IAS 23 ‘Borrowing Costs’ requires capitalization of directly-attributable borrowing costs as part of the cost of the asset. Other borrowing costs are expensed out in the period in which they are incurred.
IAS 23 deals with capitalization of cost of debt (i.e. cost on items classified as financial liabilities) and not actual or imputed cost of equity, including preferred capital not classified as a liability.
IAS 23 is not applied to qualifying assets measured at fair value (such as a biological asset within the scope of IAS 41 Agriculture), or inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis.
Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds. Borrowing costs may include:
- interest expense recognized through application of the effective interest method (under IFRS 9,
- finance cost recognized on unwinding of lease liabilities (under IFRS 16 Leases) and
- exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Qualifying costs may be (a) inventories, (b) manufacturing plants, (c) power generation facilities, (d) intangible assets, (e) investment properties, (f) bearer plants.
FAQ 1: What is meant by a ‘substantial period’?
The standard does not define ‘substantial period’. However, it is generally considered to be a time longer than one year.
FAQ 2: What is not a qualifying asset?
Financial assets, and inventories that are manufactured, or otherwise produced, over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired are not qualifying assets.
Borrowing costs eligible for capitalization
Borrowing costs are capitalized (and included in the cost of the asset) when these are directly attributable to the acquisition, construction or production of a qualifying asset and can be measured reliably. Other borrowing costs are charged to profit or loss in the period in which they are incurred.
FAQ 3: To what extent can an entity capitalize borrowing costs in a hyperinflationary economy?
An entity in a hyperinflationary economy recognizes the part of the borrowing costs that compensates for inflation as expense.
FAQ 4: What are directly attributable borrowing costs?
Directly attributable borrowing costs are those that would have been avoided if the expenditure on the qualifying asset had not been made.
When funds are borrowed specifically for the qualifying asset, it is easy to identify the directly attributable borrowing costs.
In case of specific borrowing, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
In many cases it may be difficult to identify a direct relationship between particular borrowings and a qualifying asset and to determine the borrowings that could otherwise have been avoided. This is the case, for example, when
- financing activity of an entity is coordinated centrally,
- an entity is party of a group which uses a range of debt instruments to borrow funds at varying rates of interest, and lends those funds on various bases to other entities in the group,
- borrowings are denominated in or linked to foreign currencies,
- the group operates in highly inflationary economies, and from fluctuations in exchange rates.
When general borrowings are used to finance a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation by applying a capitalisation rate to the expenditures on that asset.
Determining the capitalization rate
The capitalisation rate is the weighted average of the borrowing costs applicable to all borrowings of the entity that are outstanding during the period. This excluded any specific borrowings obtained by the entity until substantially all the activities necessary to prepare that asset for its intended use or sale are complete.
The amount of borrowing costs that an entity capitalises during a period shall not exceed the amount of borrowing costs it incurred during that period.
Whether an entity calculates the weighted average capitalisation rate at its own level or at the group level depends on the integration of the company’s financial management with the group.
FAQ 5: What happens when the carrying amount of the qualifying asset exceeds it recoverable amount as a result of capitalization of borrowing costs?
When the carrying amount or the expected ultimate cost of the qualifying asset exceeds its recoverable amount or net realisable value, the carrying amount is written down or written off in accordance with the requirements of other Standards. In certain circumstances, the amount of the write‑down or write‑off is written back in accordance with those other Standards.
Commencement of capitalisation
Borrowing costs are capitalized starting from the date when the entity first meets all of the following conditions:
- it incurs expenditures for the asset;
- it incurs borrowing costs; and
- it undertakes activities that are necessary to prepare the asset for its intended use or sale.
FAQ 6: Which expenditures qualify the commencement criteria?
Expenditures on a qualifying asset include only those expenditures that have resulted in payments of cash, transfers of other assets or the assumption of interest‑bearing liabilities. It means that where a entity receives any progress payments and/or grants in connection with the asset, expenditures paid out of those funds would not qualify for capitalization of borrowing costs.
FAQ 7: Can an entity use the average carrying amount of the qualifying asset during a period as an approximation of total expenditure incurred on the asset?
Yes. the average carrying amount of the asset during a period, including borrowing costs previously capitalised, is normally a reasonable approximation of the expenditures to which the capitalisation rate is applied in that period.
The activities necessary to prepare the asset for its intended use or sale encompass more than the physical construction of the asset. They include technical and administrative work prior to the commencement of physical construction. However, such activities exclude the holding of an asset when no production or development that changes the asset’s condition is taking place.
For example, when land is held but no development or pre-development activities are taking place, no borrowing costs can be capitalized. However, if an entity is actively engaged in obtaining regulatory permits for construction, carrying out detailed design, etc., borrowing costs may be capitalized.
Suspension of capitalisation
An entity shall suspend capitalisation of borrowing costs during extended periods in which it suspends active development of a qualifying asset (because such costs are costs of holding partially completed assets and do not qualify for capitalisation.
FAQ 8: What is meant by ‘extended period’?
The Standard does not offer any guidance on what is meant by ‘extended period’. Judgement is required in determining whether a suspension period is an expended period considering the overall construction period of the qualifying asset.
However, an entity does not normally suspend capitalising borrowing costs during a period when:
- It carries out substantial technical and administrative work.
- A temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale.
FAQ 9: Can an entity continue to capitalize borrowing costs during lock-downs imposed due to a pandemic?
Unless an entity continues to carry out significant ‘technical and administrative activities’ and/or the lockdown is for a very short duration, say a month, it may not continue to capitalize borrowing costs. This is because the delay triggered by a pandemic is not a ‘necessary part of the process of getting an asset ready for its intended use.’
Cessation of capitalisation
An entity shall cease capitalising borrowing costs when ‘substantially’ all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. This is normally the date when the physical construction of the asset is complete even though routine administrative work might still continue.
FAQ 10: When to cease capitalization of borrowing costs when a qualifying asset is completed in parts?
When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalising borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale.
For example, a business park comprising several buildings, each of which can be used individually, is an example of a qualifying asset for which each part is capable of being usable while construction continues on other parts.
Some qualifying assets, such as a refinery or a steel mill, need to be complete before any part can be used. In such cases, capitalization may continue until the whole unit is substantially complete.
An entity shall disclose the following regarding capitalization of borrowing costs:
- the amount of borrowing costs capitalised during the period; and
- the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.