Chapter11 borrowingcosts2008

Gripping IFRS Capitalisation of borrowing costs

Chapter 11
Capitalisation of Borrowing Costs

Reference: IAS 23

Contents: Page

1. Introduction and definitions 365

1.1 Overview 365
1.2 Borrowing costs 365
1.3 Qualifying assets 365
1.4 Qualifying borrowing costs 366

2. Expensing borrowing costs 366

2.1 Recognition 366
2.2 Measurement 366
Example 1: expensing borrowing costs 366

3. Capitalising borrowing costs 367

3.1 Recognition 367

3.1.1 Commencement of capitalisation 367
Example 2: capitalisation of borrowing costs: all criteria met at same time 367
Example 3: commencement of capitalisation: criteria met at different times 368
Example 4: commencement of capitalisation: criteria met at different times 368

3.1.2 Suspension of capitalisation 369
Example 5: delays in construction 369

3.1.3 Cessation of capitalisation 369
Example 6: end of construction 370

3.2 Measurement 370

3.2.1 Measurement: specific loans 372
Example 7: specific loans 372
Example 8: specific loans: costs paid on specific days 373
Example 9: specific loans: costs paid evenly over a period 374
Example 10: specific loans: loan raised before construction begins 375

3.2.2 Measurement: general loans 375
Example 11: general loan: costs incurred evenly 376
Example 12: general loan: costs incurred at the end of each month 377
Example 13: general loan: costs incurred at the start of each month 379

4. A comparison of the methods 380

5. Disclosure 380

6. Summary 382

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1 Introduction and definitions

1.1 Overview
IAS 23 was revised in March 2007. Those of you who have studied this standard previously
will notice that in the previous version of IAS 23, accountants were able to choose between:
• the benchmark treatment (expensing borrowing costs); and
• the allowed alternative treatment (capitalising borrowing costs).
In the revised version of IAS 23, however, you will notice that there is no reference at all to
the benchmark or allowed alternative treatments. The revised IAS 23 has it that accountants
must capitalise borrowing costs (the previous allowed alternative treatment) that are incurred
on qualifying assets. Thus borrowing costs on non-qualifying assets are always expensed.
Therefore, IAS 23 now requires that an entity:
• capitalise borrowing costs that were incurred on a qualifying asset; and
• expense borrowing costs that were not incurred on a qualifying asset.
Up until now you will have indirectly been exposed to borrowing costs where borrowing
costs are generally expensed (i.e. the presupposition in such examples would have been that
the borrowing costs were not incurred on a qualifying asset). We will now learn how and
when to capitalise borrowing costs. In a nutshell, borrowing costs that relate to qualifying
assets must be capitalised assuming that criteria for recognition of an asset are also met.
One of the more significant reasons behind capitalising borrowing costs instead of expensing
them is that the cost of financing is generally a significant cost, and is generally a necessary
evil in order to bring an asset to a location and condition that makes it useable or saleable.
Costs that are significant and necessary should surely form part of the asset’s cost. There are
arguments against capitalizing borrowing costs as well, of course. These are discussed at the
end of this chapter, but are largely academic now, given that there is no longer a choice.

1.2 Borrowing costs
Borrowing costs are those costs that are incurred by the entity in connection with the
borrowing of funds.
Other names often used for borrowing costs include:
• interest expense; and
• finance charges.
Borrowings costs may include:
• interest incurred on loans (including bank overdraft);
• amortisation of discounts (or premiums);
• finance charges on finance leases;
• exchange difference on foreign loan accounts; and
• costs of raising debt.

1.3 Qualifying assets

Qualifying assets are those that take a substantial period of time to get ready for their
intended use or sale.
Qualifying assets may include:
• manufacturing plants;
• power generation facilities;
• intangible assets;
• investment properties; and
• inventories.

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1.4 Qualifying borrowing costs (IAS 23.8 - .10)

Borrowing costs that must be capitalised to the cost of an asset are those that:
• are directly attributable
• to the acquisition, manufacture or production
• of a qualifying asset; and those that
• would have been avoided had the expenditure on the qualifying asset not been made.

It is sometimes quite difficult to identify a direct link between borrowing costs incurred and a
specific asset since:
• the borrowings may not have been specifically raised for that asset, but may be general
borrowings (i.e. the entity may have a range of debt instruments at a range of varying
interest rates);
• the borrowings may not even be denominated in your local currency (i.e. the borrowings
may be foreign borrowings); and
• the borrowings may be subject to hyper-inflation (borrowing costs that compensate for
inflation are always expensed).

The lists of complications are seemingly endless thus frequently requiring your professional
judgement. These complications in calculation of the borrowing costs to be capitalised are
expanded upon in the section entitled ‘measuement’.

2 Expensing borrowing costs

2.1 Recognition (IAS 23.8 - .9)

Whenever borrowing costs do not meet the conditions for capitalisation, they are expensed.

Expensing borrowing costs simply means to include the borrowing costs as an expense in
profit or loss in the period in which they were incurred (i.e. as and when interest is charged in
accordance with the terms of the borrowing agreement).

2.2 Measurement

The amount of borrowing costs expensed is simply the amount charged by the lender in
accordance with the borrowing agreement.

Example 1: expensing borrowing costs
Yay Limited incurred C100 000 interest (during the year ended 31 December 20X5) on a loan
that was used to finance the construction of a factory plant.

The factory plant was not considered to be a qualifying asset.
Required:
Provided the necessary journal entries for expensing the interest in Yay Limited’s books for
the year ended 31 December 20X5.
Solution to example 1: expensing borrowing costs

Comment:
When to recognise an expense: when the interest is incurred.
How much to expense: the amount of interest charged by the lender in terms of the agreement.

Debit Credit
Finance costs (expense) 100 000
Bank/ liability 100 000
Interest incurred during the period is expensed

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3 Capitalising borrowing costs

3.1 Recognition (IAS 23.8 - .9)

To capitalise borrowing costs simply means to include them in the cost of the related
qualifying assets. In other words, the borrowing costs are recognised as an asset.

Before the borrowing costs may be recognised as an asset, they must meet the basic
recognition criteria for an asset:
• future economic benefits must be probable; and
• the costs must be reliably measurable.

Borrowing costs that must be capitalised are those:
• that are directly attributable
• to the acquisition, construction or production
• of a qualifying asset.

Directly attributable means: if the assets had not been constructed, acquired or produced then
these costs could have been avoided.

An example of an acquisition is the purchase of a building. An example of the construction
of an asset is the building of a manufacturing plant. An example of the production of an asset
is the manufacture of inventory.

When to recognise borrowing costs as part of the asset (capitalisation) is affected by:
• Commencement date: capitalisation starts from the date on which certain criteria are met;
• Suspension period: capitalisation must stop temporarily when certain criteria are met;
• Cessation date: capitalisation must stop permanently when certain criteria are met.

When borrowing costs are capitalised, the carrying amount of the asset will obviously be
increased by the borrowing costs incurred. The cost of these borrowings will eventually
reduce profits, but only when the qualifying asset affects profit or loss (e.g. through the
depreciation expense when the qualifying asset is an item of property, plant and equipment).

3.1.1 Commencement of capitalisation (IAS 23.17 - .19)

Assuming the basic recognition criteria are met, an entity must start to capitalise borrowing
costs from the date that all the following criteria are met:
• the entity is preparing the asset for its intended use or sale (activity is happening);
• expenditure is being incurred by the entity in preparing the asset; and
• borrowing costs are being incurred.

The date that all three criteria are met is known as the commencement date.

Example 2: capitalisation of borrowing costs - all criteria met at same time

Yippee Limited incurred C100 000 interest on a loan used to finance the construction of a
building during the year ended 31 December 20X5:
• The building was considered to be a qualifying asset.
• Construction of the building began on 1 January 20X5, when the loan was raised.
• It is probable that the building would result in future economic benefits and the borrowing
costs are reliably measurable.
• The construction of the building began as soon as the loan was raised.

Required:
Provide the necessary journal entries to capitalise the borrowing costs in Yippee Limited’s
books for the year ended 31 December 20X5.

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Solution to example 2: capitalisation of borrowing costs - all criteria met at same time

Comment: Interest must be recognised as part of the cost of the qualifying asset. Interest is recognised
as part of the asset (capitalisation) from the time that all criteria for capitalisation are met. All criteria
are met on the same date (1 January 20X5):
• a loan is raised on 1 January 20X5 on which interest is being incurred;
• activities start on 1 January 20X5; and
• expenditure related to the activities start on 1 January 20X5 is being incurred.
The basic recognition criteria are also met and therefore the amount to be capitalised is calculated from
1 January 20X5.
Debit Credit
Finance costs (expense) 100 000 x 12 / 12 100 000
Interest on the loan incurred first expensed
Building: cost (asset) 100 000 x 12 / 12 100 000
Interest on the loan capitalised to the cost of the building

Example 3: commencement of capitalisation - criteria met at different times

Dawdle Limited borrowed C100 000 on the 30 June 20X5 to build a factory to store its goods.
The necessary building materials were only available on 31 August 20X5 and it was then that
Dawdle Limited began construction. The building is considered to be a qualifying asset.

Required:
Discuss when Dawdle Limited may begin capitalising the interest incurred.

Solution to example 3: commencement of capitalisation - criteria met at different times

All three criteria must be met before the entity may begin capitalisation. From the 30 June 20X5,
Dawdle Limited borrowed funds and began incurring borrowing costs, but had not yet met the other
two criteria (activities were not underway and costs on the asset were not being incurred). On the
31 August 20X5, however, Dawdle both acquired the construction materials and began construction
thereby fulfilling all three criteria. Dawdle Limited may therefore only begin capitalising the
borrowing costs on the 31 August 20X5 (assuming that it was probable that the building would render
future economic benefits and that the costs were considered reliably measurable).

Example 4: commencement of capitalisation - criteria met at different times

Hoorah Limited incurred C100 000 interest for the year ended 31 December 20X5 on a loan
of C1 000 000, raised on 1 January 20X5. The loan was raised to finance the construction of
a building during the year ended 31 December 20X5. The building is a qualifying asset.
Construction began on 1 February 20X5.

Required:
Provide the necessary journal entries to capitalise the borrowing costs in Hoorah Limited’s
books for the year ended 31 December 20X5.

Solution to example 4: commencement of capitalisation - criteria met at different times

Comment: Borrowing costs are being incurred from 1 January 20X5, but activities and related
expenditure are only incurred from 1 February 20X5: all three criteria for capitalisation are therefore
only met from 1 February 20X5 and therefore capitalisation may only occur from this date:

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20X5 Debit Credit
Finance costs (expense) 100 000 x 12 / 12 100 000
Interest on the loan incurred first expensed: total interest incurred for
the year (given: 100 000)
Building: cost (asset) 100 000 x 11 / 12 91 667
Interest on the loan capitalised to the cost of the building; from
commencement date (1 February 20X5)

3.1.2 Suspension of capitalisation (IAS 23.20 - .21)

If the active development of the qualifying asset is interrupted or delayed for a long period of
time, the capitalisation of the borrowing costs must be suspended.

Capitalisation of borrowing costs must not be suspended, however, if:
• the delay is only temporary;
• if the delay is due to substantial technical or administrative work; or
• if the delay is a necessary part of getting the asset ready for its intended use.

A typical example of when borrowing costs should continue to be capitalised despite a delay
is a wine farm that has to wait for its inventory of wine to mature in order to ensure a saleable
condition. In this case, borrowing costs that are incurred during this period of maturation
would continue to be capitalised to the cost of the inventory of wine.

Example 5: delays in construction

A hotel is under construction in 20X5. Borrowing costs of C300 000 are incurred on a loan
during 20X5. The loan was specifically raised on 1 January 20X5 for the sole purpose of the
construction of the hotel.

Required:
Discuss how much of the interest may be capitalised assuming that:
A. The builders go on strike for a period of two months, during which no progress is made.
B. The builders of the hotel had to wait for five days for the cement in the foundations to dry.

Solution to example 5: delays in construction

A. During these two months, the interest incurred may not be capitalised to the asset as it is a
substantial and unnecessary interruption to the construction process.

B. The borrowing costs must still be capitalised as it is merely a temporary delay and is a normal part
of the construction process.

3.1.3 Cessation of capitalisation

The entity must stop capitalising borrowing costs when the asset:
• is ready for its intended use or sale; or
• is substantially complete and capable of being used or sold.

By way of example, capitalisation would cease if routine administration work or minor
modifications are all that remains to be done (e.g. decoration of a new building to the client’s
specifications) in order to bring the asset to a useable or saleable condition.

If an asset is completed in parts where each part is capable of being used separately from the
other parts, then capitalisation of borrowing costs ceases on each part as and when each part is
completed. An example of such an asset would be an office park: as office blocks are

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completed, these office blocks may begin to be used by tenants. An example of an asset that
would not be capable of being used or sold in parts is a factory plant that requires parts to be
made in sequence and where the plant becomes operational only when all parts are completed.

Example 6: end of construction

Flabby Limited began construction of a block of flats on 1 January 20X5. The block of flats
is to be leased out to tenants in the future.

On 1 January 20X5, Flabby Limited correctly began capitalising borrowing costs (on a
C2 000 000 loan raised for the construction) to the cost of the property.

On 30 September 20X5, the building of the block was complete but no tenants could be
found. On 15 November 20X5, however, after lowering the rentals, the entire building was
rented out to tenants.

Interest of C200 000 (at 10% on the loan) was incurred during the 12-month period ended
31 December 20X5.

Required:
Discuss when Flabby Limited should stop capitalising the interest expense to the asset
(building) and show the journal entries relating to interest.

Solution to example 6: end of construction

Capitalisation should cease when:
• the asset is ready for its intended use or sale.

On the 30 September 20X5 the construction was completed. Although the asset was not being leased it
was ready to be leased to tenants on 30 September 20X5, and therefore capitalisation must cease on
30 September 20X5 (because one of the three criteria for capitalisation is no longer met: activity has
ceased). All subsequent interest incurred must be expensed.

Journals in 20X5: Debit Credit
Interest incurred: 200 000 (given)

Building (asset) 150 000
Interest capitalised: 200 000 x 9 / 12 (to completion date: 30/9/20X5)

3.2 Measurement (IAS 23.10 - .15)

Not all borrowing costs may be capitalised. The list of borrowing costs that may be
capitalised are given in IAS 23 and are included under paragraph 1.2 above.

Notice that this list excludes certain costs associated with raising funds or otherwise financing
a qualifying asset. This suggests that costs that do not appear on this list may not be
capitalised. Borrowing costs therefore exclude:
• cost of raising share capital that is recognised as equity, for example:
- dividends on ordinary share capital;
- dividends on non-redeemable preference share capital (dividends on redeemable
preference share capital may be capitalised because redeemable preference shares are
recognised as liabilities and not equity);
• cost of using internal funds (e.g. if one uses existing cash resources instead of borrowing
more funds, there is a indirect cost being the lost income, often measured using the

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companies weighted average cost of capital or the market interest rates that could
otherwise have been earned);
• foreign exchange differences that are incurred as a result of acquiring the qualifying asset
on credit terms with no interest charged (e.g. if an asset is purchased for $ 1 000 on
1 January 20X1 when the exchange rate is C7: $1, then the entity owes C7 000 on the
transaction date, but if the payment is only necessary on 30 June 20X1 and if the payment
is made on this date, and if the exchange rate is C10: $1 on this date, then the entity will
have to pay C10 000: the asset will be recorded at C7 000 and the C3 000 exchange
difference will have to be expensed since it does not relate to a borrowing cost).

The formula used to measure the borrowing costs that may be capitalised depends on the
source of the borrowings. There are two sources of borrowings, which include:
• specific borrowings and
• general borrowings.

Unfortunately IAS 23 does not define what is meant by specific and general borrowings. The
difference between specific and general borrowings can, however, be explained as follows:
• specific borrowings are taken out for the sole purpose of financing the construction,
acquisition or production of a qualifying asset; whereas
• general borrowings are those funds that are entered into for a ‘general’ purpose. These
funds may be utilised for buying inventory, paying off creditors and a multitude of other
purposes in addition to the construction, acquisition or production of a qualifying asset.

When determining whether your borrowings are either general or specific, it is useful to
remember that whilst a bank overdraft facility is often used as general purpose borrowings, it
is also possible for a bank overdraft facility to be arranged specifically for a qualifying asset.
The particular circumstances should, therefore, always be considered when deciding whether
the borrowing is specific or general.

Measuring the borrowing costs to be capitalised is sometimes more complicated that it first
appears. The basic questions that one needs to answer when measuring the borrowing costs
to be capitalised include:
• are the borrowings specific or general or is there a mix of both specific and general?
• is the borrowing a precise amount (e.g. a loan) or does it increase as expenditure is paid
for (e.g. a bank overdraft)?
• are the expenditures (on which interest is incurred) incurred evenly or at the beginning or
end of a period or at haphazard times during a period?
• how long are the periods during which capitalisation is allowed?

In considering whether the borrowings specific or general or is there a mix of both specific
and general, remember that:
• where the borrowings are specific:
- you will need the actual rate of interest/s charged on the borrowing/s; and
- you will need to ascertain whether any surplus borrowings were invested upon which
interest income was earned (if so, remember to reduce the interest expense by the
interest income);
• where the borrowings are general:
- you will need the weighted average rate of interest charged (assuming there is more
than one general borrowing outstanding during the period);

In considering whether the borrowing is a precise amount (e.g. a loan) or whether it increase
as expenditure is paid for (e.g. a bank overdraft), bear in mind that:
• if the borrowing is a loan ( a precise amount), you will use the capital sum; and
• if the borrowing is an overdraft (a fluctuating amount), you will use the relevant
expenditures and will need to know when they were incurred (or whether they were
incurred relatively evenly).

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In assessing whether the expenditures (on which interest is incurred) are incurred evenly or at
the beginning or end of a period or at haphazard times during a period, bear in mind that:
• interest expense can be measured using average borrowing balances if the costs are
incurred evenly, whereas actual borrowing balances should be used (whether specific or
general borrowings) if costs are incurred at the beginning or end of a period; and
• interest income should be measured using average investment balances if the costs are
incurred evenly, whereas actual investment balances should be used (if it is a specific
borrowing) if costs are incurred at the beginning or end of a period,.

In determining the periods during which capitalisation must occur, you will need to know:
• the commencement date:
borrowings may be outstanding (and incurring interest) before commencement date in
which case interest expense (and interest income on any surplus funds invested) up to
commencement date must be ignored when calculating the portion to be capitalised;
• the cessation date:
borrowings may be outstanding (and incurring interest) after cessation date in which case
interest expense (and interest income on any surplus funds invested) after cessation date
must be ignored when calculating the portion to be capitalised; and
• whether there was a suspension period between these two dates:
borrowings may be outstanding (and incurring interest) during a suspension period in
which case interest expense (and interest income on any surplus funds invested) during
this period must be ignored when calculating the portion to be capitalised.

3.2.1 Measurement: specific loans (IAS 23.12 - .13)

All of the borrowing costs incurred on a specific loan are capitalised to the asset. If these
funds are invested prior to the date they were utilised then any interest earned must be
subtracted from the interest incurred (borrowing costs), in which case only the net amount
may be capitalised.

Example 7: specific loans

Yahoo Limited borrowed C500 000 from the bank on 1 January 20X5 to begin the
construction of a building. The interest payable on the loan during 20X5 was C50 000
(calculated at 10%). The company invested all surplus funds raised in a fixed deposit and
earned C24 000 interest during 20X5. No capital portion of the loan was repaid during the
year ended 31 December 20X5. All criteria for capitalisation of borrowing costs were met
on 1 January 20X5. The building is a qualifying asset.

Required:
Calculate the amount of borrowing costs that must be capitalised in terms of IAS 23 and show
the necessary journal entries.

Solution to example 7: specific loans

Comment: this example shows that interest income is used to reduce the amount of borrowings that
may be capitalised when the borrowing is a specific borrowing.

Calculations: C
Interest incurred 500 000 x 10% 50 000
Interest earned given (24 000)
Total to be capitalised 26 000

Debit Credit
Interest incurred on the loan first expensed

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Debit Credit
Interest income 24 000
Interest income earned on investment of surplus loan funds
Building: cost (asset) 50 000 – 24 000 26 000
Portion of interest on the loan capitalised to the cost of the building

When calculating the interest income you may find that actual amounts invested can be used.
This happens when, for example, the expenditures are infrequent and/ or happen at the start or
end of a period. This will mean that the investment balance will remain unchanged for a
period of time. The calculation of the amount of borrowing costs on specific borrowings that
must be capitalised is therefore:
• total interest incurred on specific borrowings:
capital borrowed x interest rate x period borrowed
• less interest income earned from investment of surplus borrowings:
amount invested x interest rate x period invested.

Very often, however, average amounts invested need to be used instead of actual amounts
invested. This happens more frequently when the borrowing is a general borrowing, but can
apply to a specific borrowing where, for example, the expenditure is paid relatively evenly
over a period of time, with the result that the balance on the investment account (being the
surplus borrowings that are invested) is constantly changing. In this case, it is normally
acceptable to calculate the interest earned on the average investment balance over a period of
time (rather than on the actual balance on a specific day). The calculation of the amount of
borrowing costs on specific borrowings that must be capitalised could therefore be:
• total interest incurred on specific borrowings:
capital borrowed x interest rate x period borrowed
• less interest income earned from investment of surplus borrowings:
(investment o/ balance + investment c/ balance) / 2 x interest rate x period invested

Example 8: specific loans – costs paid on specific days

Haha Limited borrowed C500 000 from the bank on 1 January 20X5 to begin the
construction of a building (a qualifying asset). Construction began on 1 January 20X5 (i.e.
all criteria for capitalisation of borrowing costs were met). The interest rate payable on the
loan was 10%. The company paid construction costs of C400 000 on 1 March 20X5.
Surplus funds were invested in a fixed deposit and earned interest at 6% per annum. No
capital portion of the loan was repaid during the year ended 31 December 20X5.

Required:
Calculate the amount of borrowing costs that must be capitalised.

Solution to example 8: specific loans – costs paid on specific days

Comment: The borrowings are raised two months before they were required. These surplus funds are
invested for January and February and the balance on this account for these two months remains stable
at C500 000. On March, however, payments totaling C400 000 are made, thus reducing the investment
balance to C100 000. This balance remains stable for the remaining ten months of the year. Since the
expenditure is not incurred evenly over a period but is incurred on a specific day, the interest income
for the purposes of the calculation of the borrowing costs to be capitalised should be calculated using
the actual investment balances (C500 000 for 2 months and C100 000 for 10 months).

Calculations: C
Borrowing costs incurred 500 000 x 10% x 12 / 12 50 000
Interest earned 500 000 x 6% x 2 / 12 + (500 000 – 400 000) x 6% x 10/ 12 (10 000)
Capitalised borrowing costs 40 000

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Debit Credit
Interest incurred on the loan is first expensed
Building: cost (asset) 40 000

Example 9: specific loans – costs paid evenly over a period

Hooray Limited borrowed C500 000 from the bank on 1 January 20X5 to begin the
construction of a building (a qualifying asset).
Construction begins on 1 January 20X5 (all criteria for capitalisation of borrowing costs
were met on this date).
The interest rate payable on the loan was 10%.
The company paid construction costs of C400 000 evenly between 1 March 20X5 and
31 December 20X5.
Surplus funds are invested in a fixed deposit and earned interest at 6% per annum. No
capital portion of the loan was repaid during the year ended 31 December 20X5.

Required:
Calculate the amount of borrowing costs that must be capitalised.

Solution to example 9: specific loans – costs paid evenly over a period

Comment: The borrowings are raised two months before they were required. These surplus funds are
invested for January and February and the balance on this account for these two months remains stable
at C500 000. From March, however, the amount invested gradually reduces as payments are made (the
balance of C500 000 on 1 March gradually decreases to a balance of C100 000 (C500 000 – C400 000)
on 31 December. Since the payments are incurred evenly over this ten-month period, the interest
income for the purposes of the calculation of the borrowing costs to be capitalised may be calculated
using the average of these two balances (C500 000 and C100 000).

Calculations: C
Interest incurred 500 000 x 10% x 12 / 12 50 000
Interest earned (500 000 x 6% x 2 / 12) + (500 000 + 100 000) / 2 x 6% x 10/ 12 (20 000)

Debit Credit
Interest incurred on the loan is first expensed

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Example 10: specific loans – loan raised before construction begins

Yeeha Limited borrowed C500 000 from the bank on 1 January 20X5 to begin the
construction of a building (a qualifying asset).
Construction began on 1 February 20X5 (i.e. all criteria for capitalisation of borrowing
costs were met on this date).
The interest rate payable on the loan is 10%.
The company paid construction costs of C400 000 on 1 March 20X5.
Surplus funds are invested in a fixed deposit and earned interest at 6% per annum.
No capital portion of the loan was repaid during the year ended 31 December 20X5.

Required:
Calculate the amount of borrowing costs that may be capitalised.

Solution to example 10: specific loans – loan raised before construction begins

Compare this to example 8, in which the construction began on 1 January 20X5. In this example, the
loan is taken out before construction begins. All criteria for capitalisation are therefore only met on
1 February 20X1 (commencement date) and therefore the interest that is incurred/ earned before this
date must be ignored for the purpose of calculating the portion of interest to be capitalised.

Calculations: C
Interest incurred after 500 000 x 10% x 11 / 12 45 833
commencement date (i.e. excludes January interest expense)
Interest earned after (500 000 x 6% x 1 / 12) + (500 000 - 400 000) x 6% x 10 / 12 (7 500)
commencement date (i.e. excludes January interest income)

Debit Credit
Interest incurred on the loan first expensed: 500 000 x 10% x 12/ 12
Interest income earned on investment of surplus loan funds:
(500 000 x 6% x 2 / 12) + (500 000 – 400 000) x 6% x 10 / 12

3.2.2 Measurement: general loans (IAS 17.14 - .15)

General loans are used for many purposes and therefore it cannot be said that all the interest
incurred thereon was ‘directly attributable to the qualifying asset’. Therefore, not all the
interest incurred on a general loan may be capitalised to the asset.

If the entity has used a general loan for a qualifying asset, the costs eligible for capitalisation
are the weighted average cost of borrowings, calculated as follows:
• capitalisation rate x the average expenditure relating to the qualifying asset.
• The capitalisation rate is:
the weighted average interest rate on the loans borrowed by the entity.
• The average expenditure is:
expenditure for the period / 2

The total amount of interest capitalised may not exceed the total interest paid or incurred.

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Example 11: general loans – costs incurred evenly

Bizarre Limited had a C500 000 7% existing general loan outstanding on 1 January 20X5. It
raised an additional general loan of C600 000 on 1 January 20X5 at an interest rate of 12.5%.
Bizarre Limited did not make any repayments on either loan during the year.
Construction began on 1 January 20X5.
The company spent the following amounts per month on the construction of a building, a
qualifying asset:
C per month
1 January – 31 July (7 months) 50 000
1 August – 30 November (4 months) 30 000
1 – 31 December (1 month) 100 000

Required:
Calculate the amount of borrowing costs that must be capitalised and provide the necessary
journal entries for the year ended 31 December 20X5, assuming that the amounts were spent
evenly during each month.

Solution to example 11: general loans – costs incurred evenly

Comment: There are two borrowings, both of which are general borrowings and therefore the
borrowing costs to be capitalised is based on the expenditures incurred and the weighted average
interest rate. Since the expenditures are incurred evenly, average expenditures are used. Since the
borrowings are general, one does not consider interest income in the calculation of the amount to be
capitalised.

W1: Borrowing costs to be capitalised
The loans are general loans and therefore the formula is: ‘Capitalisation rate x Average expenditure’.

Capitalisation rate (weighted average interest rate):
= interest incurred on general borrowings/ borrowings outstanding during the period
= [(C500 000 x 7% x 12 / 12) + (C600 000 x 12.5% x 12 / 12)] / 1 100 000 total borrowings
= 10%

Cumulative expenditure C
1 January 20X5 Opening balance 0
January – July 50 000 x 7 months 350 000
31 July 20X5 Closing balance 350 000
August - November 30 000 x 4 months 120 000
30 November 20X5 Closing balance 470 000
December 100 000 x 1 month 100 000
31 December 20X5 Closing balance 570 000

Capitalisation rate x average expenditure: C
Jan – July (0 + 350 000) / 2 x 10% x 7 / 12 months; 10 208
OR: (50 000 x 7 months) / 2 x 10 % x 7 / 12 months
Aug – Nov (350 000 + 470 000) / 2 x10% x 4 / 12 months; 13 667
OR: {(30 000 x 4 months) / 2 + 50 000 x 7} x 10 % x 4 / 12 months
Dec (470 000 + 570 000) / 2 x 10% x 1 / 12 months; 4 333
OR {(100 000 x 1) / 2 + 50 000 x 7 + 30 000 x 4 }x 10% x 1/ 12
Total to be capitalised: 28 208

376 Chapter 11


The above calculation can be done the long way around, if preferred:

Expense incurred evenly during each month
Balance (A) Expense (B) Balance (C ) Balance (D ) Interest % Months Capitalise
January 0 50 000 50 000 25 000 10% 1 208
February 50 000 50 000 100 000 75 000 10% 1 625
March 100 000 50 000 150 000 125 000 10% 1 1 042
April 150 000 50 000 200 000 175 000 10% 1 1 458
May 200 000 50 000 250 000 225 000 10% 1 1 875
June 250 000 50 000 300 000 275 000 10% 1 2 292
July 300 000 50 000 350 000 325 000 10% 1 2 708
August 350 000 30 000 380 000 365 000 10% 1 3 042
September 380 000 30 000 410 000 395 000 10% 1 3 292
October 410 000 30 000 440 000 425 000 10% 1 3 542
November 440 000 30 000 470 000 455 000 10% 1 3 792
December 470 000 100 000 570 000 520 000 10% 1 4 333
570 000 28 209

Balance (A): first day of the month
Expense (B): incurred on the last day of the month
Balance (C): last day of the month
Balance (D): average balance = (A + C) / 2
Capitalise: interest expense that may be capitalised: Balance (A) x interest rate x 1 / 12
Capitalisation rate (weighted average interest rate): see calculation above

Journals in 20X5: Debit Credit
Construction costs incurred: 50 000 x 7 + 30 000 x 4 + 100 000 x 1
This journal would actually be processed separately for each and
every payment but is shown here as a cumulative journal for ease
Finance costs incurred: 500 000 x 7% + 600 000 x 12.5%
Finance costs capitalised: (W1)

Example 12: general loans – costs incurred at the end of each month

qualifying asset:
C per month
1 January – 31 July 50 000
1 August – 30 November 30 000
1 – 31 December 100 000

Required:
journal entries for the year ended 31 December 20X5, assuming that the amounts were paid at
the end of each month.

377 Chapter 11


Solution to example 12: general loans – costs incurred at the end of each month

Comment: There are two borrowings, both of which are general borrowings and therefore the interest to
be capitalised is based on the expenditures incurred and the weighted average interest rate. Since the
expenditures are incurred at the end of the month, actual expenditures should be used instead
(assuming the difference between using actual and average expenses is considered by the entity to be
material). The interest is calculated as follows: the opening balance at the beginning of each month
multiplied by the weighted average interest rate multiplied by 1/ 12.


Expense incurred at end of each month
Balance (A) Expense (B) Balance (C ) Interest Months Capitalise (D)
January 0 50 000 50 000 10% 1 0
February 50 000 50 000 100 000 10% 1 417
March 100 000 50 000 150 000 10% 1 833
April 150 000 50 000 200 000 10% 1 1 250
May 200 000 50 000 250 000 10% 1 1 667
June 250 000 50 000 300 000 10% 1 2 083
July 300 000 50 000 350 000 10% 1 2 500
August 350 000 30 000 380 000 10% 1 2 917
September 380 000 30 000 410 000 10% 1 3 167
October 410 000 30 000 440 000 10% 1 3 417
November 440 000 30 000 470 000 10% 1 3 667
December 470 000 100 000 570 000 10% 1 3 917
570 000 25 835

Balance (A): balance on the first day of the month
Expense (B): incurred on the last day of the month
Balance (C): balance on the last day of the month
Capitalise (D): interest expense that may be capitalised: A x interest rate x 1 / 12
= 10%

Journals in 20X5:
Debit Credit
Finance costs capitalised: (W1)

378 Chapter 11


Example 13: general loans – costs incurred at the start of each month

qualifying asset:
C
per month
1 January – 31 July 50 000
1 August – 30 November 30 000
1 – 31 December 100 000

Required:
journal entries for the year ended 31 December 20X5, assuming that the amounts were paid at
the beginning of each month.

Solution to example 13: general loans – costs incurred at the start of each month

Comment: There are two borrowings, both of which are general borrowings and therefore the interest to
be capitalised is based on the expenditures incurred and the weighted average interest rate. Since the
expenditures are incurred at the beginning of each month, actual expenditures should be used instead
(assuming that the difference between using actual and average expenses is considered by the entity to
be material). The interest is calculated as: the opening balance at the beginning of each month
multiplied by the weighted average interest rate multiplied by 1/ 12.


Expense incurred at beginning of each month
Balance (A) Expense (B) Balance (C ) Interest % Months Capitalise
January 0 50 000 50 000 10% 1 417
February 50 000 50 000 100 000 10% 1 833
March 100 000 50 000 150 000 10% 1 1 250
April 150 000 50 000 200 000 10% 1 1 667
May 200 000 50 000 250 000 10% 1 2 083
June 250 000 50 000 300 000 10% 1 2 500
July 300 000 50 000 350 000 10% 1 2 917
August 350 000 30 000 380 000 10% 1 3 167
September 380 000 30 000 410 000 10% 1 3 417
October 410 000 30 000 440 000 10% 1 3 667
November 440 000 30 000 470 000 10% 1 3 917
December 470 000 100 000 570 000 10% 1 4 750
570 000 30 585

Balance (A): balance on the first day of the month before payment of expense
Expense (B): incurred on the first day of the month
Balance (C): adjusted balance on the first day of the month after payment of expense
Capitalise: interest expense that may be capitalised: C x interest rate x 1 / 12
= 10%

379 Chapter 11


Journals in 20X5:
Debit Credit
Finance costs capitalised: 30 585 (W1)

4 A comparison of the methods

It is interesting to note that many accountants expected the revised IAS 23 to make the
expensing of borrowing costs compulsory and to outlaw the capitalisation thereof – not the
other way around! There are arguments both for and against the capitalisation of borrowing
costs.

Some argue that the capitalisation of borrowing costs is more appropriate than the expensing
them because:
• interest should not be treated any differently to the other directly attributable costs that are
capitalised in terms of IAS 16: Property, Plant and Equipment (improves consistency);
• if the entity had purchased the qualifying asset, the construction company (seller) would
have included any borrowing costs that they incurred into the purchase price: it therefore
improves comparability between companies that purchase assets and those that construct
their own (improves comparability); and
• if the entity does not capitalise the borrowing costs, it will result in a decrease in their
profit, merely because they decided to self-construct the asset. A better approach, it is
argued, would be to recognise the borrowing costs as part of the cost of the asset and then
recognise these costs as an expense (e.g. depreciation) over the period that the asset is
used and earns revenue (improves matching of expense to income).

Some of the arguments against capitalizing borrowing costs include:
• borrowing costs incurred when constructing an asset should be expensed in the period in
which they are incurred, just as any other finance costs would be (improves consistency
and matching of expenses to the period in which they were incurred);
• the calculation of the portion of the borrowing costs to be capitalised is, in practice, very
subjective and could therefore result in errors and manipulation and therefore expensing
the actual borrowing costs incurred is less prone to error (improves reliability); and
• when interest is treated as an expense, cash flows for the period will approximate the
profit for the period, which is more useful to the user (improves relevance) since it helps
to predict cash flows.

5 Disclosure (IAS 23.26)

The entity must disclose the following in the financial statements:
• the total amount of borrowing costs capitalised;
• the amount of borrowing costs expensed as finance costs in the statement of
comprehensive income (this is an IAS 1 requirement – not a requirement of IAS 21);
• the capitalisation rate used to calculate the borrowing costs for a general loan.

380 Chapter 11


Company name
Statement of comprehensive income (extracts)
For the year ended 31 December
20X5 20X4
Note C C
Profit before finance costs x x
Finance costs 3. X X
Profit before tax x x
Other comprehensive income x x
Total comprehensive income x x

Company name
Notes to the financial statement (extracts)
For the year ended 31 December

3. Finance costs 20X5 20X4
C C
Interest incurred Z Z
Less interest capitalised IAS 23 requirement (Y) (Y)
Finance cost expense IAS 1 requirement X X

381 Chapter 11


6. Summary

IAS 23
Borrowing costs

Expense Capitalise
If not related to a qualifying asset If it relates to a qualifying asset and
meets all criteria for capitalisation

Qualifying borrowing costs
Capitalise borrowing costs that relate to costs:
• directly attributable to the
• acquisition, construction or production of
• a qualifying asset and if
• future economic benefits are probable and
• costs can be reliably measured

Qualifying asset
• those that take a long time to get ready

Measurement

General borrowings Specific borrowings
• Capitalise borrowing costs using • Capitalise the total amount of
the following formula: borrowing costs actually incurred
Capitalisation rate (CR) x the • Less any interest income earned
expenditure; on the temporary investment of
• but limit to the actual borrowing any surplus borrowings
costs incurred
• CR = weighted average borrowing
costs divided by the general
outstanding borrowings

Start Pause Stop
• Interest is being the construction of the the asset is ready for
incurred; asset is interrupted or its intended use or
• Expenditure on the delayed for a long period of sale;
production of the time; (or if it is substantially
asset is being (do not pause if the delay ready).
incurred; and is necessary).
• Activities are in
progress

This is the
commencement date

382 Chapter 11

Chapter11 borrowingcosts2008

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