IAS 23 – Borrowing Costs

2 Borrowing costs eligible for capitalisation

1. Borrowing costs must be directly attributable to the asset and can be measured reliably
2. Borrowing costs were incurred towards on borrowings that were applied on acquisition, construction or production of asset and it is probable that future economic benefits will flow to the entity
3. Directly attributable borrowing costs are those costs that would have been avoided if the expenditure on assets had not been made. expenditures that have resulted in payments of cash, transfers of other assets or the assumption of interest-bearing liabilities for the acquisition, construction or production of asset.
4. Asset must be a qualifying asset

If all of the conditions stated above are met only then borrowing costs can be capitalized otherwise it will be expensed i.e. accounted for in profit and loss account.

If entity has made borrowings specifically for a qualifying asset then borrowing costs incurred that are directly attributable are readily identifiable and the all of the actual borrowing costs incurred towards such borrowings are eligible for capitalization.

However, if the entity has temporarily invested part of such specific borrowings and has earned an income then such income shall be offset against the actual costs incurred towards borrowing and the net amount will be capitalised.

In some cases, applies funds on qualifying asset out of the loans which were not acquired specifically for a qualifying asset rather to meet different obligations. Such borrowings are general borrowings and are often with different interest rates.

To overcome the difficulty, entity uses a single capitalization rate which is weighted average of the borrowing costs incurred on outstanding borrowings during the period.

Any income earned on temporary investment out of general borrowings shall not be cancelled out against borrowing cost on general borrowings

The borrowing costs capitalized shall not exceed the borrowing cost incurred during the period. In other words the maximum borrowing cost eligible for capitalization is the actual amount incurred.

IAS 23 recognises the fact that borrowing arrangements or the way borrowings are applied to the qualifying assets may get so complex that it is difficult to determine the amount of borrowing costs attributable to qualifying asset. In such case entity is allowed to exercise judgement to determine amount of borrowing to be capitalized.

Examples are:

• Loans taken in foreign currency or linked to foreign currency where exchange rate fluctuates significantly.
• Parent has borrowed money on different rates and then lends the same to subsidiaries on varying conditions.