CHAPTER-5 Assets Based Accounting Standards

AS-16 : BORROWING COSTS

INTRODUCTION
1. According to AS-16 Borrowing cost on Qualifying asset is capitalised
2. Borrowing costs are interest and other costs incurred by an enterprise in connection with
the borrowing of funds. It would include:-
(i) Interest and commitment charges on bank borrowings and other short term and long
term borrowings
(ii) Amortisation of discount or premiums relating to borrowings
(iii) Amortisation of ancilliary costs incurred in connection with the arrangement of
borrowings
(iv) Finance charge in respect of assets acquired under finance leases or under other
similar arrangements, and
(v) Exchange difference arising from foreign currency borrowings to the extent that they
are regarded as adjustment to the interest cost.
It does not include cost incurred for raising funds through equity shares or preference
shares.
3. Qualifying Asset : A qualifying asset is an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale.
The examples of qualifying assets are manufacturing plants, power generation facilities,
inventory of alcohol, Investment properties, Construction of bridge/factory shed, ship
building, aircraft etc.
But purchase of machineries ready for use, inventory, trucks & vehicles, Computers,
investments, advances given to the suppliers for purchase of any asset or amount invested
in working capital are not qualifying assets.
4. Substantial period : Ordinarily, a period of 12 months is considered as substantial period of
time unless a shorter or longer period can be justified on the basis of fact and circumstances
of the case.
5. Borrowing costs that are directly attributable to the acquisition, construction or production
of a qualifying asset should be capitalised. Directly attributable cost are those cost that
would have been avoided if the expenditure on the qualifying asset had not been made.
Borrowing cost would result in future economic benefit to the enterprise.
6. How to calculate and capitalise interest?
(i) Specific loan: When enterprise borrows funds specifically for the purpose of obtaining
a particular qualifying asset, the borrowing cost that directly relate to that qualifying
asset can be readily identifiable and capitalise over that specific asset.
(ii) Non specific loan: When an enterprise borrow funds by multiple debt instruments/
loans at varying rates of interest for obtaining different qualifying assets it is difficult
to identify the borrowing cost to any specific asset. In this case amount of borrowing

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cost eligible for capitalisation should be determined by applying capitalisation rate

to the expenditure on that asset. Capitalisation rate is the weighted average rate of
interest on such various non specific borrowings.
7. Any income earned on the temporary investment of specific borrowing should be deducted
from the borrowing cost incurred.
8. Commencement of capitalisation : Capitalisation of borrowing cost should commence when
all the following conditions are satisfied.
(i) Expenditure for acquisition, construction or production of a particular asset is being
incurred.
(ii) Borrowing costs are being incurred, and
(iii) Activities that are necessary to prepare the asset for its intended use or sale are in
progress.
Expenditure on qualifying asset includes:-
(a) Transfer of cash
(b) Transfer of other assets, or
(c) Assumption of interest bearing securities
Expenditure should be reduced by progress payments received and Grants received in
connection with the asset.
9. Suspension of capitalisation : Borrowing cost incurred during an extended period in which
activities necessary to prepare an asset for its intended use or sale are interrupted are not
capitalised.
However when such interruption is due to normal forces, the capitalisation is not suspended.
Capitalisation of borrowing cost is not suspended when a temporary delay is necessary part
of the process of getting an asset ready for its intended use or sale.
10. Cessation of Capitalisation : Capitalisation of borrowing cost should cease when:-
(i) Substantially all the activities necessary to prepare the qualifying asset for its
intended use or sale are complete.
(ii) Borrowing cost has ceased.
11. Disclosure:
The financial statements should disclose:
(i) The accounting policy adopted for borrowing cost; and
(ii) The amount of borrowing cost capitalised during the period.

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CLASS WORK
Q-1 The company has obtained Institutional Term Loan of ` 580 lakhs for modernisation and
renovation of its Plant & Machinery. Plant & Machinery acquired under the modernisation
scheme and installation completed on 31st March, 20X2 amounted to ` 406 lakhs, ` 58 lakhs
has been advanced to suppliers for additional assets and the balance loan of ` 116 lakhs
has been utilised for working capital purpose. The Accountant is on a dilemma as to how
to account for the total interest of ` 52.20 lakhs incurred during 20X1-20X2 on the entire
Institutional Term Loan of ` 580 lakhs.
Q-2 H Ltd. incurs borrowing costs for the purpose of construction of a qualifying asset for its
own use. The construction gets completed on May 31, 20X1. However, decoration work is
under process which is expected to be completed by November 20X1 after which H Ltd. will
be able to start using the said asset for its own use. H Ltd. wants to capitalize the eligible
borrowing costs incurred up to November 20X1.
Ans. The capitalization of borrowing costs shall cease when substantially all the activities
necessary to prepare the qualifying assets for its intended use or sale is completed.
In the given case, H Ltd. should capitalize borrowing costs only up to May 31, 20X1. The
borrowing cost incurred thereafter cannot be capitalized as the asset was ready for its
intended use on May 31, 20X1. The fact that decoration work was being carried out should
not be considered as the asset was ready for its intended use on May 31, 20X1.
Q-3 ABC Ltd. is in the process of getting an entertainment park constructed. For this purpose,
it has taken loan from a bank. The said park consists of several rides and facilities, each of
which can be used individually. Three fourth part of the park has been constructed and can
be opened up for public, while construction on the remaining part is continuing. Whether
the capitalization of borrowing cost should continue for the whole park until construction
continues?
Ans. ABC Ltd. is in process of constructing an entertainment park which consists of several rides
and facilities that can operate independently for their intended use. Even though the park
as whole is not complete, the individual facilities are ready for their intended use.
The cessation of capitalization depends upon the nature of the qualifying assets, particularly
where the qualifying assets consists of various parts. There are qualifying assets where each
part is capable of being used while the construction continues on other parts. There are
qualifying assets where all parts have to be completed before any earlier completed part
can be put to use.
Since in the given scenario, the individual facilities are capable of operating independently
and are ready for their intended use, therefore the borrowing costs shall cease to be
capitalized for the three-fourth part of the project.
Q-4 Harish Construction Company is constructing a huge building project consisting of four
phases. It is expected that the full building will be constructed over several years but Phase

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I and Phase II of the building will be started as soon as they are completed.
Following is the detail of the work done on different phases of the building during the
current year:
Phase I Phase II Phase III Phase IV
` ` ` `
Cash expenditure 10 30 25 30
Building purchased 24 34 30 38
Total expenditure 34 64 55 68
Total expenditure of all phases 221
Loan taken @ 15% at the beginning 200
of the year
During mid of the current year, Phase I and Phase II have become operational.
Find out the total amount to be capitalized and to be expensed during the year.
Q-5 Paras Ltd. had the following borrowings during a year in respect of capital expansion.

Plant Cost of Asset (`) Remarks

Plant P 100 lakhs No specific borrowings
Plant G 125 lakhs Bank loan of ` 65 lakhs at 10%
Plant R 175 lakhs 9% Debentures of ` 125 lakhs were
issued.
In addition to the specific borrowings stated above, the Company had obtained term loans
from two banks:
(1) ` 100 lakhs at 10% from Corporation Bank and
(2) ` 110 lakhs at 11.50% from State Bank of India, to meet its capital expansion
requirements.
Determine the amount of borrowing costs to be capitalized in each of the above Plants, as
per AS-16.
Q-6 An industry borrowed ` 40,00,000 for purchase of machinery on 1.6.2007. Interest on loan is
9% per annum. The machinery was put to use from 1.1.2008. Pass journal entry for the year
ended 31.3.2008 to record the borrowing cost of loan as per AS 16.
Q-7 Rohini Limited has obtained loan from an Institution for ` 500 lakhs for modernization and
renovating the Plant and Machinery. The installation of plant and machinery was completed
on 31-3-2009 amounting to ` 320 lakhs and ` 50 lakhs advanced to suppliers of additional
assets and ` 320 lakhs and ` 50 lakhs advanced to suppliers of additional assets and the
balance of ` 130 lakhs has been utilized for working capital requirements. Total interest paid
for the above loan amounted to ` 65 lakhs during 2008-09. You are required to state how the
interest on institutional loan is to be accounted for in the year 2008-09.
Q-8 GHI Limited obtained a loan for `70 lakhs on 15th April, 2010 from JKL Bank, to be utilized
as under:

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` in lakhs
Construction of Factory shed 25
Purchase of Machinery 20
Working capital 15
Advance for purchase of Truck 10
In March 2011, construction of the factory shed was completed and machinery, which was
ready for its intended use, was installed. Delivery of Truck was received in the next financial
year. Total interest of `9,10,000 was charged by the bank for the financial year ending 31-
03-2011.
Show the treatment of interest under AS 16and also explain the nature of Assets.
Q-9 Axe Limited began construction of a new plant on 1st April, 2011 and obtained a special loan
of ` 4,00,000 to finance the construction of the plant. The rate of interest on loan was 10%.
The expenditure that were made on the project of plant were as follows:

`
1st April, 2011 5,00,000
1st August, 2011 12,00,000
1st January, 2012 2,00,000
The company’s other outstanding non-specific loan was ` 23,00,000 at an interest rate of
12%.
The construction of the plant completed on 31st March, 2012. You are required to:
(a) Calculate the amount of interest to be capitalized as per the provisions of AS 16
“Borrowing Cost”.
(b) Pass a journal entry for capitalizing the cost and the borrowing cost in respect of the
plant.
Q-10 On 1st April, 2011, Amazing Construction Ltd. obtained a loan of `32 crores to be utilized as
under:
(i) Construction of sealink across two cities: `25 crores
(work was held up totally for a month during the year
due to high water levels)
(ii) Purchase of equipments and machineries `3 crores
(iii) Working capital `2 crores
(iv) Purchase of vehicles `50,00,000
(v) Advance for tools/cranes etc. `50,00,000
(vi) Purchase of technical know-how `1 crores
(vii) Total interest charged by the bank for the year ending 31 st March, `80,00,000
2012
Show the treatment of interest by Amazing Construction Ltd.
Q-11 A company capitalizes interest cost of holding investments and adds to cost of investment
every year, thereby understating interest cost in profit and loss account. Comment on the
accounting treatment done by the company in context of the relevant AS.
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Q-12 Take Ltd. has borrowed `30 lakhs from State Bank of India during the financial year 2016-
2017. The borrowings are used to invest in shares of Give Ltd., a subsidiary company of
Take Ltd., which is implementing a new project, estimated to cost `50 lakhs. As on 31st
March, 2017, since the said project was not complete, the directors of Take Ltd. resolved to
capitalise the interest accruing on borrowings amounting to `4 lakhs and add it to the cost
of investments. Comment.
Q-13 ABC Ltd borrowed 1,00,000 US $ on 1st April, 2017 @ 5% p.a. interest to acquire qualifying
asset. If the same loan is borrowed in India then it would cost 11% p.a. interest. The qualifying
asset was ready for its intended use on 31-3-2018. The details of foreign exchange rates
were as follows:
On 1-4-2017 1 US $ = 60 INR
On 31-3-2018 1 US $ = 65 INR
Give appropriate treatment of Borrowing cost for the year ended 31st March, 2018 as per
para 4(E) of As-16.
Q-14
Assume NDA Limited begins Construction on a new building on 1st January, 2004. In addition
NDA Limited obtained a Rs. 1 lakh loan to finance the construction of the building on 1st
January, 2004 at an annual interest rate of 10%. The company’s outstanding debt during
2004 Consists of two loans of Rs. 6 lakhs Rs.8 lakhs with interest rates of 11% and 13%,
respectively. Expenditure that were made on the building project were as follows:

January 2004 200000

April 2004 300000
July 2004 400000
December 2004 120000
Compute the cost to be capitalised including borrowing cost.
Ans.
Average expenditure Rs. 6,35,000. Capitalisation rate for Non specific loans 12.14%. Interest
capitalised Rs. 74,950 ( 10,000 on specific loan and Rs. 64,950 on non specific loan of Rs.
5,35,000.
Q-15 The Company deals in purchase and sale of timber. Maturity period of timber for sale is five
years. The Company taken loan to meet the cost of holding of timber upto maturity. The
company has included the interest charge in value of stock of time as at the balance sheet.
Give comment.
Ans.
Company stand is correct as per As – 16.
Q-16
Amount (Rs.)
Expenditure incurred till 31-03-2008 5,00,000
Interest cost capitalized for the financial year 2007-08 @ 13% 26,000
Amount borrowed till 31-03-08 is 2,00,000
Assets transferred to construction during 2008-09 1,00,000
Cash payment during 2008-09 75,000

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Progress payment received 3,50,000

New borrowing during 2008-09 @ 13% 2,00,000
Calculate the amount of borrowing cost to be capitalised.
Ans. Borrowing cost= 4,00,000 * 13%= 52,000. Money borrowed including previously capitalised
interest= 4,00,000 + 26,000= 4,26,000. Expenditure incurred = 5,00,000 + 26,000 capitalised
interest + 75,000 cash + 1,00,000 asset transferred – 3,50,000 progress payment= 3,51,000.
Borrowing cost to be capitalised = 52,000 *(3,51,000/4,26,000)= 42,845.
Q-17 Raj & Co. has taken a loan of US$ 20,000 at the beginning of the financial year for a specific
project at an interest rate of 6% per annum, payable annually. On the day of taking loan, the
exchange rate between currencies was ` 48 per 1 US$. The exchange rate at the closing of
the financial year was ` 50 per 1 US$. The corresponding amount could have been borrowed
by the company in Indian Rupee at an interest rate of 11% per annum. Determine the
treatment of borrowing cost in the books of accounts.
Ans.
Interest expenses Rs. 60,000. Increase in liability Rs. 40,000. Interest if loan is in INR-
Rs. 1,05,600. Difference in interest Rs. 45,600. Exchange difference Rs. 40,000 considered
borrowing cost.
Q-18
M/s. Ayush Ltd. began construction of a new building on 1st January, 2014.; It obtained `
3 lakh special loan to finance the construction of the building on 1st January, 2014 at an
Interest rate of 12% p.a. The company’s other outstanding two non-specific loans were:

Amount Rate of Interest

` 6,00,000 11% p.a.
` 11,00,000 13% p.a.
The expenditure that were made on the building project were as follows :

Amount (`)
January, 2014 3,00,000
April, 2014 3,50,000
July, 2014 5,50,000
December, 2014 1,50,000
Building was completed on 31st December, 2014. Following the principles prescribed in AS 16
‘Borrowing Cost’, calculate the amount of interest to be capitalized and pass one Journal
Entry for capitalizing the cost-and borrowing in respect of the building.
Ans. Average expenditure Rs. 8,50,000. Capitalisation rate for Non specific loans 12.29%. Interest
capitalised Rs. 1,03,595 ( 36,000 on specific loan and Rs. 67,595 on non specific loan of Rs.
5,50,000.
Q-19 A company incorporated in June 2017, has setup a factory within a period of 8 months with
borrowed funds. The construction period of the assets had reduced drastically due to usage
of technical innovations by the company. Whether interest on borrowings for the period
prior to the date of setting up the factory should be capitalized although it has taken less

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than 12 months for the assets to get ready for use. You are required to comment on the
necessary treatment with reference to AS 16.
Ans. As per para 3.2 to AS 16 'Borrowing Costs', a qualifying asset is an asset that necessarily
akes a substantial period of time to get ready for its intended use or sale.
Further, Explanation to the above para states that what constitutes a substantial period
of time primarily depends on the facts and circumstances of each case. However, ordinarily,
a period of twelve months is considered as substantial period of time unless a shorter
or longer period can be justified on the basis of facts and circumstances of the case. In
estimating the period, time which an asset takes, technologically and commercially, to get
it ready for its intended use or sale is considered.
It may be implied that there is a rebuttable presumption that a 12 months period constitutes
substantial period of time.
Under present circumstances where construction period has reduced drastically due to
technical innovation, the 12 months period should at best be looked at as a benchmark and
not as a conclusive yardstick. It may so happen that an asset under normal circumstances
may take more than 12 months to complete. However, an enterprise that completes the asset
in 8 months should not be penalized for its efficiency by denying it interest capitalization
and vice versa.
The substantial period criteria ensures that enterprises do not spend a lot of time and effort
capturing immaterial interest cost for purposes of capitalization.
Therefore, if the factory is constructed in 8 months then it shall be considered as a qualifying
asset. The interest on borrowings for the same shall be capitalised although it has taken
less than 12 months for the asset to get ready to use.
Q-20 In May, 2016, Capacity Ltd. took a bank loan to be used specifically for the construction of a
new factory building. The construction was completed in January, 2017 and the building was
put to its use immediately thereafter. Interest on the actual amount used for construction
of the building till its completion was Rs.18 lakhs, whereas the total interest payable to the
bank on the loan for the period till 31st March, 2017 amounted to Rs. 25 lakhs.
Can Rs. 25 lakhs be treated as part of the cost of factory building and thus be capitalized
on the plea that the loan was specifically taken for the construction of factory building?
Explain the treatment in line with the provisions of AS 16.
Ans. AS 16 clearly states that capitalization of borrowing costs should cease when substantially
all the activities necessary to prepare the qualifying asset for its intended use are completed.
Therefore, interest on the amount that has been used for the construction of the building up
to the date of completion (January, 2017) i.e. Rs.18 lakhs alone can be capitalized. It cannot
be extended to Rs.25 lakhs.

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Q-21 ABC Limited has started construction of an asset on 1st December, 2020, which continues till
31st March, 2021 (and is expected to go beyond a year). The entity has not taken any specific
borrowings to finance the construction of the asset but has incurred finance costs on its
general borrowings during the construction period. The directly attributable expenditure at
the beginning of the month on this asset was ` 10 lakh in December 2020 and ` 4 lakh in
each of the months of January to March 2021. At the beginning of the year, the entity had
taken Inter Corporate Deposits of ` 20 lakh at 9% rate of interest and had an overdraft of
` 4 lakh, which increased to ‘ 8 lakh on 1st March, 2021. Interest was paid on the overdraft
at 10% until 1st January, 2021 and then the rate was increased to 12%. You are required to
calculate the annual capitalization rate for computation of borrowing cost in accordance
with AS 16 ‘Borrowing Costs’.
Q-22 The borrowings profile of Santra Pharmaceuticals Ltd. set up for the manufacture of
antibiotics at Navi Mumbai is as under:

Date Nature of borrowings Amount Purpose of Incidental

borrowed borrowings expenses
(`)
1st January, 15% demand loan 60 lakhs Acquisition of 8.33%
2016 fixed assets
1st July, 14.5% Term loan 40 lakhs Acquisition of 5%
2016 plant and
machinery
1st October, 14% bonds 50 lakhs Acquisition of 8%
2016 fixed assets
The incidental expenses consist of commission and service charges for arranging the loans
and are paid after rounding off to the nearest lakh.
Fixed assets considered as qualifying assets are as under:

`
Sterile Manufacturing shed 10,00,000
P lant and machinery (total) 90,00,000
Other fixed assets 10,00,000
The Project is completed on 1st January, 2017 and is ready for commercial production. Show
the capitalization of the borrowing costs.
Q-23 Fee Ltd. borrows a sum of ` 20 crore from Coffee Ltd., repayable as a single bullet payment at
the end of 5 years. The interest thereon @ 5% p.a. is payable at yearly rests. Since the market
is 8%, Fee Ltd. paid an origination fee of ` 2.40 crores to Coffee Ltd. to compensate Coffee
Ltd. for the lower rate of interest. Apart from the above, there are no other transactions
between the two parties. You are required to show the value at which Coffee Ltd., would
recognize the loan and the annual interest thereon.

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MCQS
1. As per AS 16, all the following are qualifying assets except
(a) Manufacturing plants and Power generation facilities
(b) Inventories that require substantial period of time
(c) Assets those are ready for sale.
(d) None of the above
2. Which of the following statement is correct:
(a) Entire exchange gain is reduced from the cost of the Qualifying asset.
(b) Entire exchange loss is added to the cost of a Qualifying asset.
(c) No adjustment is done for the exchange loss while computing cost of Qualifying
asset.
(d) None of the above
3. Capitalisation rate considers:
(a) Borrowing costs on general borrowings only.
(b) Borrowing costs on general and specific borrowings both.
(c) Borrowing costs on specific borrowings only
(d) None of the above
4. If the amount eligible for capitalisation in case of inventory as per AS 16 is ` 12,000 and
cost of inventory is ` 40,000 and its net realizable value is ` 45,000; What amount can be
capitalised as a part of inventory cost.
(a) ` 12,000. (b) ` 5,000. (c) ` 7,000. (c) ` 10,000.
5. X Ltd is commencing a new construction project, which is to be financed by borrowing. The
key dates are as follows:
(i) 15th May, 20X1: Loan interest relating to the project starts to be incurred
(ii) 2nd June, 20X1: Technical site planning commences
(iii) 19th June, 20X1: Expenditure on the project started to be incurred
(iv) 18th July, 20X1: Construction work commences Identify the commencement date for
capitalisation under AS 16.
(a) 15th May, 20X1. (b) 19th June, 20X1.
(c) 18th July, 20X1. (d) 2nd June, 20X1
Answers

1 (c) 2 (c) 3 (a) 4 (b) 5 (b)

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HOME WORK
Q-1 When capitalization of borrowing cost should cease as per Accounting Standard 16? Explain
the provision.
Ans. Capitalization of borrowing costs should cease when substantially all the activities necessary
to prepare the qualifying asset for its intended use or sale are complete. An asset is normally
ready for its intended use or sale when its physical construction or production is complete
even though routine administrative work might still continue. If minor modifications such
as the decoration of a property to the user’s specification, are all that are outstanding,
this indicates that substantially all the activities are complete. When the construction of a
qualifying asset is completed in parts and a completed part is capable of being used while
construction continues for the other parts, capitalisation of borrowing costs in relation to
a part should cease when substantially all the activities necessary to prepare that part for
its intended use or sale are complete.
Q-2 Sun Co-operative Society Ltd. has borrowed a sum of US$12.50 million at the commencement
of the financial year 2016-2017 for its solar energy project at LIBOR (London Interbank
Offered Rate) of 1% + 4%. The interest is payable at the end of the respective financial
year. The loan was availed at the then rate of ` 45 to the US dollar while the rate as on
31st March, 2017 is ` 48 to the US dollar. Had Sun Co-operative Society Ltd. borrowed the
Rupee equivalent in India, the interest would have been 11%. You are required to compute
‘Borrowing Cost’. Also show the amount of exchange difference as per prevailing Accounting
Standards.
Q-3 X Limited began construction of a new plant on 1st April 2016 and obtained a special loan
of ` 8 lakhs to finance the construction of the plant. The rate of interest on loan was 10 per
cent per annum.
The expenditure that was made on the project of plant construction was as follows:

`
1-4-2016 10,00,000
1-8-2016 24,00,000
1-1-2017 4,00,000
The Company’s other outstanding non-specific loan was ` 46,00,000 at an interest of 12
percent per annum.
The construction of the plant was completed on 31-3-2017. You are required to calculate
the amount of interest to be capitalized as per the provision of AS 16 of the borrowing cost
(including cost).

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