BORROWING COSTS

Borrowing costs are defined as interest and any other costs we may incur in connection with the
borrowing funds. These costs must be capitalised to the cost of the asset only if they are

• Directly attributable
• To the acquisition, construction or production
• Of a qualifying asset.

A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use
or sale.

Where an asset is not considered to be a qualifying asset borrowings costs are expensed.

Example 1

Yay Limited raised a loan of R1 000 000 on 30 June 20x5. There are no capital repayments during
2005, the loan has an interest rate of 10%. The loan was used to finance the construction of factory
plant. The factory plant was not considered to be a qualifying asset.

You’re required to journalise the interest on 31 December 2005.

Solution

In the above example, Yay Ltd borrowed a loan of R1 000 000. It incurred a borrowing cost of
interest at 10%. This interest will be capitalised on the cost of factory plant only if factory plant is a
qualifying asset. If not this 10% interest will be recognised as an expense in the statement of
comprehensive income in 2005.

Loan was taken on 30 June 2005, the financial year ends on December so the interest will be paid for
a period of 6 months this year.

R1 000 000 x 0.10 = R50 000

Journal entry

DR. Finance costs (E) R50 000

CR. Bank/Payables R50 000

Capitalisation of borrowing costs

Construction of a qualifying asset

Borrowing costs are recognised as part of the cost of the asset (capitalised) during what we call
capitalisation period. This period has a start date and an end date and may be broken for a period of
time somewhere between these dates:

• Commencement date
• Suspension period
• Cessation period
 • Capitalisation will commence if activities are in progress, borrowing costs are incurred and
expenditure in the production of the asset is being incurred.

Example 2

Yippee Limited incurred R100 000 interest during the year on a loan that was taken specifically for
financing the construction of a building, a qualifying asset.

• The loan was raised on 01 January 2005

• Construction began on 01 January 2005 and related construction costs were
incurred from this date

You are required to journalise the interest in Yippee Ltd’s books for December year end.

Solution

Borrowing costs incurred are R100 000(interest) they will capitalised to the cost of Building only if
they meet the above 3 requirements.

We have incurred borrowings costs the day we take a loan 01 January 2005, activities began on the
same day and other expenses related to the construction of an asset are incurred on the same day
therefore the capitalisation will commence on January 01.

Journal entry

DR. Finance cost R100 000

CR. Bank/Payables R100 000

Interest on loan incurred first expensed

DR. Building R100 000

CR. Finance cost R100 000

Interest on loan capitalised to the cost of Building

Example 3

Yippee Limited borrowed R100 000 on 30 June 2005 in order to construct a qualifying asset
(Building). The building materials were only available on 31 August 2005 from which point Yippee
began construction.

You are required to discuss when Yippee Limited will begin to capitalise interest.

Solution

On 30 June 2005 we borrowed a loan of R100 000 on this day we incur borrowing costs. On 31
August we began construction and obviously we will incur another expenses related to construction
for example salaries.

Therefore capitalisation will commence on 31 August after we have incurred borrowing costs,
activities has started and other expenses as well are incurred.

Example 4
Yippee Limited borrowed R1 000 000 on 01 January 2005 in order to construct a qualifying asset
(Building). Interest incurred on this day is R100 000. Construction began on 01 February 2005.

Borrowing costs are incurred on 01 January 2005, but activities began on 01 February 2005 and
any related costs also incur on this day therefore capitalisation will start in February 2005.

Journal entries

01/01/2005

DR. BANK (A) R1 000 000

CR. LOAN PAYABLE (L) R1 000 000

31/12/2005

DR. FINANCE COST (E) R100 000

CR. BANK/LIABILITY R100 000

DR. BUILDING: COST (A) R91 667

(R100 000 X 11/12)
CR. FINANCE COST (E) R91 667

We multiplied the interest by 11/12 because the capitalisation period was for a period of 11 months
from February to December.

• Capitalisation of borrowing costs will be temporary suspended when active development of

a qualifying asset is interrupted or delayed for a long period of time.
We will suspend capitalisation if and only if the delay is:
✓ Is for a long period of time and
✓ It is not necessary in getting the asset ready for its intended use
✓ It is not for substantial technical or administrative work.
Look at example 5 in your book page 725.

• Capitalisation of borrowing costs will cease when substantially all activities necessary to
prepare the qualifying asset for its intended use are complete.
(End of construction)
Look at example 6 in your book page 726.

MEASUREMENT OF THE AMOUNT CAPITALISED

Measurement of borrowing costs to be capitalised depends on whether:

• Borrowings are specific – a loan taken specifically for producing/acquiring a qualifying
asset only.
• Borrowings are general – a loan taken for producing/acquiring a qualifying asset and
paying creditors or buying inventory.

Specific loans/borrowings

Borrowing costs to be capitalised = BC incurred during construction period – Investment income

earned during construction period.
Example 1 Specific Loans

Yahoo Limited borrowed R500 000 on 01 January 2005 to fund the construction of a building (QA).
• Interest payable in 2005 was R50 000 (calculated at 10%)
• All surplus borrowings were invested and interest of R24 000 was earned.
• All criteria for a capitalisation of borrowing costs were met on 01 January 2005.
• The building was not yet complete at 31 December 2005.

Show related journal entries for the year ended 31 December 2005.

Solution

DR. FINANCE COST (E) R50 000

CR. BANK/LIABILITY R50 000

DR. BANK (A) R24 000

CR. INTEREST INCOME (I) R24 000

DR. BUILDING: COST (A) W1 R26 000

CR. FINANCE COST R26 000

W1: Calculation of amount to be capitalised during the construction period

Interest incurred during construction period R50 000

Less investment income earned (R24 000)
Total to be capitalised R26 000

Example 2

Yippee Limited raised a bank loan of R500 000 on 01 January 2005 to construct a building, a
qualifying asset. Construction began on 01 March 2005 when all criteria for capitalisation of
borrowing cost were met.

The company paid construction costs of R400 000 on 01 March 2005.

The interest rate payable on the loan was 10%.

Surplus funds were invested in a fixed deposit and earned interest at 6% per annum.

You are required to calculate borrowing costs to be capitalised during the year ended 31
December 2005.

Solution

1. Interest expense/Finance cost R50 000

(R500 000 x 0.10)

2. Interest earned on an investment

We have borrowed R500 000 on January but construction began on March so we invested
R500 000 for two months while we are waiting for activities to progress in March therefore
we will have to calculate interest income on the 1st two months January and February.

R500 000 x 6% x 2/12 = R5 000

 Then on March 01 we take R400 000 from our loan of R500 000 to pay for construction
costs, this means we have remaining balance of R100 000 that is still invested. Therefore
we should calculate an interest income we earned for a period starting from March to
December.
R100 000 x 6% x 10/12 = R5 000

Total interest income is R10 000.

Therefore

Borrowing costs incurred R41 667

(R50 000 x 10/12)
Less investment income earned (R10 000)

Borrowing costs to be capitalised R31 667

General loans

The 1st thing you calculate it’s a capitalisation rate.

Capitalisation rate = interest incurred on general loans/ total general loans x 100

Then after that you need to use the following table.

Period A B C D E
1st period
0 Expenses (A+B/2)* C X % X M/12 A+ B*
incurred OR OR
during the (A+B) A+B+D
period OR
(A+0)

2nd period Previous E XXX XXX XXX XXX

you
calculated

Then the total interest to be capitalised is the total you will get from column D.

Calculation of C column

It will be A+B/2 if the payments are made evenly

A+B if the payments are made at the beginning of each period

A+0 if the payments are made at the end of each period

Calculation of D column

The % used there is the capitalisation rate you calculated above. And M is for months in the current
period.

Calculation of E column
E is equal to A+B if they didn’t say that interest is compounded.

Then if it is compounded your E is equal to

A+B+D

Please look at examples in your book.