What is Borrowing Costs?
Borrowing costs are the costs which are directly attributable to the acquisition, construction, or production of a qualifying asset as part of the cost of that asset. Other borrowing costs are recognized as expenses.
Borrowing costs may be capitalized, or may be recognized as revenue expenses. Interest costs relating to the borrowing of fund to acquire the capital asset or to procuring raw materials are borrowing costs but one will be capital in nature and another will be revenue expenses.
Scope of Borrowing costs
Borrowing costs is interest cost and any other cost that arises in ordrr to borrow the funds. It includes:
- Interest
- Discount on issuance of loan note or debenture
- Premium on redemption of loan note debenture
- Any interest costs included in finance lease
- Interest on overdraft
- Any issuance cost on loan instruments
- Exchange differences on borrowings in foreign currencies, but only those representing the adjustment to interest costs.
However, Borrowing Costs do not include imputed or actual cost of equity capital.
Accounting Treatment of borrowing costs
Recognition:
Borrowing costs will be capitalized when it is directly attributable to the acquisition, construction or production of a qualifying asset.
IAS 23 referred 3 types of borrowing costs as mentioned under which should be capitalized:
- Interest expenses
- Finance charges on finance leases under IAS 17; and
- Exchange differences on borrowings in foreign currencies, but only those representing the adjustment to interest costs.
Other borrowing costs are recognized as expenses.
However, IAS 23 is silent on some types of expenses and there are doubts whether they are borrowing costs or not, for example:
- Interest cost on derivatives used to manage interest rate risk on borrowings;
- Dividends payable on preference shares (or other types of shares classified as liabilities);
- Gains or losses arising from early repayment of borrowings, etc.
Qualifying assets
Qualifying assets are the assets that take a substantial period of time to get ready for their intended use of sale. An asset will be regarded as qualifying , if that asset takes more than 1 year to be ready, then it would be qualifying. Point to be noted that not only property, plant and equipment as mentioned IAS 16 will be regarded as qualifying assets, Inventories or intangibles assets may also be considered as qualifying assets depending on their nature.
Qualifying Assets measures at fair market value.
Examples of qualifying assets includes:
- Inventories
- Manufacturing Plants
- Intangible assets
- Investment Property
Recognition of Borrowing Cost
Cost Incurred for the Construction or for acquisition of qualifying assets
The borrowing costs which is incurred for the construction or acquisition of qualifying assets will be capitalized as part of cost of such asset. The costs which relates to a qualifying assets is called ” Eligible Borrowing Cost” as it becomes eligible to be capitalized in the cost of asset.
The borrowing costs related to qualifying asset, which becomes eligible to be capitalized, is that borrowing costs that can be avoided if that assets is not produced or cosntructed. The cost of qualifying asset including the capitalized borrowing cost should not exceed the Recoverable value of the asset, if exceeded then the asset will be written down to its recoverable value as per the requirements of IAS 36.
Other borrowing costs
Except construction costs or cost of qualifying assets, all other borrowing costs will be treated as revenue expenses and will be charged to Income statement.
Measurement of Eligible Borrowing Cost to be Capitalized
The measurement of the borrowing cost related to the qualifying asset which is capitalize as part of the cost of such asset, depends upon:
1. Specific Loan/Fund:
If the funds are borrowed specifically for the construction or acquisition of qualifying assets is called specific fund/loan. In such case, the borrowing costs for capitalization will be, the difference between actual borrowing cost incurred on the asset less any income from temporary investment of funds during the period of construction.
2. General Loan/Funds:
The loan which is borrowed for the qualifying asset and general use in business both is called general loan. In such situation the borrowing cost eligible for capitalization will be calculated as, the expenditure on the qualifying asset during the accounting period will be multiplied with weighted average borrowing cost percentage of the entity in respect of the loans which were outstanding during the accounting period.