASPE does not require capitalization of interest; it is a policy choice. In Section 3850, <em>Interest Capitalized - Disclosure Considerations</em>, only disclosure is dealt with and the basic recommendation is that the amount of interest capitalized in the period shall be disclosed.
For which type of asset is one allowed to capitalize borrowing costs?
One can only capitalize borrowing costs for a qualifying asset, which is an asset that requires “substantial” time to get ready for use or sale.
Larken Ltd. wants to capitalize interest costs on borrowings that relate to the purchase of inventory. They purchase and distribute candies. Should the auditor agree with this request?
No - in this case the inventory is not a qualifying asset as it does not take a substantial time to get ready for use or sale.
In determining whether an asset is a “qualifying” asset, what time period would generally be considered a “substantial time” to get the asset ready for use or sale?
The term “substantial” is not defined in the handbook, but a year or even slightly less than a year, would be considered “substantial”.
Is there any difference with respect to the requirement to capitalize interest, if an asset is carried on the books at fair value?
Yes - the requirement to capitalize interest for a qualifying asset becomes optional, if an asset is carried on the books at fair value.
The owners of Mystical Entertainment Ltd. (MEL) loaned the company $50,000 interest free to build props for a play. MEL approached the auditors and requested that they set up interest which would be capitalized in the props, as had they borrowed the money from a bank, they would have incurred interest (and the props took 1 year to build). Should the auditors agree with the request?
No - the auditors should not agree as even though the props are a qualifying asset, only actual interest incurred is allowed to be capitalized. Notional interest cannot be capitalized.
What are the 3 conditions that must be met before beginning to capitalize borrowing costs?
An entity is allowed to begin capitalizing borrowing costs when the following 3 conditions are met:\n\n(a) expenditures are incurred;\n\n(b) borrowing costs are incurred; and\n\n(c) activities are undertaken that are necessary to prepare the asset for use or sale
BCG Inc. borrowed $100,000 for 12 months, at 5% interest, specifically to build a machine. Interest income of $200 was earned during the year. What will be the capitalized amount at the end of 12 months on BCG’s balance sheet?
The machine is a qualifying asset so BCG can capitalize the avoidable borrowing costs of $5,000 ($100,000 x 5%) to finance the asset, less the interest earned of $200. Therefore, the capitalized amount would be $4,800. The $200 constitutes temporary investment income which should be netted against the capitalized amount.
Aggessco Ltd. has a line of credit with a bank for $1,000,000 to fund general operating activities. They paid 5% interest over the course of the year. During the year they built 5 hotels. They would like to capitalize $10,000 of interest in each hotel ($1,000,000 x 5% / 5 hotels). Are they allowed to do this?
No - the $1,000,000 is general borrowings and they are allowed to capitalize a portion of this $1,000,000, based on a formula.
At what point does an organization stop capitalizing interest on a qualifying asset?
Capitalization of interest should cease when <strong>substantially</strong> all activities needed to prepare the asset for its intended use are complete.
If a company incurs interest related to a qualifying asset, can the company choose to expense the interest?
Under IFRS the company is required to capitalize interest on asset specific debt and general borrowings unless the asset is measured at fair value.
Hotel Ltd. is in the business of constructing hotels and has a December 21 year end. Over the course of the whole year, the company was building 1 hotel. The company financed the construction with debt that was not assumed specifically to build the hotel and consisted of the following: 7% debt issued on May 1 (previous year) in the amount of $1.1 million, which matured on November 30 and 5% debt issued on April 1 (current year) in the amount of $500,000 which matures the following year, Feb. 28. What is the capitalization rate?
The capitalization rate is computed as follows:\n\n7% debt of $1.1 million over the course of 11 months = $1,100,000 x 11/12 = $1,008,333 x .07 = $70,583 borrowing costs\n\n5% debt on $500,000, issued Apr. 1 (9 months) = $500,000 x 9/12 = $375,000 x .05 = $18,750 borrowing costs\n\nCapitalization rate is: $89,333 ($70,583 + $18,750) / $1,600,000 ($1,008,333 + $375,000) = 6.46%.\n\n
During the year, Scifi Inc. worked on developing a new technology. Scifi has a December 31 year end. The costs incurred qualify as development costs and the intangible asset is a qualifying asset. Scifi incurred consulting fees of: $250,000 (Feb. 1), $375,000 (Apr. 1) and $500,000 (July 1). They borrowed $400,000 specifically for the technology and had a $2,000,000 line of credit. What was the average carrying amount (expenditures) of the qualifying asset related to the general borrowings (that would be multiplied by the capitalization rate) to compute the capitalized interest cost on general borrowings?
It is assumed that the $400,000 of specific borrowings were applied to the $250,000 (Feb. 1) and $150,000 (of the $375,000) (Apr. 1) consulting fees. Therefore, the average expenditure for the remaining fees is:\n\n$225,000 x 9/12 = $168,750 and $500,000 x 6/12 = $250,000 for a total of $418,750.\n\nThe $418,750 would be multiplied by the capitalization rate to compute the interest capitalized on the general borrowings.
