Module 7

PAS 23 BORROWING COST and PAS 24 RELATED PARTY DISCLOSURES

Introduction
PAS 23 Borrowing Costs requires that borrowing costs directly attributable to the
acquisition, construction or production of a 'qualifying asset' (one that necessarily takes a
substantial period of time to get ready for its intended use or sale) are included in the cost of the
asset. Other borrowing costs are recognized as an expense.

PAS 24 Related Party Disclosures requires disclosures about transactions and outstanding
balances with an entity's related parties. The standard defines various classes of entities and people
as related parties and sets out the disclosures required in respect of those parties, including the
compensation of key management personnel.

Learning Outcomes:
a. State the core principle under PAS 23;
b. Compute for borrowing costs that are eligible for capitalization;
c. Enumerate examples of related parties; and
d. Describe the disclosure requirements for related parties.

PAS 23 Borrowing Cost

Core principle
“Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying
asset form part of the cost of that asset. Other borrowing costs are recognized as an expense.” (PAS 23.1)

Borrowing costs are interest and other costs incurred by an entity in connection with the
borrowing of funds. Borrowing costs may include:
• interest expense on financial liabilities or lease liabilities computed using the effective
interest method
• exchange differences arising from foreign currency borrowings to the extent that they are
regarded as an adjustment to interest costs.

Borrowing costs do not include actual or imputed cost of equity or capital.

Qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale. Depending on the circumstances, any of the following may be qualifying
assets:
a. Inventories that take a long time period of time to produce;
b. Items of PPE (e.g. Building) that take long a period of time to construct or to get ready for
its instended use; and
c. Intangible assets that take a long time period of time to produce.

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 Example 1
A telecom company has acquired a 3G licence. The licence could be sold or
licensed to a third party. However, management intends to use it to operate
a wireless network. Development of the network starts when the licence is
acquired.

Should borrowing costs on the acquisition of the 3G licence be capitalised until

the network is ready for its intended use?

Solution
Yes. The licence has been exclusively acquired to operate the wireless network.
The fact that the licence can be used or licensed to a third party is irrelevant.
The acquisition of the licence is the first step in a wider investment project
(developing the network). It is part of the network investment, which meets the
definition of a qualifying asset.

Example 2
A real estate company has incurred expenses for the acquisition of a permit
allowing the construction of a building. It has also acquired equipment that will
be used for the construction of various buildings.

Can borrowing costs on the acquisition of the permit and the equipment be
capitalised until the construction of the building is complete?

Solution
Yes for the permit, which is specific to one building. It is the first step in a wider
investment project. It is part of the construction cost of the building, which meets
the definition of a qualifying asset.

No for the equipment, which will be used for other construction projects. It is
ready for its ‘intended use’ at the acquisition date. It does not meet the definition
of a qualifying asset.

The following are not qualifying assets:

a. Financial assets;
b. Inventories that are manufactured, or otherwise produced, over a short period of time;
c. Assets that are ready for their intended use or sale when acquired;
d. Assets that are routinely manufactured or otherwise produced in large quantities on a
repetitive basis; and
e. Assets measured at fair value.

Capitalization of Borrowing Costs

Borrowing costs are capitalized if they are avoidable, meaning they would not have been incurred
if the expenditure on the qualifying asset had not been made.

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 Commencement of Capitalization
The capitalization of borrowing costs as part of the cost of a qualifying asset commences on the
date when all of the following conditions are met:
a. The entity incurs expenditures for the asset;
b. The entity incurs borrowing costs; and
c. It undertakes activities that are necessary to prepare the asset for its intended use or sale.

Suspension of Capitalization
Capitalization of borrowing costs shall be suspended during extended periods of suspension of
active development of a qualifying asset. Borrowing costs during these periods are expensed.

Capitalization, however, is not suspended if substantial technical and administrative work is being
performed or a temporary delay is a necessary part of the development process. For example,
capitalization is not suspended when construction is temporarily stopped due to a typhoon.

Cessation of Capitalization
An entity shall cease capitalizing borrowing costs when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete. If the construction of a
qualifying asset is completed in parts, capitalization ceases for each part that is completed and
ready for its intended use. Capitalization continues for the uncompleted parts.

Specific Borrowing
Specific borrowing refers to funds borrowed specifically for the purpose of obtaining a qualifying
asset.
The capitalizable borrowing costs on specific borrowings are computed as follows:

Capitalizable BC = Actual borrowing costs – Investment Income

Illustration:
On January 1, 2019, XYZ Corporation obtained a 10%, ₱1M loan, specifically to finance the
construction of the building. The proceeds of the loan were temporarily invested and earned
interest income of ₱20,000. The construction was completed on December 31, 2019.

Capitalizable BC = ( 1M x 10%) – 20,000

= 80,000

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 General Borrowing
General borrowings are those obtained for more that one purpose, e.g., the acquisition or
construction of a qualifying asset and some other purpose.

The capitalizable borrowing costs on general borrowings are computed as follows:

Total interest expense on general borrowings ₱ xx

Divide by: Total general borrowings xx
Capitalization rate %

Average expenditure on the asset ₱ xx

Multiply by: Capitalization rate %
Borrowing cost that may be eligible for capitalization ₱ xx

The borrowing cost to be capitalized is the lower of the amount computed using the formula
above and the actual borrowing costs.

Illustration:
On January 1, 2019, ABC Corporation had the following general borrowings. A part of the
proceeds was used to finance the construction of a qualifying asset.

Principal
12% short-tem note ₱10,000,000
14% bank loan (3-year) 18,000,000
16% note payable (5-year) 22,000,000

Expenditures made on the qualifying asset were as follows:

January 1 ₱4,800,000
March 31 2,200,000
July 31 3,500,000
October 31 5,400,000
December 31 300,000

Capitalizable BC = Average Expenditure x Capitalization Rate

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 The average expenditure is computed as follows:

Months outstanding
Expenditures Average Expenditure
Date over 12 Months
(a) (c) = (a) x (b)
(b)
January 1 4,800,000 12/12 4,800,000
March 31 2,200,000 9/12 1,650,000
July 31 3,500,000 5/12 1,458,000
October 31 5,400,000 3/12 1,350,000
December 31 300,000 0/12 –
9,258,333

The capitalization rate is computed as follows:

Principal Principal x Interest Rate Interest Expense

12% short-tem note ₱10,000,000 10,000,000 x 12% ₱1,200,000.00
14% bank loan (3-year) 18,000,000 18,000,000 x 14% ₱2,520,000.00
16% note payable (5-year) 22,000,000 22,000,000 x 16% ₱3,520,000.00
₱50,000,000 ₱7,240,000.00

Total interest expense on general borrowings

Capitalization Rate =
Total general borrowings

₱7,240,000
Capitalization Rate =
₱50,000,000

Capitalization Rate = 14.48%

Capitalizable BC = Average Expenditure x Capitalization Rate

Capitalizable BC = ₱9,258,333 x 14.48%

Capitalizable BC = ₱1,340,607

* The computed capitalizable borrowing cost (₱1,340,607) is lower than the actual borrowing cost
(₱7,240,000). Therefore, the borrowing cost eligible for capitalization is ₱1,340,607.

Disclosure
a. The amount of borrowing costs capitalized during the period.
b. The capitalization rate used to determine the capitalizable borrowing costs.

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 Financial Statement Presentation
Qualifying assets are not segregated from other assets in the financial statements. They are
presented as regular assets under their normal classification as provided under other standards.

PAS 24 Related Party Disclosures

Objective and Scope

PAS 24 prescribes the necessary disclosures regarding related party relationships and transactions,
outstanding balances and commitments between an entity and its related parties.

Core Principle
The financial position and profit or loss of an entity may be affected by a related party
relationship even if related party transactions do not occur. The mere existence of the relationship
may be sufficient to affect the transactions of the entity with other parties.
Necessary disclosures, therefore, should be provided to draw users’ attention to the
possible effects of such relationships and transactions on the financial statements presented.

Related Parties
A related party is “a person or entity that is related to the reporting entity that is preparing
its financial statements (referred to as the 'reporting entity').” (PAS 24)

Parties are related if one party has the ability to affect the financial and operating decisions
of the other party through control, significant influence or joint control.
Control, significant influence or joint control refer to the degree of one party’s ability to
affect the relevant decisions of another.

Examples of related parties:

a. Parent and its subsidiaries;
b. Fellow subsidiaries with a common parent;
c. Investor and investee relationship where control, joint control or significant influence
exists.
d. Key management personnel
e. Close family member
f. Post-employment benefit plan

Examples of Identifying Related Parties

Parent entity has a controlling interest in Subsidiaries A, B and C and has significant influence
over Associates 1 and 2. Subsidiary C has significant influence over Associate 3.

For Parent’s separate financial statements, Subsidiaries A, B and C and Associates 1, 2 and 3 are
related parties. [FRS 102.33.2(b)(i) & (ii)]

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 For Subsidiary A’s financial statements, Parent, Subsidiaries B and C and Associates 1, 2 and 3
are related parties. For Subsidiary B’s separate financial statements, Parent, Subsidiaries A and C
and Associates 1, 2 and 3 are related parties. For Subsidiary C’s financial statements, Parent,
Subsidiaries A and B and Associates 1, 2 and 3 are related parties. [FRS 102.33.2(b)(i) & (ii)]

For the financial statements of Associates 1, 2 and 3, Parent and Subsidiaries A, B and C are related
parties. [FRS 102.33.2(b)(ii)]

Associates 1, 2 and 3 are not related to each other.

For Parent’s consolidated financial statements, Associates 1, 2 and 3 are related to the Group.

Definition of terms
• Control – an investor controls an investee when the investor is exposed, or has rights, to
variable returns from its involvement with the investee and has the ability to affect those
returns through its power over the investee.

• Significant influence – the power to participate in the financial and operating policy
decisions of an entity, but is not control over those policies. Significant influence may be
gained by share ownership, statute or agreement.

• Joint control – the contractually agreed sharing of control over an economic activity.

• Key management personnel are those persons having authority and responsibility for
planning, directing and controlling the activities of the entity, directly or indirectly,
including any director (whether executive or otherwise) of that entity.

• Close members of the family of an individual

➢ the individual’s domestic partner and children;
➢ children of the individual’s domestic partner; and
➢ dependents of the individual or the individual’s domestic partner.

• A related party transaction is a transfer of resources, services or obligations between a

reporting entity and a related party, regardless of whether a price is charged.

Unrelated parties
The following are not related parties:
a. Two entities simply because they have a director in common.
b. Two venturers simply because they share joint control over a joint venture.
c. Providers of finance, trade unions, public utilities, and departments and agencies of a
government that does not control, jointly control or significantly influence the reporting
entity, simply by virtue of their normal dealings with an entity.

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 d. A customer, supplier, franchisor, distributor or general agent with whom an entity transacts
a significant volume of business, simply by virtue of the resulting economic dependence.

Disclosure
a. Parent-subsidiary relationship regardless of whether there have been transactions
between them.
b. Loans to key management personnel and key management personnel compensation
broken down into the following categories:
• Short term employee benefits;
• Post-employment benefits;
• Other long term benefits;
• Termination benefits; and
• Share based payment.

c. Related party transactions – nature of transaction and outstanding balances.

*Disclosures that related party transactions were made on terms equivalent to those that prevail
in arm’s length transactions are made only if such terms can be substantiated.

Government Related Entities

Government related entity is “an entity that is controlled, jointly controlled or significantly
influenced by a government.” (PAS 24.9)

A government related entity discloses the following if there have been related party transactions
with the government:
a. Name of the government and the nature of the relationship;
b. Nature and amount of each individually significant transaction; and
c. Other transactions that are collectively significant but are inidividually significant.

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT THE
WRITTEN PERMISSION OF THE UNIVERSITY IS STRICTLY PROHIBITED.
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