IAS 23 Borrowing Costs

IAS 23 Borrowing Costs is an accounting standard that is part of IFRS and that contains the requirements for certain finance costs to be capitalized with the cost of qualifying assets for which such finance costs are being incurred.

The rationale behind the requirements in IAS 23 is the matching principle of accounting, which states that expenses need to match the accounting period of the related revenues that the expenses generate. If finance cost is being incurred to create an asset, it should not be expensed right away but should be added to the cost of the asset. This is because the revenues generated by the asset will likely happen in later accounting periods. When such finance costs are capitalized as part of the cost of the asset, they are correctly matched with the revenues generated through depreciation of the asset or otherwise.

Scope

IAS 23 shall be applied when an entity incurs costs on borrowing of funds. However the standard is not required to be applied with respect to:

  • an asset that is measured at fair value
  • inventories that are produced in large quantities on repetitive basis

Definitions

Borrowing cost is the interest and other charges incurred in connection with funds borrowed. The following are part of borrowing costs:

  • Interest expense as per IFRS 9’s effective interest rate method
  • Finance charge as per IFRS 16 Leases
  • Exchange adjustments to foreign currency interest costs.

Qualifying asset is one which takes substantial amount of time to complete. Various assets may fulfil this definition such as inventories, plant and machinery, intangibles, investment properties and bearer plants.

Recognition

Costs to be capitalized

Borrowing costs that are directly attributable to acquisition, construction or production of a qualifying assets shall be capitalized as part of the cost of that asset. Other borrowing costs should be expensed in the period in which they are incurred.

Borrowing costs that need to be capitalized are those that would have been avoided if the expenditure on the qualifying asset had not been made.

Funds are specifically borrowed

If the sole purpose of a borrowing is to construct or acquire an asset, the borrowing costs to be capitalized are those that are actually incurred on such borrowing, including commitment and similar charges. Any income from investment of excess funds during the capitalization period (see capitalization process below) is subtracted from the borrowing cost to be capitalized.

Funds are used from a general pool

If an entity uses funds from multiple borrowings which are not related to specific projects and are used generally, the borrowing costs should be capitalized using the weighted average rate applicable to borrowings that are outstanding but excluding any borrowings specifically identified as above. In this case, borrowing costs capitalized must not exceed the actual finance charges incurred.

Capitalization process

Commencement

Capitalization starts from the date when activities to acquire or produce the qualifying asset have commenced, expenditure is being incurred on those activities and interest is also being incurred. Capitalization only commences when all these conditions are met.

Suspension

Capitalization is paused when there is disruption in the activities to acquire or produce the asset. However, capitalization is not suspended if the disruption is only due to temporary delay that is necessary part of the process or there is necessary technical or administrative work that needs to be done for activities to resume.

Cessation

Capitalization stops when the activities to get the asset ready for its intended use are substantially complete. For large assets being constructed in parts with each part capable of being used standalone, this condition applies on per part basis. An example of such asset is an amusement park having different sections that open to public as they get completed. This means that once a section of that park is complete, the capitalization of borrowing costs is stopped for that section of the park but continues for other sections that are work-in-progress.

Disclosures

IAS 23 requires disclosures of the amount of borrowing cost capitalized during the year and the rate used to determine the capitalized borrowing cost.

by Irfanullah Jan, ACCA and last modified on

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