Intermediate Accounting 1 - MODULE 8

Content Standards:
▪ Elaboration of the items included in borrowing costs.
▪ Explaination about the concept of a qualifying asset for purposes of capitalization of borrowing cost.
▪ Enumeration of the distinctions between specific borrowing and general borrowing in relation to
capitalization of borrowing costs.

Declarative Knowledge:
▪ Definition of Borrowing Costs
▪ Qualifying Asset
▪ Accounting for Borrowing Cost
▪ Asset financed by Specific Borrowing
▪ Asset financed by General Borrowing
▪ Asset financed both by specific and general borrowing
▪ Specific borrowing for asset used for general purposes
▪ Disclosures related to borrowing Cost

Functional Knowledge:
▪ Enumerating the items included in borrowing costs.
▪ Describing the concept of a qualifying asset for purposes of capitalization of borrowing cost.
▪ Identifying the distinctions between specific borrowing and general borrowing in relation to
capitalization of borrowing costs.

Intended Learning Outcome:

▪ Identify the items included in borrowing costs and understand the concept of a qualifying asset for
purposes of capitalization of borrowing cost.
▪ Analyze the distinctions between specific borrowing and general borrowing in relation to capitalization
of borrowing costs.

Suggested Teaching/ Learning Activities:

▪ Chapter assessment theory questions and problem solving.
Chapter 25: Borrowing Cost
Borrowing Costs are interest and other costs that an entity incurs in connection with borrowing of funds.
Borrowing cost may include: [IAS 23.6]

▪ Interest expense calculated by the effective interest method under IAS 39.
▪ Finance charges in respect of finance leases recognised in accordance with IAS 17 Leases.
▪ Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an
adjustment to interest costs.

A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use or sale.
[IAS 23.5] That could be property, plant, and equipment and investment property during the construction
period, intangible assets during the development period, or "made-to-order" inventories.

Two types of assets that would otherwise be qualifying assets are excluded from the scope of IAS 23:

▪ Qualifying assets measured at fair value, such as biological assets accounted for under IAS 41
▪ Agriculture inventories that are manufactured, or otherwise produced, in large quantities on a repetitive
basis and that take a substantial period to get ready for sale (for example, maturing whisky)
▪ Assets that are ready for their intended use or sale when acquired.

Accounting for Borrowing Cost

▪ Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset form part of the cost of that asset and, therefore, should be capitalised.
▪ Other borrowing costs are recognised as an expense. [IAS 23.8]

Asset financed by “specific borrowing”

Where funds are borrowed specifically for the purpose of acquiring a qualifying assets, costs eligible for
capitalisation are the actual costs incurred less any income earned on the temporary investment of such
borrowings.

Illustration 1
On January 1 of the current year, an entity obtained a loan of P4,000,000 at an interest rate of 10%, specifically
to finance the construction of its new building. Availments from the loan were made quarterly in equal amounts.
Total borrowing cost incurred amounted to P250,000 for the current year. Prior to their disbursement, the
proceeds of the borrowing were temporarily invested and earned interest income of P40,000. The building was
completed on December 31 of the current year. The amount of capitalizable borrowing cost is computed as
follows:
Actual Borrowing Cost 250,000
Less: Interest income from 40,000
investments proceeds
Capitalizable Borrowing 210,000
Cost

Asset financed by “general borrowing”

If the funds are borrowed generally and used for acquiring a qualifying asset, the eligible amount is determined
by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate will be the average of
the borrowing costs multiplied by the average carrying amount of the asset during the asset [IAS 23.14]
Illustration 2
An entity had the following borrowings on January 1 of the current year. The borrowings were made for general
purposes and the proceeds were partly used to finance the construction of a new building.
Principal Borrowing Cost
10% Bank Loan 2,800,000 280,000
12% Short-Term Note 1,600,000 160,000
12% Long-Term Note 2,000,000 240,000
6,400,000 680,000

The construction of the building was started on January 1 and was completed on December 31 of the current
year. Expenditures on the building were made as follows:
January 31 400,000
March 31 1,000,000
June 30 1,200,000
September 30 1,000,000
December 31 400,000
Total Cost 4,000,000

The average carrying amount of the building is determined as follows:

Date (a) Expenditures (b) Monthly (axb) Amount
Outstanding
January 31 400,000 12 4,800,000
March 31 1,000,000 9 9,000,000
June 30 1,200,000 6 7,200,000
September 30 1,000,000 3 3,000,000
December 31 400,000 0 -
24,000,000
Average Carrying 2,000,000
Amount (24,000,000/12)

Another Approach
Date (a) Expenditures (b) Fraction (axb) Average
January 31 400,000 12/12 400,000
March 31 1,000,000 9/12 750,000
June 30 1,200,000 6/12 600,000
September 30 1,000,000 3/12 250,000
December 31 400,000 - -
2,000,000

Note that any investment income from specific borrowing is deducted from the capitalizable borrowing cost.
However no specific guidance is provided for general borrowing with respect to investment income.
Accordingly, any investment income from general borrowing is not deducted from capitalizable borrowing cost.

Specific Borrowing for Asset used for General Purposes

If the asset is financed by specific borrowing but a portion is used for working capital purposes, the borrowing
shall be treated as a general borrowing in determining capitalizable borrowing cost. Thus, the capitalizable
borrowing cost is equal to the average expenditures on the asset multiplied by the average interest rate.
Commencement of Capitalization
Capitalisation should commence when:
▪ Expenditures are being incurred.
▪ Borrowing costs are being incurred.
▪ Activities that are necessary to prepare the asset for its intended use or sale are in progress.
(encompasses more than the physical construction of the asset, these include technical and
administrative work prior to the commencement pf physical construction such as drawing up plans and
obtaining permit for a building.)
Suspension of Capitalization
Capitalisation should be suspended during periods in which active development is interrupted. [IAS 23.20]

Cessation of Capitalization
Capitalisation should cease when substantially all of the activities necessary to prepare the asset for its intended
use or sale are complete. [IAS 23.22] If only minor modifications are outstanding, this indicates that
substantially all of the activities are complete. [IAS 23.23]

Where construction is completed in stages, which can be used while construction of the other parts continues,
capitalisation of attributable borrowing costs should cease when substantially all of the activities necessary to
prepare that part for its intended use or sale are complete. [IAS 23.24]

Disclosures Related to Borrowing Cost

▪ Amount of borrowing cost capitalised during the period.
▪ Capitalisation rate used.

Segregation of assets that re “qualifying assets” from other assets in the statement of financial position is not
required to be disclosed.

Prepared By: Ms. Charmaine Buan, CPA

References:
1. Financial Accounting Volume 1, 2011 ed. – Conrado T. Valix, Jose F. Peralta and Christian Aris M.
Valix
2. https://www.iasplus.com/en/standards/ias/ias40