Finance & Accounting

All you need to know about IAS 23 on Borrowing Costs

IAS 23 addresses whether interest or financing charges of borrowing money should be expensed or capitalized. The standard specifies whether borrowing expenses must be capitalized and, if so, for how much period.

Need for IAS 23

Certain assets, such as property, plant or equipment (PPE), investment property, and personalized inventory, may require a significant amount of time to prepare for their intended use or sale. If you borrow money to develop or build such assets, there is a financing cost associated with the borrowing. This borrowing cost is directly relatable to the qualifying asset’s purchase, construction, or production, the benefits of which are realized during the asset’s useful life. As a result, the standard can assist you in determining whether these borrowing expenses should be capitalized in the year of incurrence and expensed over time, or they should be entirely expensed in the year in which they are incurred.

IAS 23 is a small but crucial accounting standard that affects the statement of financial position and financial performance in current and future periods by deciding whether borrowing expenses should be capitalized or expensed. One can also understand how to compute the borrowing costs that are to be capitalized.

What are the principles governing IAS 23?

The method of accounting for borrowing costs in respect of debts is covered by IAS 23. Interest expenditure on loans (as defined by IFRS 9 Financial Instruments), finance expenses on leases (as defined by IFRS 16 Leases), and exchange rate differences on foreign currency borrowings, to the degree considered as an adjustment to interest costs, are all included.

The standard becomes relevant for you if you have assets that need a significant amount of time to prepare for usage. These are referred to as qualified assets. It does not, however, contain biological assets (see IAS 41 Agriculture) or some inventories that are created in huge quantities on a regular basis but require a long time to prepare for sale (for example, fine wine).

The essential premise of IAS 23 is that if you incur borrowing expenses that are directly linked to the purchase, building, or production of a qualified asset, such costs must be capitalized as part of the asset’s cost. This has an impact on the depreciation or amortization charges in the current and the subsequent periods. All other borrowing charges are recorded as an expense in the profit or loss statement. Therefore, one has to determine if any borrowing expenses incurred during the period must be separated and capitalized.

If you borrow money particularly for the building, development, or production of an asset, calculating the amount that must be capitalized is simple. But if the funds are borrowed from a general pool of multiple borrowings, or if the asset is partially utilized while the construction is finished in phases, you will need to undertake additional calculations to determine the amount to be capitalized.

Computation of borrowing costs to be capitalized

Borrowing expenses directly linked to the building, development, or production of an asset must be capitalized. If you borrowed cash expressly for a certain asset, the amount capitalized is the real interest cost. If you make revenue from the temporary investment of your borrowings, you must subtract it from the interest cost capitalized.

If you borrowed money for a specific asset from a broad pool of borrowings, you shall need to figure out what the capitalization rate is. This is the general pool’s weighted average cost of capital. When the borrowed funds are employed on the qualified asset, the computed rate is applied to them.

In addition, if the specified borrowings are insufficient, the remainder of the expenditure is expected to be funded from the general pool, which has a weighted average cost of capital. In this situation, your capitalized interest expense is made up of amounts depending on various interest rates applied to specific borrowings as well as a portion of borrowings^[1] from the general pool.

Commencement and suspension of capitalization of borrowing costs

IAS 23 establishes criteria for when to begin and stop capitalization of borrowing expenses. This is done to guarantee that the time during which borrowing expenses are capitalized by various companies is consistent.

When the essential operations to get the asset ready for its planned use have begun, as well as when both the expenditure on the asset and borrowing expenses have been incurred, one should begin capitalization. For example, if an unusual period of activity stoppage occurs, the borrowing expenses incurred during that period must not be capitalized. If you borrowed money but haven’t begun working on the asset yet, the borrowing charges are deducted from your profit until you begin the operations.

When nearly all of the operations required to prepare the asset for its planned use or sale are completed, i.e., there is substantial completion, one must cease to capitalize the borrowing expenses. It hardly makes a difference whether the asset is used or not (i.e., put to use). Moreover, the term “substantially” is not clarified in the standard; thus, management may have to exercise their discretion. It does, however, imply that the majority of the tasks have been performed and that just minor tasks remain.

If the qualifying asset is made up of many sections, you can stop capitalizing the borrowing expenses for the portion that has been completed. You will, however, continue to capitalize borrowing expenses on the other components of the asset where work is being done to get it ready for its planned use.

Disclosure requirements

A company needs to disclose the following in relation to its borrowing costs:

“The amount of borrowing costs that were capitalized during the period, as well as the capitalization rate that was used to calculate the amount of borrowing costs that were eligible for capitalization.”

Conclusion

Borrowing costs particularly applicable to the purchase, building, or manufacturing of a ‘qualifying asset’ (one that must take a significant amount of time to prepare for its intended use or sale) must be included in the asset’s cost, according to IAS 23 on Borrowing Costs. The cost of other borrowings is recorded as an expenditure. In March 2007, IAS 23 was republished, and it now applies to annual reporting periods on or after January 1, 2009.

Read our Article:Significant disclosure under IFRS 7 for Financial Instruments