BORROWING COST

Borrowing costs are interest and other costs that an entity

incurs in connection with the borrowing of funds. IAS 23
provides guidance on how to measure borrowing costs,
particularly when the costs of acquisition, construction or
production are funded by an entity's general borrowings

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
recognised as an expense.

Borrowing costs are interest and other costs that an entity

incurs in connection with the borrowing of funds. IAS 23
provides guidance on how to measure borrowing costs,
particularly when the costs of acquisition, construction or
production are funded by an entity’s general borrowings.

STANDARD HISTORY

In April 2001 the International Accounting Standards Board

(Board) adopted IAS 23 Borrowing Costs, which had
originally been issued by the International Accounting
Standards Committee in December 1993. IAS 23 Borrowing
Costs replaced IAS 23 Capitalisation of Borrowing
Costs (issued in March 1984).

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In March 2007 the Board issued a revised IAS 23 that
eliminated the option of immediate recognition of borrowing
costs as an expense

Borrowing Costs 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 recognised as an expense.

SCOPE

An entity shall apply this Standard in accounting for

borrowing costs:

The Standard does not deal with the actual or imputed cost
of equity, including preferred capital not classified as a
liability. An entity is not required to apply the Standard to
borrowing costs directly attributable to the acquisition,
construction or production of:

a. A qualifying asset measured at fair value, for example a

biological asset within the scope of IAS 41 Agriculture; or
b. Inventories that are manufactured, or otherwise
produced, in large quantities on a repetitive basis.

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Definitions: This Standard uses the following terms with the
meanings specified:

Borrowing costs are interest and other costs that an entity

incurs in connection with the borrowing of funds. A
qualifying asset is an asset that necessarily takes a
substantial period of time to get ready for its intended use or
sale.

Borrowing costs may include:

a. Interest expense calculated using the effective interest

method as described in IFRS 9
b. Interest in respect of lease liabilities recognised in
accordance with IFRS 16 Leases; and
c. Exchange differences arising from foreign currency
borrowings to the extent that they are regarded as an
adjustment to interest costs.

Depending on the circumstances, any of the following may be

qualifying assets:

a. Inventories
b. Manufacturing plants
c. Power generation facilities
d. Intangible assets
e. Investment properties
f. Bearer plants.

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Financial assets, and inventories that are manufactured, or
otherwise produced, over a short period of time, are not
qualifying assets. Assets that are ready for their intended use
or sale when acquired are not qualifying assets. Recognition
An entity shall capitalise borrowing costs that are directly
attributable to the acquisition, construction or production of
a qualifying asset as part of the cost of that asset. An entity
shall recognise other borrowing costs as an expense in the
period in which it incurs them. Borrowing costs that are
directly attributable to the acquisition, construction or
production of a qualifying asset are included in the cost of
that asset. Such borrowing costs are capitalised as part of
the cost of the asset when it is probable that they will result
in future economic benefits to the entity and the costs can be
measured reliably.

When an entity applies IAS 29 Financial Reporting in

Hyperinflationary Economies, it recognises as an expense the
part of borrowing costs that compensates for inflation during
the same period in accordance with paragraph 21 of that
Standard. Borrowing costs eligible for capitalization. The
borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset
are those borrowing costs that would have been avoided if
the expenditure on the qualifying asset had not been made.
When an entity borrows funds specifically for the purpose of

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obtaining a particular qualifying asset, the borrowing costs
that directly relate to that qualifying asset can be readily
identified. It may be difficult to identify a direct relationship
between particular borrowings and a qualifying asset and to
determine the borrowings that could otherwise have been
avoided. Such a difficulty occurs, for example, when the
financing activity of an entity is co-ordinated centrally.

Difficulties also arise when a group uses a range of debt

instruments to borrow funds at varying rates of interest, and
lends those funds on various bases to other entities in the
group. Other complications arise through the use of loans
denominated in or linked to foreign currencies, when the
group operates in highly inflationary economies, and from
fluctuations in exchange rates. As a result, the determination
of the amount of borrowing costs that are directly
attributable to the acquisition of a qualifying asset is difficult
and the exercise of judgement is required. 8 9 10 11 IAS 23
© IFRS Foundation A1255 To the extent that an entity
borrows funds specifically for the purpose of obtaining a
qualifying asset, the entity shall determine the amount of
borrowing costs eligible for capitalisation as the actual
borrowing costs incurred on that borrowing during the
period less any investment income on the temporary
investment of those borrowings.

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The financing arrangements for a qualifying asset may result
in an entity obtaining borrowed funds and incurring
associated borrowing costs before some or all of the funds
are used for expenditures on the qualifying asset. In such
circumstances, the funds are often temporarily invested
pending their expenditure on the qualifying asset.

In determining the amount of borrowing costs eligible for

capitalisation during a period, any investment income earned
on such funds is deducted from the borrowing costs
incurred. To the extent that an entity borrows funds
generally and uses them for the purpose of obtaining a
qualifying asset, the entity shall determine the amount of
borrowing costs eligible for capitalisation by applying a
capitalisation rate to the expenditures on that asset. The
capitalisation rate shall be the weighted average of the
borrowing costs applicable to all borrowings of the entity that
are outstanding during the period.

However, an entity shall exclude from this calculation

borrowing costs applicable to borrowings made specifically
for the purpose of obtaining a qualifying asset until
substantially all the activities necessary to prepare that asset
for its intended use or sale are complete. The amount of
borrowing costs that an entity capitalises during a period
shall not exceed the amount of borrowing costs it incurred

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during that period. In some circumstances, it is appropriate
to include all borrowings of the parent and its subsidiaries
when computing a weighted average of the borrowing costs;
in other circumstances, it is appropriate for each subsidiary
to use a weighted average of the borrowing costs applicable
to its own borrowings. Excess of the carrying amount of the
qualifying asset over recoverable amount.

When the carrying amount or the expected ultimate cost of

the qualifying asset exceeds its recoverable amount or net
realisable value, the carrying amount is written down or
written off in accordance with the requirements of other
Standards. In certain circumstances, the amount of the
write-down or write-off is written back in accordance with
those other Standards.

COMMENCEMENT OF CAPITALIZATION

An entity shall begin capitalising borrowing costs as part of

the cost of a qualifying asset on the commencement date.
The commencement date for capitalisation is the date when
the entity first meets all of the following conditions:

(a) It incurs expenditures for the asset

(b) It incurs borrowing costs; and

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(c) It undertakes activities that are necessary to prepare the
asset for its intended use or sale.

Expenditures on a qualifying asset include only those

expenditures that have resulted in payments of cash,
transfers of other assets or the assumption of interest-
bearing liabilities. Expenditures are reduced by any progress
payments received and grants received in connection with
the asset (see IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance).

The average carrying amount of the asset during a period,

including borrowing costs previously capitalised, is normally
a reasonable approximation of the expenditures to which the
capitalisation rate is applied in that period. The activities
necessary to prepare the asset for its intended use or sale
encompass more than the physical construction of the asset.
They include technical and administrative work prior to the
commencement of physical construction, such as the
activities associated with obtaining permits prior to the
commencement of the physical construction.

However, such activities exclude the holding of an asset

when no production or development that changes the asset’s
condition is taking place. For example, borrowing costs
incurred while land is under development are capitalised
during the period in which activities related to the

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development are being undertaken. However, borrowing
costs incurred while land acquired for building purposes is
held without any associated development activity do not
qualify for capitalisation.

SUSPENSION OF CAPITALISATION

An entity shall suspend capitalisation of borrowing costs

during extended periods in which it suspends active
development of a qualifying asset. An entity may incur
borrowing costs during an extended period in which it
suspends the activities necessary to prepare an asset for its
intended use or sale. Such costs are costs of holding partially
completed assets and do not qualify for capitalisation.

However, an entity does not normally suspend capitalising

borrowing costs during a period when it carries out
substantial technical and administrative work. An entity also
does not suspend capitalising borrowing costs when a
temporary delay is a necessary part of the process of getting
an asset ready for its intended use or sale. For example,
capitalisation continues during the extended period that high
water levels delay construction of a bridge, if such high water
levels are common during the construction period in the
geographical region involved.

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CESSATION OF CAPITALISATION

An entity shall cease capitalising borrowing costs 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 the
physical construction of the asset is complete even though
routine administrative work might still continue. If minor
modifications, such as the decoration of a property to the
purchaser’s or user’s specification, are all that are
outstanding, this indicates that substantially all the
activities are complete.

When an entity completes the construction of a qualifying

asset in parts and each part is capable of being used while
construction continues on other parts, the entity shall cease
capitalising borrowing costs when it completes substantially
all the activities necessary to prepare that part for its
intended use or sale. A business park comprising several
buildings, each of which can be used individually, is an
example of a qualifying asset for which each part is capable
of being usable while construction continues on other parts.
An example of a qualifying asset that needs to be complete
before any part can be used is an industrial plant involving
several processes which are carried out in sequence at

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different parts of the plant within the same site, such as a
steel mill.

DISCLOSURE

An entity shall disclose:

(a) the amount of borrowing costs capitalised during the

period; and

(b) the capitalisation rate used to determine the amount of

borrowing costs eligible for capitalisation.

TRANSITIONAL PROVISIONS

When application of this Standard constitutes a change in

accounting policy, an entity shall apply the Standard to
borrowing costs relating to qualifying assets for which the
commencement date for capitalisation is on or after the
effective date. However, an entity may designate any date
before the effective date and apply the Standard to borrowing
costs relating to all qualifying assets for which the
commencement date for capitalisation is on or after that
date.

Annual Improvements to IFRS Standards 2015–2017 Cycle,

issued in December 2017, amended paragraph 14. An entity
shall apply those amendments to borrowing costs incurred

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on or after the beginning of the annual reporting period in
which the entity first applies those amendments.

Effective date

An entity shall apply the Standard for annual periods

beginning on or after 1 January 2009. Earlier application is
permitted. If an entity applies the Standard from a date
before 1 January 2009, it shall disclose that fact. Paragraph
6 was amended by Improvements to IFRSs issued in May
2008. An entity shall apply that amendment for annual
periods beginning on or after 1 January 2009. Earlier
application is permitted. If an entity applies the amendment
for an earlier period it shall disclose that fact. IFRS 9, as
issued in July 2014, amended paragraph 6.

An entity shall apply that amendment when it applies IFRS

9. 24 25 26 27 28 28A 29 29A 29B IAS 23 A1258 © IFRS
Foundation IFRS 16, issued in January 2016, amended
paragraph 6. An entity shall apply that amendment when it
applies IFRS 16. Annual Improvements to IFRS Standards
2015–2017 Cycle, issued in December 2017, amended
paragraph 14 and added paragraph 28A. An entity shall
apply those amendments for annual reporting periods
beginning on or after 1 January 2019. Earlier application is
permitted. If an entity applies those amendments earlier, it
shall disclose that fact.

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 TYPES OF BORROWING COST

Borrowing cost refers to the expense incurred by a company

or an individual for obtaining funds from a lender. It can be
classified into different types based on the source, nature,
and terms of the borrowing. Here are some of the most
common types of borrowing costs:

Interest Expense

Interest expense is the cost of borrowing money, usually

expressed as a percentage of the outstanding loan balance. It
is a common borrowing cost for businesses and individuals
who take out loans from banks or other financial
institutions. The interest rate can vary depending on the
creditworthiness of the borrower, the term of the loan, and
the prevailing market interest rates.

Commitment Fees

Commitment fees are charges levied by lenders for making

funds available to a borrower on a standby basis. These fees
are typically calculated as a percentage of the undrawn
portion of a credit facility. Commitment fees are common in
commercial lending, such as lines of credit or revolving
loans.

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Origination Fees

Origination fees are upfront charges paid to lenders for

processing and underwriting a loan application. These fees
can vary widely depending on the type and size of the loan,
as well as the lender’s policies and practices. Origination fees
are often expressed as a percentage of the loan amount and
are typically non-refundable, even if the loan is not approved
or disbursed.

Prepayment Penalties

Prepayment penalties are fees charged to borrowers who pay

off their loans early or refinance them before the end of the
loan term. These penalties are designed to compensate
lenders for lost interest income and administrative costs
associated with early loan payoff. Prepayment penalties can
be substantial, so it’s important for borrowers to understand
them before committing to a loan agreement.

Credit Spreads

Credit spreads refer to the difference between the yield on a

borrower’s debt and the yield on a risk-free benchmark, such
as U.S. Treasury bonds. Credit spreads reflect the perceived
credit risk of the borrower and can vary widely depending on
market conditions and economic factors. A wider credit

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spread indicates higher borrowing costs for the borrower due
to increased perceived risk.

FACTORS INFLUENCING BORROWING COSTS

Borrowing costs, also known as the cost of debt, are

influenced by a variety of factors that can impact the interest
rates and fees associated with borrowing money. These
factors can vary depending on the type of loan or credit being
sought, the borrower’s financial situation, market conditions,
and other external economic factors. Understanding these
influences is crucial for individuals and businesses looking
to borrow money as it can help them make informed
decisions and secure the most favorable borrowing terms.

1. Creditworthiness of the Borrower: One of the primary

factors influencing borrowing costs is the creditworthiness of
the borrower. Lenders assess the credit score and credit
history of an individual or business to determine the level of
risk associated with lending money. Borrowers with higher
credit scores are generally seen as less risky and may qualify
for lower interest rates and fees compared to those with
lower credit scores.

2. Market Interest Rates: The overall interest rate

environment in the market plays a significant role in
determining borrowing costs. Market interest rates are

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influenced by various factors such as inflation, economic
growth, central bank policies, and global economic
conditions. When market interest rates are low, borrowers
can typically access credit at lower costs. Conversely, when
interest rates rise, borrowing costs tend to increase as well.

3. Loan Term and Type: The term of the loan and its type
also impact borrowing costs. Short-term loans usually come
with lower interest rates but may have higher monthly
payments, while long-term loans often have higher interest
rates but lower monthly payments. Additionally, secured
loans backed by collateral tend to have lower interest rates
compared to unsecured loans.

4. Economic Conditions: The overall economic conditions,

both globally and domestically, can influence borrowing
costs. Factors such as GDP growth, unemployment rates,
inflation, and market volatility can impact lenders’
willingness to lend money and the terms they offer to
borrowers. During periods of economic uncertainty or
recession, borrowing costs may increase as lenders seek to
mitigate risks.

5. Lender’s Policies and Competition: Individual lenders

may have different policies and risk appetites that can affect
borrowing costs. Some lenders may specialize in certain
types of loans or borrowers, leading to varying interest rates

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and fees. Competition among lenders also plays a role in
determining borrowing costs, as borrowers may be able to
secure better terms by shopping around and comparing
offers from multiple financial institutions.

6. Loan Amount and Down Payment: The amount being

borrowed and the size of the down payment can impact
borrowing costs as well. Larger loan amounts may come with
higher interest rates, while a larger down payment can help
reduce the overall cost of borrowing by lowering the loan-to-
value ratio.

7. Regulatory Environment: Regulatory policies imposed by

government authorities can also influence borrowing costs.
Regulations such as usury laws, consumer protection laws,
and banking regulations can impact the terms and
conditions under which lenders operate, ultimately affecting
the cost of borrowing for consumers.

In conclusion, borrowing costs are influenced by a complex

interplay of factors including the creditworthiness of the
borrower, market interest rates, loan terms, economic
conditions, lender policies, loan amount, down payment size,
and regulatory environment. By understanding these factors
and how they interact with each other, borrowers can make
informed decisions when seeking financing options.

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 THE IMPORTANCE OF UNDERSTANDING BORROWING
COST

Understanding borrowing costs is crucial for individuals,

businesses, and governments alike. Borrowing cost refers to
the expense associated with taking out a loan or issuing debt
securities. It encompasses various components such as
interest rates, fees, and other charges that borrowers incur
when accessing external funds. Here are some key reasons
why understanding borrowing costs is essential:

1. Financial Planning and Budgeting: One of the primary

reasons for comprehending borrowing costs is to facilitate
effective financial planning and budgeting. By knowing the
cost of borrowing, individuals and organizations can
accurately estimate their total expenses related to obtaining
funds. This knowledge enables them to plan their budgets
efficiently, ensuring that they can meet their financial
obligations without facing unexpected financial strain.

2. Decision-Making: Understanding borrowing costs plays a

significant role in decision-making processes. Whether it
involves making investments, expanding operations, or
funding projects, having a clear understanding of the
associated borrowing expenses helps in evaluating the
feasibility and profitability of such endeavors. It allows

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borrowers to assess whether the potential returns from
utilizing borrowed funds outweigh the costs involved.

3. Comparison of Financing Options: Different financing

options come with varying borrowing costs. By
understanding these costs, borrowers can compare different
loan products or debt instruments to choose the most cost-
effective option that aligns with their financial goals.
Comparing interest rates, repayment terms, and additional
fees enables individuals and businesses to make informed
decisions regarding their financing choices.

4. Risk Management: Borrowing costs also play a crucial

role in risk management strategies. High borrowing costs can
increase financial risks for borrowers, especially if they
struggle to meet repayment obligations. Understanding these
costs helps in assessing the level of risk associated with
taking on debt and implementing risk mitigation measures
accordingly.

5. Impact on Creditworthiness: The cost of borrowing

directly influences an individual’s or entity’s
creditworthiness. Lenders consider borrowing costs when
evaluating credit applications, as they indicate the borrower’s
ability to manage debt responsibly. A thorough
understanding of borrowing costs allows borrowers to

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maintain a good credit profile by managing their debts
effectively and making timely repayments.

In conclusion, understanding borrowing costs is essential for

making informed financial decisions, managing risks
effectively, and maintaining a healthy financial position. By
grasping the intricacies of borrowing expenses, individuals
and organizations can navigate the lending landscape more
confidently and strategically.

Full IFRS:

Under full IFRS (International Financial Reporting

Standards), borrowing costs are addressed in IAS 23,
“Borrowing Costs.” According to IAS 23, borrowing costs that
are directly attributable to the acquisition, construction, or
production of a qualifying asset should be capitalized as part
of the cost of that 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 capitalization of borrowing costs
ceases when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are
complete.

IFRS for SMEs:

In contrast, under IFRS for SMEs (International Financial

Reporting Standards for Small and Medium-sized Entities),

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the treatment of borrowing costs is simpler. IFRS for SMEs
does not require the capitalization of borrowing costs as part
of the cost of a qualifying asset. Instead, entities can choose
to expense borrowing costs as incurred or capitalize them if
they meet certain criteria.

Full IFRS: Borrowing costs directly attributable to the

acquisition, construction, or production of a qualifying asset
should be capitalized.

IFRS for SMEs: Borrowing costs can be expensed as

incurred or capitalized based on certain criteria.

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 HOW ARE BORROWING COSTS TREATED UNDER IFRS
STANDARDS?

IAS 23 requires the capitalization of interest and certain

other costs that are directly attributable to the acquisition or
construction of ‘qualifying assets’. Companies apply the
following step-by-step analysis to determine the borrowing
costs to be capitalized.

Step 1: Identify qualifying assets

Qualifying assets are those that necessarily take a

substantial period of time to get ready for their intended use
or sale. While IAS 23 does not define ‘substantial period of
time’, in our view it is a period well in excess of six months.
Qualifying assets might be, for example, manufacturing
plants, intangible assets and infrastructure assets such as
bridges and railways. Inventories that are manufactured or
otherwise produced in a short period of time, and assets that
are ready for their intended use or sale when acquired, are
not qualifying assets. Borrowing costs related to these types
of assets do not qualify for capitalization.

Recent developments

The IFRS Interpretations Committee recently clarified in

an Agenda Decision how IAS 23 applies to the construction
of a residential multi-unit real estate development if the

22
developer is selling units to customers before and during
construction and recognizes the related revenue over time as
it transfers control to customers. The Agenda Decision
concludes that the receivable, contract asset and inventory
recognized for the development are not qualifying assets.

A receivable could never be a qualifying asset because it is

‘ready for use’ at the time of its initial recognition. Likewise,
the contract asset, as defined in IFRS 153, represents the real
estate developer’s right to financial consideration as it
transfers control of each unit over time. Inventory for the
unsold units could be sold at any time during development;
therefore, the units are ready for their intended sale and are
not qualifying assets, even though their completion may take
a substantial period of time.

Step 2: Identify eligible costs

Not all amounts classified as interest costs qualify for

capitalization. Only those that are ‘directly attributable’ to
the acquisition or development of the qualifying asset are
eligible. Such costs would have been avoided if the
expenditure on the qualifying asset had not been made. This
includes interest on borrowings made specifically for the
purpose of obtaining the qualifying asset (specific
borrowings) and the cost of other borrowings that could have

23
been repaid if the expenditure for the asset had not been
incurred (general borrowings).

Eligible costs are pre-tax and include interest costs

calculated under the effective interest method, finance
charges on lease liabilities, and foreign exchange differences
to the extent that they are regarded as an adjustment to
interest costs.

Step 3: Determine the capitalization rate for general

borrowings and calculate the costs to be capitalized

The capitalization rate considers the weighted-average

interest cost applicable to general borrowings outstanding
during the period. It is applied to the weighted-average
accumulated expenditure on the asset during the period
minus any progress payments or grants received on the
asset. The amount capitalized cannot exceed the actual
interest costs incurred during the period. If qualifying assets
are financed through specific borrowings, the company
capitalizes the actual borrowing costs on those specific
borrowings less any income from temporary investment.

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Step 4: Determine the period of capitalization

Capitalization begins when expenditure and borrowing costs

for the asset are being incurred and activities that are
necessary to prepare the asset for its intended use are in
progress. Capitalization ceases when activities necessary to
prepare the asset for its intended use are substantially
complete

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