Borrowing costs

(IAS-23)
Introduction
IAS 23 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.

Adoption Status
IAS 23 was reissued in March 2007 and applies to annual periods beginning on or after 1
January 2009.

Objective
The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing
costs include interest on bank overdrafts and borrowings, finance charges on finance leases and
exchange differences on foreign currency borrowings where they are regarded as an adjustment
to interest costs.

Scope
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)

Key Definitions
Borrowing costs
Interest and other costs incurred by an entity in connection with the borrowing of funds.
Example:
i) Interest expense calculated using the effective interest rate method
ii) Finance charges in respect of finance lease
iii) Exchange differences arising from foreign currency borrowings to the extent they are
regarded as an adjustment to interest costs

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Qualifying Asset
An asset that necessarily takes a substantial period of time to get ready for its intended use or
sale is known as qualifying asset.
Example:
i) Inventories
ii) Manufacturing plants
iii) Power generation facilities
iv) Intangible assets
v) Investment properties
Example of non-qualifying asset [short period of time to get ready for its intended use or
sale]:
i) Financial assets and inventories that are manufactured or otherwise produced over
a short period of time are not qualifying assets.
ii) Assets that are ready for their intended use or sale when purchased are not
qualifying assets.

Recognition
Borrowing costs should be capitalized if they are directly attributable to the acquisition,
construction or production of a qualifying asset as part of its cost. Other borrowing costs are
expensed on the SPL as incurred.

Measurement
a) Specific borrowing:
Where funds are borrowed specifically, costs eligible for capitalization are the actual costs
incurred less any income earned on the temporary investment of such borrowings. [IAS 23.12]
However, IAS 23 is silent about investment losses on the temporary investment of such
borrowings.
b) General borrowing:
Where funds are part of a general pool, the eligible amount is determined by applying a
capitalization rate to the expenditure on that asset. The capitalization rate will be the weighted
average of the borrowing costs applicable to the general pool. [IAS 23.14]

Disclosure
The following disclosure needs to be made:
 amount of borrowing cost capitalized during the period
 capitalization rate used

Period of capitalization:
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This includes the discussion on the following:

Commencement of capitalization The commencement date for capitalization is the date

when entity first meets all of the following conditions:

 It incurs expenditure for the asset.

 It incurs Borrowing costs.
 Activities necessary to prepare the asset have
started.
Expenditure on a qualifying asset include only:

 cash payments.
 transfer of other asset.
 interest-bearing liabilities.

Suspension of capitalization An entity shall suspend capitalization:

 During extended period in which it suspends

active development of a qualifying asset.
 holding partially completed assets.

An entity shall not suspend capitalization:

 when a temporary delay is necessary.

 entity carries out substantial technical and
administrative work.

Cessation of capitalization  Capitalization of borrowing cost should cease

when the asset is substantially complete, even
though routine administrative work might still
continue.
 When an entity completes the construction of a
qualifying asset in parts, the entity will cease
capitalization when it completes substantially all
activities, even construction continues on the
other parts.

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 Problems
Problem-1
Case-1:
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. Do the acquisition of the permit and the equipment meet the definition of
qualifying assets? Explain.
Case-2:
A telecom company has acquired a 3G license. The license 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 license is acquired. Should the acquisition of the 3G license meet the
definition of a qualifying asset? Explain.

Solution:
Case-1:
The permit relates to a specific building. The permit meets the definition of a qualifying asset
and hence forms a part of the construction cost of the building.
But equipment has been acquired for the construction of various buildings. Hence equipment
does not meet the definition of a qualifying asset.
Case-2:
Yes. The license has been exclusively acquired to operate the wireless network. The fact that the
license can be used or licensed to a third party is irrelevant. The acquisition of the license 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.

Problem-2:
ABC Ltd. decided to shift its office from Baridhara to Gulshan. For the purpose, it acquired an
office building for Tk. 30 million which may require short period of time to get ready for use.
ABC borrowed Tk. 20 million from City Bank at 10% rate of interest per annum for acquiring
the building and the remaining was arranged by self-finance.
Required:
a) Compute the interest cost per annum.
b) Does the building meet the definition of a qualifying asset? Explain.
c) Can ABC capitalize the interest cost on the borrowings for the office building?
Where it has to show the interest cost?

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 d) Can ABC capitalize the interest cost on the borrowings for the office building if
the office building is a qualifying asset?

Solution:
a) Interest cost p.a. = 20 ×10% =2 million
b) As the building may require short period of time, it does not meet the definition of a
qualifying asset.
c) As the building is not a qualifying asset, ABC cannot capitalize the interest cost. It
has to show the interest cost on the SPL as an expense.
d) If the building requires substantial period of time, it will be a qualifying asset. If it is
a qualifying asset, the interest cost (Tk. 2 million) can be capitalized with the cost of
the building (Tk. 30 million) and the building cost will be Tk. 32 million on the SFP.

Problem-3:
On 1 July 2023, ABC. Ltd borrowed Tk. 1.8 million to finance the production of two assets, both
of which were expected to take a year to build. Work started during 2023. The loan facility was
drawn down and incurred on 1 July 2023, and was utilized as follows, with the remaining funds
invested temporarily.
Asset A Asset B
1 July 2023 400 600
1 January 2024 300 -
1 March 2024 - 500
The loan rate was 8% and ABC can invest surplus funds at 6%.
Required:
Ignoring compound interest, calculate the borrowing costs, which may be capitalized for each of
the assets and consequently the cost of each asset as at 30 June 2024.

Solution:
Both the assets are qualifying assets.
Interest to be capitalized:
Asset A Asset B
Total interest expense
(7,00,000 * 8%) 56,000
(11,00,000 * 8%) 88,000
Less: Investment income:
(3,00,000 * 6% * 6/12) (9,000)
(5,00,000*6%* * 8/12) (20,000)
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 45,000 68,000
Cost of each asset 7, 45,000 11, 68,000

Problem-4:
On 1 May 2023, ABC Ltd. took a loan of Tk. 1 million from a bank at the annual interest rate of
5%. The purpose of this loan was to finance a construction of a cinema hall.
The construction started on 1 June 2023. ABC temporarily invested Tk. 8,00,000 borrowed
money during the months of June and July 2023 at the rate of 2% per annum.
What borrowing cost can be capitalized in 2023? Assume all interest was paid.

Solution:
This is the case of a specific borrowing.
Borrowing costs to be capitalized:
10, 00,000 * 5% * 7/12 = 29,167
Less: Investment income
(8, 00,000*.02*2/12) = (2,667)
Net interest to be capitalized 26,500
Total cost of the asset = 10, 26,500
Capitalization should start from the starting period of construction, not from the date of loan.
May interest cannot be capitalized; rather it is to be shown on SPL.

Problem-5:
ABC Ltd. had the following loans in place at the beginning and end of 2023:
Particulars 1 January 2023 31 December 2023
Bank loan, 6% p.a. - 2,00,000
Bank loan, 8% p.a. 1,30,000 1,30,000
Debenture stock, 5.5 p.a. 50,000 50,000
The 6% bank loan was taken in July 2023 to finance the construction of a new production hall,
construction of which began on 1 March 2023.
The 8% bank loan and debenture stock were taken for general purpose and ABC used them to
finance general spending and the construction of a new machinery. ABC used Tk. 60,000 for the
construction of the machinery on 1 February 2023 and Tk. 25,000 on 1 September 2023.
What borrowing cost should be capitalized for the new machinery?

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Solution:
This is the case of a general borrowing.
8% bank loan and 5.5% debenture stock were taken for general spending and the construction of
the new machinery. The question asks for calculating the borrowing cost for the new machinery.
As the borrowing is generalized, the weighted average rate needs to be calculated as follows:

Weighted average rate = (8% * 1, 30,000 / 1, 80,000) + (5.5% * 50,000/1, 80,000)

= 7.33%
Borrowing costs to be capitalized = (60,000 * 7.33% * 11/12) + (25,000 * 7.33% * 4/12)
= Tk. 4,642

Problem-6:
On December 1, 2023, ABC Ltd. began construction of homes for those families that were hit by
the cyclone and were homeless. The construction is expected to take 3.5 years. It is being
financed by the issuance of bonds for Tk. 7 million at 12% per annum. The bonds were issued at
the beginning of the construction. The bonds carry a 1.5% issuance cost. The project is also
financed by the issuance of share capital with a 14% cost of capital. ABC has opted under IAS
23 to capitalize borrowing costs.
Required:
Compute the borrowing costs that need to be capitalized under IAS 23.

Solution:
Homes are here qualifying assets and therefore borrowing costs can be capitalized as a part of the
cost of the homes.
Borrowing costs to be capitalized:
Interest expense = 70, 00,000 × 12% = Tk. 8, 40,000
Amortization of issuance cost:
(70, 00,000 × 1.5%) / 3.5 years = Tk. 30,000
Total borrowing costs to be capitalized = Tk. 8, 70,000 (8, 40,000+30,000)
Cost of capital as not related to borrowing will not be considered.

Capitalization of borrowing costs arising from foreign currency

borrowings:

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IAS 23 states that borrowing costs may include exchange differences arising from foreign
currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Unfortunately, IAS 23 does not provide any guidance in this area. January 2008 IFRIC
update includes a short discussion on this topic, but the conclusion is that an entity needs to
develop its own accounting policy, which will often require judgment.
It is generally accepted that exchange differences arising from foreign currency borrowings,
including impact of derivatives hedging foreign currency exposure (e.g. swaps), can be included
in borrowing costs eligible for capitalization. However, care is needed when determining to what
extent exchange differences are regarded as an adjustment to interest costs and when other
circumstances may be the cause of exchange differences. Here entities need to bear in mind that,
as a rule, exchange differences on monetary assets are immediately recognized in P/L. Entities
with significant exchange differences arising from foreign currency borrowings should disclose
the accounting policy applied.
The gains and losses regarded as adjustment to interest cost are mainly the difference between:

 The borrowing costs that would be incurred if you borrowed in your own functional
currency; and
 The borrowing costs actually incurred on foreign currency borrowings.

IFRIC (Interpretation committee for IFRS) considered 2 methods:

1. estimate the portion of exchange loss or gain to capitalize based on forward currency
rates at the inception of the loan, or
2. estimate it based on interest rates on similar borrowings in the functional currency

The second method is easier to apply.

Practically, we may just limit the exchange differences to capitalize so that the total borrowing
costs capitalized do not exceed the amount of hypothetical borrowing costs on similar loan in the
functional currency.
Problem-7:
Entity A has EUR as its functional currency. It borrows USD 1 million on 1 January 2023 to
finance the construction of a new office building with a repayment date on 31 December 2023.
As the interest rate is high in EUR, they negotiate the loan in USD in one international bank. The
interest on the loan is fixed at 3% and is payable on 31 December 2023 together with principal
amount. The EUR/USD rate on 1 January 2023 is 1.2 (i.e. 1 EUR = 1.2 USD) and 1.1 on 31
December 2023. An equivalent loan in EUR would bear an interest of 4%.
Required:
a) Compute the exchange difference eligible for capitalization.
b) Show the journal entry to record the full exchange loss on foreign currency
borrowing.

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Solution:
a) Entity determines exchange differences eligible for capitalization as follows.
a Loan of USD 1Million (principal) translated to EUR on 1 Jan. 2023 8,33,333
(EUR/USD =1.2)
b Loan of USD 1 Million (principal) translated to EUR on 31 Dec. 2023 9,0,9,091
(EUR/USD=1.1)
c Exchange losses on principal (b-a) 75,758
d Interest paid on principal at 3% (9,09,091 ×3%) 27,273
e Interest that would be paid on equivalent principal in EUR at 4% 33,333
(8,33,333 ×4%)
f Interest paid capitalized (f=d) 27,273
g Capitalized foreign exchange effect regarded as an adjustment to interest 6,061
costs (e-d)
h Total capitalized (f+g) 33,333
i Exchange losses recognized in P/L (c-g) 69,697

b) The recording entry to deal with the full exchange loss on foreign currency loan is
as follows:

PPE: Office building Dr 6,061

P/L Dr 69,697
Loan Cr 75,758

Comprehensive problem

On 1 July, 2022, ABC Ltd. entered into a Tk. 2.20 million contract for the construction of
a building. The building was completed at the end of June 2023. During the period, the following
payments were made to the contractor:
Payment date Amount (in Tk.’000)
1 July 2022 200
30 September 2022 600
31 March 2023 1,200
30 June 2023 200
Total 2,200
ABC’s borrowings as at the year end of 30 June 2023 were as follows:

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 a) 10% four-year note with simple interest payable annually, which relates specifically
to the project; debt outstanding at 30 June 2023 amounted to
Tk. 7, 00,000. Interest of Tk. 65,000 was incurred on these borrowings during the
year, and interest income of Tk. 20,000 was earned on these funds while they were
held in anticipation of payments.
b) 12.5% 10-year note with simple interest payable annually; debt outstanding at 1 July
2022 amounted to Tk. 10, 00,000 and remained unchanged during the year.
c) 10% 10-year note with simple interest payable annually; debt outstanding at 1 July
2022 amounted to Tk. 15, 00,000 and remained unchanged during the year.

Assume for purposes of this problem that interest expenses equals borrowing costs and
the building is a qualifying asset.
Required:
Calculate the amount of borrowing costs to be capitalized.

Solution:
Expenditures incurred in obtaining a qualifying asset are first allocated to any specific
borrowings. The remaining expenditures are allocated to any general borrowings

Payment date Expenditure Amount allocated to Weighted for period

general borrowings outstanding
1 July 2022 200 0 0
30 September 2022 600 100* 100×9/12 = 75
31 March 2023 1,200 1,200 1,200×3/12=300
30 June 2023 200 200 200×0/12 = 0
Total 2,200 375
*Specific borrowings of Tk. 7, 00,000 are fully utilized; remainder of expenditure is therefore
allocated to general borrowings.
The capitalization rate relating to general borrowings is the weighted average of the borrowing
costs applicable to the entity’s borrowings that are outstanding during the period, other than
borrowings made specifically for the purpose of obtaining a qualifying asset.
Weighted average rate = 12.5 %( 1,000/2,500) + 10% (1,500/2,500)
= 11%
Borrowing costs to be capitalized:
Specific loan 65,000
General borrowing (3, 75,000×11%) 41,250

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 Total 1, 16,250
Less: interest income on specific borrowings (20,000)
Amount eligible for capitalization 86,250

Exercises:
Exercise-1:
ABC Ltd. had the following loans in place at the beginning and end of 2023:
in million Tk.
1 January 2023 31 December 2023
10% bank loan repayable 2025 120 120
9.5% bank loan repayable 2026 80 80
8.9% debenture repayable 2024 - 150
The 8.9% debenture was issued to find the construction of a qualifying asset (a piece of mining
equipment), construction of which began on 1 July 2023.
On 1 January 2023, ABC began construction of a qualifying asset, a piece of machinery for a
hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was
Tk. 30 million on 1 January 2023, Tk. 20 million on 1 October 2023.
Required:
Calculate the borrowing costs that can be capitalized for the hydroelectric plant machine.
[Hint: Similar to problem-5]

Exercise-2:
ABC Ltd. received Tk. 20 million 6% loans on 1 January 2023 to finance construction of a new
factory. As the funds were not all required immediately, ABC invested Tk. 8 million in 3%
bonds until 30 June 2023. Construction of the factory began on 1 April 2023 and was completed
on 31 December 2023.
Required:
Calculate the amount of interest to be capitalized in respect of the factory as at 31 December
2023.
[Hint: Interest incurred from 1 January 2023 to 1 April 2023 will be charged to SPL. Interest
incurred from 1 April 2023 to 31 December can be capitalized.
Likewise, interest earned on temporary investment from 1 January 2023 to 1 April 2023 will be
recognized on the SPL and interest earned from 1 April 2023 to 30 June 2023 can be deducted
from the capitalized interest cost]

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Exercise-3:
On 1 January 20x1, ABC Company took up a Tk. 1, 50,000 bank loan at 8% per annum and
issued debentures of Tk. 50,000 at 7% per annum for no specific purposes. ABC Company used
these borrowings to finance general spending and the construction of new machinery. ABC
Company used Tk. 60,000 on 1 February 20x1 and Tk. 40, 000 on 1 September 20x1 for the
construction of the machinery. On 1st May 20x1, ABC Company took a bank loan of Tk. 5,
00,000 at annual interest rate of 6% [40% of which had been invested temporarily at annual
interest rate of 3% for 3 months]. The purpose of the loan was to finance the construction of a
building. This was a specific borrowing. The construction of the building commenced on 1st
June 20x1 and was completed by 31 December 20x1. On 1 July 20x1, ABC Company took
another bank loan of Tk. 3, 00,000 at annual interest rate of 5% to acquire a building which is
ready for its use.
Required:
a) Identify the qualifying assets in this case.
b) Compute the total interest expense on specific borrowings for 20x1.
c) Compute the capitalization rate for general borrowing.
d) Compute the total interest expense on general borrowings for 20x1.
e) Compute the borrowing costs eligible for capitalization.
f) Compute the borrowing costs to be expenses for the year 20x1.
g) Compute the value of machinery and the value of building on capitalization of borrowing
costs for 20x1. [Ignore depreciation]
h) How will you treat the borrowing cost of the non-qualifying asset?

[Hint: 8% bank loan and 7% debenture are general borrowings. Capitalization rate is to be found
for the general borrowings. 6% bank loan is a specific borrowing. 5% bank loan was undertaken
for the construction of building; which is not a qualifying asset.]

Exercise-4:
ABC Company had the following general borrowings during 2022 which were used to
finance the construction of a new building:
Principal Borrowing costs
10% bank loan 28,00,000 2,80,000
10% short-term loan 16,00,000 1,60,000
12% long-term loan 20,00,000 2,40,000
64,00,000 6,80,000

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 The construction began on January 1, 2022 and the building was completed on December
31, 2022. The building is assumed to be a qualifying asset. Reporting period ends on 31
December each year.
Expenditures on the building were made as follows:
January 1 4,00,000
March 31 10,00,000
June 30 12,00,000
September 30 10,00,000
December 31 4,00,000
Total 40,00,000

Required:
a) What interest rate should be used to calculate capitalize borrowing cost?
b) What is the amount of capitalized borrowing cost?
c) Determine the value of building on the statement of financial position.
d) Determine the borrowing cost to be shown on the statement of profit or loss.

[Hint: See comprehensive problem]

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borrowing-cost-problem-solutions/20208319

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