CHAPTER 25

BORROWING COSTS

 Under PAS 23, paragraph 5, borrowing costs are defined interest and other costs that an

entity incurs in connection usth borrowing of funds.

Paragraph 6 provides that borrowing costs specifically include:

a. Interest expense calculated using the effective interest method.

b. Finance charge with respect to a finance lense.

c. Exchange difference arising from foreign currency borrowing to the extent that it is

regarded as an adjustment to interest cost.

Excluded from capitalization

 PAS 23 does not require capitalization of borrowing costs relating to the following:

a. Assets measured at fair value, such as biological assets.

b. Inventory manufactured or produced 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. Assets that are ready for their 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.

The borrowing costs that are directly attributable to the acquisition, construction or

production of a qualifying asset are borrowing costs that would have been avoided if the

expenditure on the qualifying asset had not been made.

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 troim 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 amount of 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.

 PAS 23, paragraph 18, provides that the average expenditures during a period shall include

the borrowing cost previously capitalized.

PROBLEMS AND THEORIES

Problem 25-1 (IFRS)

On January 1, 2019, Hamlet Company borrowed P6,000,000 at an annual interest rate of 10% to

finance specifically the cost of building an electricity generating plant. Construction commenced

on January 1, 2019 with a cost of P6,000,000.

Not all the cash borrowed was used immediately, so interest income of P80,000 was generated

by temporarily investing some of the borrowed funds prior to use. The project was completed on

November 30, 2019.

1. What is the carrying amount of the plant on November 30, 2019?

a. 6,000,000

b. 6,470,000

c. 6,520,000
d. 6,550,000

Solution 25-1 Answer b

Construction cost 6,000,000

Interest (6,000,000 x 10% x 11/12) 500,000

Interest income ( 800,000)

Total cost of plant 6,470,000

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.

Problem 25-2 (IFRS)

On January 1, 2019, Cagayan Company took out a loan of P24,000,000 in order to finance

specifically the renovation of a building. The renovation work started on the same date.

The loan carried annual interest at 10%. Work on the building was substantially complete on

October 31,2019.

The loan was repaid on December 31,2019 and P200,000 investment income was earned in the

period to October 31 on the proceeds of the loan not yet used for the renovation.

1. What amount of capitalizable borrowing cost should be included in the cost of the building?

a. 2,400,000

b. 2,200,000

c. 2,000,000

d. 1,800,000

2. What amount should be reported as interest expense for 2019?

a. 800,000

b. 400,000
c. 200,000

d. 0

Solution 25-2

Question 1 Answer d

Interest actually incurred(24,000,000 x 10% x 10/12)

2,000,000

Interest income ( 200,000)

Capitalizable borrowing cost 1,800,000

Question 2 Answer b

Interest expense for November and December 2019

(24,000,000 x 10% x 2/12) 400,000

The interest from November 1 to December 31, 2019 is charged to interest expense because the

building was completed on October 31, 2019.