Borrowing Costs: Key Issues

This article aims to:

  • Discuss key issues with respect to accounting of borrowing costs under Ind-AS.

 Introduction 

Indian Accounting Standard (Ind AS) 23, Borrowing Costs regulates the principles relating to accounting of borrowing costs. As per the standard, an entity is required to capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a ‘qualifying asset’ as part of the cost of that asset.

The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. In certain cases, determination of such directly attributable costs is difficult and requires exercise of judgement. For instance, financing activity of an entity is coordinated centrally or a group 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.

Capitalisation of borrowing costs would start when an entity satisfies all of the following conditions:

  • Expenditure for the asset is being incurred
  • Borrowing costs are being incurred and
  • Activities that are necessary to make the asset ready for its intended use or sale are in

Capitalisation of borrowing costs is halted during the period in which active development of a qualifying asset itself is halted and altogether ceased when substantially all the activities necessary to make the qualifying asset ready for its intended use or sale are finished.

The guidance in Ind AS 23 is largely similar to the guidance prescribed under International Accounting Standard (IAS) 23, Borrowing Costs issued by the International Accounting Standard Board (IASB). Ind AS 23 additionally, provides guidance on how the adjustment on account of foreign exchange differences is to be determined which is not present in IAS 23.

In this article, we intend to highlight certain key areas relating to borrowing costs.

Issue 1: Qualifying asset is ready for intended use – specific borrowing considered as general borrowing :

As per the standard, to the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity is required to determine the amount of borrowing costs eligible for capitalisation by applying a capitalisation rate to the expenditures on that asset. The capitalisation rate should be the weighted average of the borrowing costs applicable to all borrowings of the entity that are outstanding during the period, excluding borrowings made specifically for the purpose of qualifying asset.

There has been a debate in the past as to whether borrowings made specifically for the purpose of a qualifying asset can be considered as part of general borrowings once the qualifying asset is ready for its intended use. In the absence of any guidance, there has been diversity in practice in such cases.

In this regard, the Expert Advisory Committee (EAC) (the committee) of the Institute of Chartered Accountants of India (ICAI) in a given case study (based on Accounting Standard (AS) 16, Borrowing Costs ) highlighted that while determining which borrowings should be considered for application of the capitalisation rate to be applied to general borrowings, an entity should exclude those borrowings which were borrowed for a specific purpose unless there is an evidence that the same were used for the capital expenditure on qualifying assets.

Therefore, under AS, even if an asset is ready for its intended use, specific borrowings in relation to a qualifying asset that would be outstanding were not considered as part of general borrowings.

On the other hand, as per US Generally Accepted Accounting Principles (GAAP), money is considered to be fungible and therefore, attributing an expenditure to a particular source of funds is considered impracticable since the funds from various sources get pooled together. Even where such attribution is practicable, the resultant identification could be arbitrary. For instance, a payment for a qualifying asset made from a bank account wherein funds raised from equity alone have been placed may as well could have been made from a different bank account.

The International Financial Reporting Standards (IFRS) also carries the same analogy as that of US GAAP, however, it was not clearly mentioned that specific borrowing should be considered as part of general borrowings, once the qualifying asset is available for intended use.

As part of the annual improvements to IFRS, on 12 December 2017, the IASB amended IAS 23 and clarified that while computing the capitalisation rate for funds borrowed generally, an entity should exclude borrowing costs applicable to borrowings made specifically for obtaining a qualifying asset, only until the asset is ready for its intended use or sale.

Borrowing costs related to specific borrowings that remain outstanding after the related qualifying asset is ready for intended use or for sale would subsequently be considered as part of the general borrowing costs of the entity.

The standard also clarifies that an entity includes funds borrowed specifically to obtain an asset other than a qualifying asset as part of general borrowings.

Similar amendment has been made in Ind AS 23 which is applicable to borrowing costs incurred on or after the beginning of the annual reporting period beginning on or after 1 April 2019.

Issue 2: Eligible amount of borrowing costs for the purpose of capitalisation :

The IFRS Interpretations Committee (IFRIC) (the committee) of IASB in its update issued in September 2018 considered a case where an entity incurs expenditure on the qualifying asset both before and after it incurs borrowing costs on the general borrowings.

As per the facts of the case, the entity did not incur any borrowings at the start of the construction of the qualifying asset. However, during the course of construction, the entity borrowed funds generally and used them to finance the construction of the qualifying asset. The issue under consideration was whether the entity is allowed to use the expenditure on the qualifying asset incurred before obtaining general borrowings while determining the amount of borrowing costs eligible for capitalisation.

Based on the guidance given in IAS 23, the IASB in this case, concluded that an entity would not begin capitalising borrowing costs until it incurs borrowing costs.

Once the entity incurs borrowing costs and therefore, satisfies all the three conditions given in the standard for capitalisation (i.e. incurs expenditure on the asset and borrowing costs and undertakes activities that are necessary to prepare the asset for its intended use or sale) then it is required to apply the standard to determine the expenditures on the qualifying asset to which it applies the capitalisation rate.

The committee observed while determining the expenditure on qualifying asset to which an entity applies capitalisation rate, it should not disregard expenditure on the qualifying asset incurred before it obtains the general borrowings



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