How to Capitalize Borrowing Costs under IAS 23
Should you capitalize or not?
When it comes to determining the cost of your assets, most standards ask to include all directly attributable items.
What about interest and other borrowing costs?
Did you know that if you have 10 dollars in your pocket and no debt, then you are wealthier than 25% of all Americans? Trust me – the corporate scene is no different!
Well, let’s be honest, borrowing money does carry a cost, and sometimes very significant one.
Here, I’m not talking about the loss of your friends or even family members, but all these quantifiable items such as interest and similar cost.
As these are often directly attributable to the acquisition of assets, they should be capitalized.
Some time ago, the standard IAS 23 Borrowing Costs gave you a choice:
- Either you could put all your borrowing costs directly in profit or loss and thus you did not have to worry about capitalizing them, or
- You could capitalize eligible borrowing costs.
Unfortunately, this choice was removed a few years ago for most of assets, and now you have to capitalize.
How?
In this article, I tried to draft a few basic rules about capitalizing borrowing costs and also, I reply to 3 most common questions received from you.
Let’s dive in.
Let’s talk basics: What does IAS 23 Borrowing Costs say?
The core principle of IAS 23 Borrowing Costs is that you should capitalize borrowing costs if they are directly attributable to the acquisition, construction or production of a qualifying asset.
Other borrowing costs are expensed in profit or loss.
Here, let me clarify 3 essential issues:
What are qualifying assets?
Qualifying assets are assets that take a substantial period of time to get ready for their intended use or sale.
Note here that IAS 23 does not say it must necessarily be an item of a property, plant and equipment under IAS 16. It can also include some inventories or intangibles, too!
But what is a “substantial period of time”?
Well, that’s not defined in IAS 23, so here you need to apply some judgment. Normally, if an asset takes more than 1 year to be ready, then it would be qualifying.
What can we capitalize?
IAS 23 specifically mentions 3 types of borrowing costs that can be capitalized:
- Interest expenses (refer to the effective interest method under IFRS 9/IAS 39);
- 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.
However, IAS 23 is pretty 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.
Here again, we need to apply our knowledge from other IFRS standards and sometimes, make a judgment, too.
How do you capitalize?
IAS 23 differentiates between capitalizing borrowing costs on general borrowings and specific borrowings.
Specific borrowings
If you borrowed some funds specifically for the acquisition of a qualifying asset, then the capitalization is easy:
You simply capitalize the actual costs incurred less any income earned on the temporary investment of such borrowings.
Let me give you a short example:
Question:
On 1st May 20X1, DEF took a loan of CU 1 000 000 from a bank at the annual interest rate of 5%. The purpose of this loan was to finance a construction of a production hall.
The construction started on 1 June 20X1. DEF temporarily invested CU 800 000 borrowed money during the months of June and July 20X1 at the rate of 2% p.a.
What borrowing cost can be capitalized in 20X1? (Assume all interest was paid).
Answer:
Although the funds were withdrawn on 1st May, the capitalization can start only on 1st June 20X1 when all criteria were met (the construction had not started until 1st June).
Calculation:
- Interest expense: CU 1 000 000 x 5% x 7/12 = CU 29 167
Note: this is very simplified calculation and if the loan is repayable in installments, then you need to take the real interest incurred (by the effective interest method). - Less investment income: CU 800 000 x 2% x 2/12 = CU 2 667
- Total borrowing cost to capitalize in 20X1: CU 26 500
Just don’t forget that the borrowing cost in May 20X1 is expensed in profit or loss, as the capitalization criteria were not met in that period.
General borrowings
Now, there’s more trouble with capitalizing general borrowings, as you need to prepare a bit more calculations.
General borrowings are those funds that are obtained for various purposes and they are used (apart from these other purposes) also for the acquisition of a qualifying asset.
In this case, you need to apply so-called capitalization rate to the borrowing funds on that asset, calculated as the weighted average of the borrowing costs applicable to general pool.
To illustrate it, let me give you an example about capitalizing borrowing costs on general borrowings.
Question:
KLM had the following loans in place at the beginning and end of 20X1:
| Description | 1 January 20X1 | 31 December 20X1 |
| Bank loan, 6% p.a. | 0 | 200 000 |
| Bank loan, 8% p.a. | 130 000 | 130 000 |
| Debenture stock, 5.5% p.a. | 50 000 | 50 000 |
The bank loan at 6% p.a. was taken in July 20X1 to finance the construction of a new production hall (construction began on 1 March 20X1).
The bank loan at 8% p.a. and debenture stock were taken for no specific purpose and KLM used them to finance general spending and the construction of a new machinery.
KLM used CU 60 000 for the construction of the machinery on 1 February 20X1 and CU 25 000 on 1 September 20X1.
What borrowing cost should be capitalized for the new machinery?
Answer:
You ignore bank loan at 6% p.a., because it is a specific borrowing for another asset.
Only general borrowings relate to the financing of the new machinery and therefore, we need to calculate the capitalization rate:
- Weighted average rate = (8% x 130 000 /(130 000+50 000)) + (5.5% x 50 000/(130 000+50 000)) = 5.78%+ 1.53% = 7.31%
- Borrowing costs for the new machinery in 20X1 = CU 60 000 x 7.31% x 11/12 + CU 25 000 x 7.31% x 4/12 = CU 4 021 + CU 609 = CU 4 630.
The hottest questions in capitalizing borrowing cost
After we know the basics, let me give you my opinion on 3 the most common and often questions I get in relation to capitalizing borrowing cost.
I receive these questions quite often, so let me shed some light there.
Question #1: Can you capitalize interest cost in the cost of inventories?
It depends.
In most cases, inventories do not take a substantial period to get ready and in this case no, you cannot capitalize.
But here, there are some examples of inventories that can take a substantial period to complete:
- Wine, cheese or whiskey that matures in bottle or cask for a long period of time;
- Large items of equipment, such as aircraft, ships etc.
In this case, you can capitalize borrowing cost, but it’s up to you if you will or won’t.
While you have no choice for PPE (you have to capitalize), you have a choice for inventories: either you capitalize, or expense in profit or loss.
Question #2: Can you capitalize foreign exchange loss on specifically borrowed money in a foreign currency?
No, you cannot do it fully.
Yes, IAS 23 says that exchange differences on foreign currency borrowings are a borrowing cost to the extent that they are regarded as an adjustment of interest cost.
Simply speaking – you can capitalize the difference between the interest on the foreign currency loan and the hypothetical interest expense in your own (functional currency), because that’s regarded as borrowing cost.
The rest must be expensed in profit or loss.
Question #3: Can you capitalize interest cost on intercompany loan for qualifying assets?
Yes, in the separate financial statements of the borrowing company.
However, be a bit careful about the consolidated financial statements, because based on the intercompany relationship (subsidiary or associate?), the intercompany loan might be eliminated.
Also, let me point out one more issue in relation to intercompany loans: often, they are provided interest-free.
Under IFRS 9, you should recognize almost all financial instruments at their fair value (sometimes plus transaction cost) and if a subsidiary gets an interest-free loan from a parent, it’s nominal amount is not at fair value.
Therefore, a subsidiary needs to set the fair value of the loan received using the market interest rates and book the difference between the loan’s fair value and the cash received in profit or loss (based on the substance of a transaction).
Then, interest expense calculated by the effective interest method is capitalized.
I know, this might sound odd: the loan is interest-free, but you still need to capitalize some borrowing cost on it. Careful!
Do you face any other issues with the borrowing cost? Please leave a comment below and share this article with your friends. Thanks!
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180 Comments
Leave a Reply
Hi Silvia,
I work in a Bank. I would like to solve an accounting issue. We have revalued all our land and Building in 2012. Now this year, we have started the operation of a new branch. So this new branch has land area 7500sq and out of which 1158sq is building area. My question is we have debit all the costs to make this building in our work in progress account. So should i reverse this WIP account and capitalize the amount to Building directly? My understandng about IAS 16 was if revaluation model is used in one class then entire assets of that class should be taken as revaluation model.
Sorry, Asma, I don’t understand your question. You have started the operation – meaning that the new branch is in a revalued building? Or you have started a construction? Why do you have WIP? Please clarify as I’m lost in your question. S.
Silvia
Finance charges on finance leases under IAS 17; and
Now we dose not have IAS 17 There is IFRS 16
thank you very much for the mailing. I really appreciate to your note.
When we can capitalize the financial lease loan interest amount. My question is as below.
1, Starting the loan period
2, When the actual interest payment happening.
Please clear me.
Hi, you should capitalise interest when it is incurred. In fact, you also need to meet 3 conditions for capitalising interest under IAS 23. S.
Hi Sylvia,
I must commend you on your time and effort to increase IFRS knowledge around the world.
A quick one Sylvia, can you briefly differentiate cost incurred from cost accrued.
My understanding is that the term “incurred” originates from the “accrual concept” as cost is incurred “when a party becomes liable”.
I have gone through the three criteria for capitalization of borrowing cost. These criteria are as follow:
“The commencement date for capitalization is the date when the entity first meets all of the following conditions:
i. it incurs expenditures for the asset;
ii. it incurs borrowing costs; and
iii. it undertakes activities that are necessary to prepare the asset for its intended use or sale.”
Please can you clarify this?
Dear Simon
I think all the thee criteria must not be seen as separately rather they will happen simultaneously i.e when you undertake some activities that are necessary to make the qualifying asset ready for its intended use (criterion iii), you might pay money for such activities (criterion) and if such money comes from borrowing or not from your pocket it carries interest/borrowing cost (criterion ii). We can understand in this order whether all thee criteria are met simultaneously. No accrual concept here is necessary.
what are the three condition to be met in capitalization of interest under IAS 23
Hi madam, I have small doubt. Can I please ask you.
Thank you Silvia,Could you please elaborate more on the question # 3 i.e., interest free inter company loan, how to set its fair value with example?
Hmmm, I see that this question comes up. As I have answered here already – exactly this example is covered in the IFRS Kit, but maybe I will elaborate some example in the separate article. S.
have question regarding the IAS 23
Year 01-07-2014 and ended on 30-06-2015
I have obtained loan form BANK 250,000 @ 3% ON 01-07-2014 for a six month and paid on 31-12-2014. and i have obtained other loan 400,000 at 01-01-2015 @ 4% interest for three month 31-03-2015 and paid. on 01-04-2015 i have obtained other loan 500,000 @ 7% for six month. these are general borrowing . please calculated the borrowing cost and capitalized rate.
Dear Azhar,
it seems that you had only 1 loan at a time – so the capitalization rate is simply an interest rate on that loan. You can calculate borrowing cost based on the amount you actually spent on a qualified asset. Just be careful, as the borrowing cost needs to be on actual incurred (paid) expenditures, not just accrued. S.
Hi Silvia, you advised in teh article” a subsidiary needs to set the fair value of the loan received using the market interest rates and book the difference between the loan’s fair value and the cash received in profit or loss.”
May I know the double entries for this adjustment both initally and in the subsequent year?
Regards
Wilson
Hi Wilson,
if you are subscribed to the IFRS Kit, this example is solved there step by step. I can’t really cover it in the comments, as there’s not enough room 🙂 S.
Please, how can we subscribe to the IFRS kit?
You can register online on this page. S.
I work in the Accounting and Auditing Board. Recently, we have received a query from a Small & Medium Enterprise company stating that their borrowing costs are substantial for specific purpose and wanted to capitalize it. Since IFRS for SMEs doesn’t allow the borrowing costs to be capitalized, can this SME be allowed to capitalize the borrowing cost? If allowed, it will tantamount to allowing SMEs to cherry-pick some standards from full IFRS and some from IFRS for SMEs. If not allowed, charging subtantial boowing costs to P/L account will have huge implications to the firm. Any advice is appreciated.
Dear Lok,
if a company is applying IFRS for SMEs, then it should not capitalise borrowing cost as in this case, the financial statements are not fully compliant with IFRS for SMEs. It’s not really permitted to pick something from full IFRS and something from IFRS for SMEs.
However, let me say here, that maybe in this case, it would be OK for the company to apply the full IFRS. Maybe other differences between IFRS for SMEs and IFRS applicable for this particular company are not that significant and the company would be able to capitalise borrowing cost. S.
Hey Silvia
Thank you so much for clarifying the borrowing cost this information is very helpful as im writing my exam on specific financial reporting next week.
Great elaboration of this cost. Thank you so much!!
its great article. i am getting some grip on standards which were my worst nightmares….. thank you once again
regards
Abdul Rehman
Very insightful, Thanks you very much. Silvia.
Hi Silvia
When a company borrows money thru buyers credit in Foreign currency , the restatemennt gain / loss is not allowed to be capitlaised, but the interest that woould have beeb incurrened in fucntional currency less the interest on the actual borrowing in FC, can be capitalised as per IAS 23.
my simple question is : is the period to be considered for capitalisation of interest cost is from the date of loan till date of replayment of the loan or only till the capitalisation ?
Hi Prashanth,
the capitalisation should stop when you complete substantially all activities to prepare the asset for its intended use or sale. It means that while you still construct the asset, you capitalise incurred interest cost and when the loan is repaid, then there will be no more interest cost to capitalise. S.
Standard says that, capitalize borrowing costs if they are directly attributable to the acquisition, construction or production of a qualifying asset
Can we capitalize the borrowing cost for the asset acquired?
please help silviya
Hi Hiras,
do you mean “for the asset acquired by purchase?” Well, I don’t think so, because an asset must be qualifying – by definition, it must take a substantial period to get ready for the intended use or sale – and if you purchase the asset, then it’s not a substantial period, is it?
ok silviya i agree with u. then why standard use the word acquisition in the borrowing cost
Hi Hiras, I think standard here means that sometime some assets takes time to assemble and if it is a substantial period of time then you can capitalize it. I would ask Silvia to comment on our understanding
This actually happens quite frequently. It could take 3 months to transport and assemble a system of equipment. Suppose the company borrow money to specifically fund the acquisition of the system. Since 3 months are commonly considered not “substantial”, does this mean we CANNOT capitalize the borrowing costs? Note that the standard states that borrowing costs MUST be capitalized if the asset is a qualifying one. But it isn’t clear if we MUST expense borrowing costs if the asset is not a qualifying one, especially in situation where the fund is used to specifically fund the acquisition of the asset.
You are the best Sylvia. Trust me, your explanation is so much simple that I sometimes find myself asking whether it’s accounting am seeing on your website. You make it very simple and easy to use. Thanks so much.
Thanks 🙂
Dear Silvia,
Thank you for the explanation of IAS 23. I very keenly follow your articles and often refer to them when I need some clarification.
Moreover, I have a question if you don’t mind, can you explain the Question 2 in detail please as I was not quite able to follow the same.
Thanks for all the Help and contributions to our world of accounting!!!!
Regards,
Rahul C.
I would like to know how is the borrowing cost should be present in the financial statements (the double entry of capitalization)
Hi Chirantha
The double entry is as follows:
DR Asset (The asset you are constructing)
CR Accrued Interest/Interest Payable/Cash
Hi Silvia, what about costs of obtaining the borrowing? Can you capitalise it?
Hi Cynthia, usually, cost of obtaining the borrowing – like some initial fees etc. are incorporated into the effective interest method and the effective interest rate changes as a result. In other words – they are neither straightly capitalized nor expensed in P/L, but instead, the loan accounting is altered to implement the effective interest method. S.
Hi Silvia
I would appreciate if you could elaborate further with examples on other borrowing costs like processing fee for loan. How to account them.
Thanking you
Sonam Choeden
DGPC
Bhutan
For specific borrowing do we calaculate interest based on the loan drawdowns on the asset or on the total loan amount. For instance if loan is for $1m and only $200k is the expenditure actually incurred. Is capitalised interest based on $1m or $200k for the specific loan?
Hello Carol
The interest should be capitalised proportionately in terms of the portion actually utilised to acquire the asset. Note that if part of the loan is invested the total interest should be reduced by the investment income before any capitalisation considerations.
pls can you give the pratical example pls ma that what am going through
Hi there, quick question on arrangement fees associated with debt taken out to purchase/invest in a subsidiary – can this arrangement fee be capitalized in line with IAS 23 (I believe it can but am not sure!).
Thanks!
Dear Michelle, arrangement fees associated with debt should be treated as a part of cash flows in the application of the effective interest method. It means – no, the fee itself is cannot be capitalized as such, but you should take it into account in the amortized cost calculation. In order words, your effective interest rate needs to count with an arrangement fee and your effective interest (capitalized or not) would be adjusted by the arrangement fee, too. S.
Hi Silvia
Thanks for clarifying on the treatment of arrangement fee. As I understand from your comment, arrangement fee incurred for obtaining loans can be amortised but not capitalised to qualifying assets.
Would you please enlighten me with the treatment of non-utilisation fee on loan facilities obtained for financing qualifying assets? Should this get written off immediately or can it be capitalised to the qualifying asset?
Thanks
Fitsum
Hey, I am a student studying the accounting standards. Do you know any place from where i can practise questions related to IAS 23?
Respected Madam. My Question is that i have obtained 3 tyoes of Loan form BANK 1st @ 3% of Rs.500,000/- from 01-07-2014 to paid Rs. 200,000/- on 31-12-2015 Remaing Rs.300,000/- un paid on 30-06-2015, 2nd Typs of Loan is Rs.100,000/-@ 5% is obtained from bank 01-07-2014 and paid on 31-may-2015. and 3rd obtain from bank 01-7-2015 is Rs.400000/ @ 6% Still un paid on 30-06-2015.All these borrowing are General BOrrowing and used for both i.e qualified assets and other . waht would be the capitalized rate.
Hi Azhar
Loan amount Rate Time Interest
500,000 3% 0.50 7,500
300,000 3% 0.50 4,500
100,000 5% 0.92 4,583
400,000 6% 1.00 24,000
Total Interst Paid 40,583
Total Loan amount 800,000
Effective Interest Rate 5.07
I would like Silvia to comment on the understanding.
Dear if the seller give us to pay the pdp (pre Delivery payment) of the aircraft on the old escalation factor which is lower than the new one and the differences between the old and the new one to be paid on the delivery with their interest can i capitalize the interest
Hi
Does the interest charges incurred on Hire Purchase of a vehicle constitute as borrowing cost and therefore can this be capitalized?
You cannot capitalize the foreign exchange gain/loss on the liability (loan) itself, because that’s NOT a borrowing cost. You need to realize here, that your loan is a financial liability that must be subsequently measured under IAS 39/IFRS 9.
Please clarify
can you please tell the accounting treatment of the income earned by the investment of idle funds in specific borrowing. Would it be treated in the P&L?
Dear Sylvia,
should the Company capitalize appraisal fee, and commitment fee related to EBRD loan?
Thanks!
Hi Dzenita,
these fees are origination fees, so you should adjust cash flows from your loan. In other words, you take these fees into account when deriving amortized cost (assuming you measure your loan at amortized cost). S.
Thank u Silvia.M for ur detailed description..
Hi Silvia,
Thank you for the explanations and comments which are very useful. Just a short question. A general borrowing agreement specifically prohibits spending money on capital expenditure and a bank approves a list of bills to be paid. List would consist of working capital items only. In this case can a company argue that interest on general borrowing will not be capitalised as a part of qualifying asset? Or this argument contradicts with substance over form principle?
Thank you in advance
Tatyana
Hi, in the case of real estate project which are basically into Mall and office premise construction and later on they put mall and office spaces on rent. For the purpose of construction, major cost goes towards buying land and also it takes substantial time to start construction after land purchase. My question is whether it is allowed to capitalize interest cost on acquisition of land which obviously forms part of Mall after construction. If yes, in local GAAP in India, land forms part of separate asset in the fixed asset register, whether answer will change.
Dear Manoj,
if the land forms a part of a development project and requires significant landscaping and adjustments, then I think it would be possible to justify the capitalization. S.
Dear Silvia, thank you for your efforts!
It’s a realy very useful site!
Just a short question.
Situation: there is some fixed assets which already installed and operated.
Expensive modernisation of that fixed asset is to be started.
Modernisation will be continued more than one year.
Fixed asset will be used during modernisation.
At your opinion, is the modernisation a qualifying assets?
Thank you in advance!
Dear Roman,
this is a very interesting question and I must say that there was a lot of discussion around capitalizing borrowing cost on renovations.
IAS 23 defines qualifying asset as an asset that takes a substantial period of time to get ready for its intended use or sale. However, you mentioned that your fixed asset will be in use during the modernisation and therefore, it has already been ready for its use/sale and it does NOT qualify for capitalization of borrowing costs.
However, if your asset would be put out of operation during the modernization and modernization would change its use (purpose, functionality, capacity, whatever), then these costs could be capitalized as the asset would be qualifying.
Hope this helps!
S.
Hi Silvia,
I have a question with regard to a loan obtained specifically to finance both the acquisition of land and construction of a building on that land. Can the interest (during the construction period) on the entire loan be capitalized? Or do I have to allocate how much is attributable to the purchase of the land and how much is attributable to the construction of the building and subsequently only capitalize the interest on the portion attributable to the construction?
Many thanks,
April
Hi Silvia…How can we differntiate general borrowings from specific borrowings because in some cases its really confusing with each other….
Hi Silvia
First of all thanks for such a nice article. I have a small query. See normally intercompany loans doest not specify the term for which they are given. So how to calculate fair value in this case?
That should be the best estimate, with reassessment each year. S.
Hi Silvia,
Quick question.
We have a loan in a foreign currency loan which is being utilized to construct a property (which will be leased).
There was a recent devaluation in the currency and we not hav a huge unrealised forex loss.
Can we capitalize this forex loss or should i be expensed?
Hi Quam,
well, FX loss on a loan can be capitalize to the extent that this loss is regarded as an adjustment to interest costs. Please see the article above. S.
Great! Very grateful to you.
Hi Silvia M.
a loan obtain for the purpose of purchase a land and construction a mall on it. first withdraw is for purchasing the land and second after the permission of building is obtained. the obtaining the building permission and designing normally takes 1 year. During this period, interest incurred, and purchased and is incurred and activities for getting the asset ready is being processed like design and government permission. therefore, in this case the land is a qualified asset as it is not ready for its intended use and the activities for getting the asset ready is being processed, the interest on purchasing the land can be capitalized?
Regards
Jameel
Hi Silvia, I’ve got a question: is it possible to add implied cost of carry (cost of holding cash) to the capitalised rate? For example at my work our cap. int. rate is based on Gross amounts – so we offset Borrowings by derivatives amount and calculate the rate as Gross Borrowing costs/Gross Debt, which results in say 5%. I was wondering if we could base this calculation on a net basis – we would offset Borrowings by derivatives as well as cash and calculate the rate as Net Borrowing costs/Net Debt. If I do that the rate increases by about 0.30-0.50%.
None of our borrowings are specific so we just apply the rate to the general pool. My argument for calculating the rate on a net basis would be that it costs us to hold the cash that we borrowed in advance of financing the projects. But then again the standard does say that “borrowing costs” are actual costs incurred, so I suppose this “implied rate” idea wouldn’t be allowed. Thanks, Tania
Dear Tania,
what specifically is a cost of holding cash? Unless it is some adjustment to the interest paid to a bank, then I doubt it is considered a borrowing cost at all. For me it seems that it is not a cost of obtaining financing; rather it is a “storage” cost and therefore, I doubt it meets the definition of borrowing costs under IAS 23.
Hi Silvia
I think holding cost is similar to commitment or non-utilization fee paid to the bank on the remaining loan balance and the borrow will continue to pay it until the full loan facility is used up.
This sort of loan facility is usually arranged for long term projects with uncertain cash flow forecast.
I don’t understand why such payments on specific borrowings do get capitalized to qualifying assets.
Dear Fitsum,
I’ve just noted I did not respond to one of your questions above. As for the non-utilization fee or holding cost: I think it would be hard and quite aggressive to state that these are borrowing costs, because they arose due to non-investing the cash into the acquisition of qualifying assets and not due to investing, isn’t it? It is unlikely that these costs are directly attributable to the construction of an asset as they arose due to holding cash, and not due to construction.
So no, I would not capitalize these payments. S.
Dear Silvia,
I was reading questions and responses on the non utilisation fees (i.e. commitment fees)and origination fees.
In case we have a real estate asset (payment is deferred)and also have an arrangement with the bank to get a loan at the later time (when the payment will be due) and for the non-utilisation period we are paying a commitment fee.
Shall we show an arrangement fee and a commitment fee as prepayment until the loan will be drawdown and on this event there will be a reclass from prepayment to loan.
As the real estate will be under development and loan will be at amortised cost, shall we show amortisation of arrangement and commitment fee separately from the “interest” as only the latter will be capitalised into asset?
Many thanks
Do we capitalize the premium on redeemable debentures to the qualifying asset if for example, the construction of the asset was specifically financed by issuing debentures at an interest rate of 12% per annum redeemable at a premium of 5%
I have really learnt a lot from all these interactions… thanks everyone for sharing your experiences.
Can we capitalise the interest and arrangement fee of the loan taken for buying land with an intention to build residential properties to be sold in the market
I mean can we add the loan interest and arrangement fee to the cost of land acquired through mortgage finance
Dear Kumar,
the arrangement fee needs to be treated as a part of the effective interest method under IFRS 9 (it means that your actual interest rate would be different from what you have in your contract, because you need to count with all cash flows from the loan).
In fact, you can capitalize the borrowing cost related to the land acquisition IF you are developing this land – i.e. you can capitalize these costs only during the period when the land is being developed. But, if you buy the land with the loan and you hold it for future development – then no, you cannot capitalize the costs during the holding period. S.
How to deal with repayment of loan in capitalization of interest. Is it assumed that due to repayment of installments interest cost will get reduced?
please, what is the treatment for borrowing cost for buildings which is for sale in theses cases:
1- if we sold all units, what we have to do with the upcoming interest expenses.
2- if partially sold and we transfer the WIP to inventory.
Hi Mohammed, if the construction ceases, then you should stop capitalizing borrowing cost. Therefore, you should expense the borrowing cost for your 2 cases. S.
hi silvia,
suppose i took loan for construction of an asset on april 1st and construction started on july 1st . i earned interest from this borrowing from april to june. do we need to deduct this amount or we will charge this as an income in pnl
Hi,first id like to thank you for your kindness and effort. my question is that if we have qualified asset that starts in mid 2016 and ends at end of 2017. do we recognize the portion of capitalized interest in 2016 first or wait till the end of construction in 2017 and then capitalize the interest. regards
Mohamad, you should capitalize in 2016 if all conditions are met. S.
i wanted to ask what are the disclosure requirements on borrowing costs in accordance with IAS 23
Hi Silvia
1) I need some guidance on accounting for break costs (breaking costs associated with refinancing a loan or restructuring. Which accounting standard should I look as it not captured in AASB 123?
2) If the break costs are inherent in the interest rate swap (i.e. we terminate the existing swaps and get a new one and the bank uplifts the rate). Is there any specific way to account for this ?
Thanks
Thanks in favfor of sharing such a fastidilus opinion, articke iis good, thsts why i have read it entirely
You are a very clever individual!
Hi Sylvia,
may I commend you for the good job you’re doing. kindly held me understand discontinued operations IFRS 5
Try here 🙂
Hi silvia Good Article on Borrowing cost
I have a question. Should borrowing Cost be capitalized upto test Run Production Date or the Date of the Final Production when final commercial operations are started?
For Example a qualifying asset starts Trial Run Production on March 16, 2017 but final commercial Operations Date when independent Engineer gives completion certificate is May 31, 207. By What date Borrowing Cost should be capitalized i.e March 16, 2017 or May 31, 2017.
Hi Silvia,
Just pondering if the Principal Repayment portion of the borrowed cost should be capitalized as well?
Thanks
No. Instead, it decreases your liability from loans.
Hey Silvia, iam thankful for this wonderful innovation.
I would also like to assist me with this which is in line with the IFRS:
On 1 June 2014, a company entered into $ 7.92 billion to contract to construct a housing estate. The housing estate was completed at the end of May 2017. During the period, the following payments were made to the contractor:
1 June 2014 : $720,000,000
30 September 2014: $2,160,000
28 February 2017 : $4,320,000
31 May 2017 : $720,000
The construction company’s borrowings as at its year end of 31 May 2017 were as follows:
10% four year note with simple interest payable annually, which relates specifically to the project; debt outstanding at 31 May 2017 amounted to $2.52 billion. Interest of $234 million was incurred on these borrowings during the year and interest income of $72 million was earned on these funds while they were held in anticipation of payments.
12.5% ten year note with simple interest payable annually; debt. Outstanding at 1 June 2014 amounted to $5.4 billion and remained unchanged during the year.
10% ten year note with simple interest payable annually; debt outstanding at 1 June 2014 amounted to $5.4 billion and remained unchanged during the year.
Required:
Determine the amount of borrowings costs eligible for capitalisation.
Thanks Madam
Hi dear, is this a homework? It seems so 🙂 You should do this yourself 🙂
Not really home work. I just came across it. Am stuck on how to arrive at the weighted general borrowings outstanding.
What approach can I use to arrive at this.
Thanks, I will be glad.
For those qualifying assets that take more than one year, how can we determine the outstanding period for the amounts allocated to general borrowings?
Thanks
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hi silvia ,please help me am die bcz tomorrory i have examination
in borrowing cost ,if you meet with demolition of existing building on site we can capitalize it? or you expens
Capitalize, if it is a removal of obstacles for building a new building. Don’t die, please :)Good luck!
Hi Silvia
Appreciate your help please.
Can those upfont fees & structure fees on bank loan (say 1% on total borrowings) for the purpose of investment in subsidiaries be capitalised? Or can we recognise on the balance sheet & amortise it over the loan period instead of immediate hit to income statement?
Thanks
Simon
Hi,
We have bought a vehicle Amount 166,000
we made a down payment to vehicle supplier 83,000
balance we financed from a bank with a total interest amount 8,011 for Two years. monthly payment 3,884…
please let me know can i capitalized the interest as well.
and what is the accounting treatment as per standard.
hie silvia
i have a question how do we deal with a situation whereby for example a company borrows 5 million with an interest of 10% for the construction of a building but at the end of the period it is stated that the cost incurred was 12 million and no other borrowings were made during the year .How do i deal with that 12 million
Hi Tafadzwa,
you can just capitalize the interest on the borrowings incurred – in your case, capitalize just 10% on 5 million. S.
Hi Ms. Silvia,
I just want to clarify something on capitalization, for example land(intended for subdivision/condo) is purchased via bank loan, can i capitalize the whole interest or just the portion of interest until property is ready for resale?
thanks
Dear Sarmibp,
usually companies do not capitalize the interest for the acquisition of the land – the reason is that the land itself is not a qualifying asset. The asset must take substantial time to complete – which is not the case for the land. S.
Hi Silivia .. Do we consider impact of interest income on WIP in case of general borrowings ?? If yes , How to Calculate ?
Ex : Bank Loan = 5 Crores (General Loan)
Expenditure on Building
Jan 35 Lacs
April 15 Lacs
June 50 Lacs
Asset is still incomplete ..
Calculate temporary interest income ? Plz Help
Dear Mir, in the case of general borrowings, you do not calculate temporary interest income. You simply capitalize interest based on the capitalization rate. If the loan is specific, only then you calculate the temporary investment income. S.
Hi Silvia!
It is getting very useful to read your articles.
I have a question to you.
When I tryied a question about IAS23, there was not any information about general borrowing. There was only specific borrowing and it is not enough to cover payments average accumulated expenditure on qualifying asset. What should I do to solve this question to find borrowing cost?
In order to be clear, I will attached the question itself here:
Borrowing cost
On 1 January 2016, HP LLP, raised funds, specifically to finance the construction of a new factory, a qualifying asset as per IAS 23, in the amount of $10,000,000 from a bank at interest rate of 8% per annum for 10 years. The entity commenced construction on 1 February 2016 and incurred expenditure of $3,500,000 at the first of each month from February to November 2016, except for September and October 2016, when the entity suspended the construction for two months due to labor strikes and shortage of materials. The building was completed and ready for use on 30 November 2016. The proceeds from specific borrowing were temporarily invested in March 2016 and generated interest income of $18,000.
Required:
Calculate the net borrowing cost that shall be capitalized as part of the cost of the new building and the net finance cost that shall be reported in the statement of profit or loss for the year ended 31 December 2016 (show journal entries).
Hi Silvia!
Just wondering, how do we capitalised the undrawn borrowings cost. Like if we have 100 million loan facility, drawn 20 million at this year, and the borrowing cost is 2 million for the whole facility, and current drawn down is 200k facility, should we just capitalize 2.2 million, or do we need to allocate the 2 million to undrawn borrowings and capitalise later?
Many thanks for your help.
Hi Silvia
If you refinance a mortgage loan, can we write-off the previously capitalized origination loan fees and set-up all the direct costs related to the refinanced mortgage loan?
Thank you!
Hi Veronica, if you measure your loans at amortized cost, then let the origination fees are incorporated within the effective interest method and they will stay there over the loan’s life. However I assume here that the exchange of debt (refinancing) is not under the terms substantially different from the original mortgage loan – if yes, then you derecognize the old loan and recognize the new loan. S.
Hi Silvia,
Great Job. I recommend your site to everyone.
One quick question. Can we capitalize borrowing costs on land acquired to construct PPE. The PPE shall take 3 years time to complete. So borrowing costs on PPE are capitalized on lets say the building, but what about the borrowing costs on the land.
Thanks,
Muhammed
Hi Silvia,
I would like to ask you if we obtain a loan and interest is payable during the period of construction, should we add interest to Weighted Average Accumulated Expenditure.
Thanks in advance
I would like to ask you when the investment income is more than the borrowing cost, how to treat it? Reduce the value of an asset or recognize it to income.
Thanks you!
Hi Silivia,
my question is regarding refinancing of existing loans that were acquired to specifically to build a qualifying asset. should interest on this refinancing be capitalised>
Hi Silvia,
My question is regarding interest charged by related party @ 5% on payments made on our behalf to vendors for constructing chemical plants with 3 phases. One part completed and commissioned in November 2015 .Last payment made in Jan 2016 for that plant. Remaining two as of 31st Dec 2017 are CWIP. They charge interest on closing balances on year end till Dec 2016. However, start charging interest on monthly basis afterwards till to date. How much interest we can capitalised and expense out as per IAS 23 considering last payments for plants CWIP made in 2016. Afterwards interest charges are on accumulated balances pilling up every month.
Hi Silvia
My question is regarding when should we pause or terminate the Capitalization of interest cost. My company is construction a warehouse for renting purposes though the construction is not complete yet we have rented the part which is ready and I look a Long Term Loan to construct the warehouse.
Also Warehouse is still 90% complete and construction is still on ,should i recognize it as asset because Warehouse is generating Income. This is first project of my company and I am not making any Income Statement for my company because it is still in capitalization phase.
Hi Silvia, in Colombia (South America) there is a bank debit tax, altough it is not specifically included in IAS 23 it is possible to include it as borrowing cost? having in mind the incremental cost principle; the company would not have incurred in that tax expense related to the loan to real estate development.
Thank you
Hi Edgar, yes I think so. IAS 23 does not prohibit the classification of costs other than those listed as borrowing costs. In this case, the basic criterion is met – bank debit tax is directly attributable to the acquisition, construction or production of qualifying asset, because the company would not have incurred this tax without these activities. S.
Hi Silvia. It is very interesting and useful site.
Could you open this section “you can capitalize the difference between the interest on the foreign currency loan and the hypothetical interest expense in your own (functional currency), because that’s regarded as borrowing cost ” with an example. Thanks in advance
Hi Asef, thank you! Actually, I have already covered this topic with example here. S.
Hi Silvia
Your work is really helpful – I was just wondering how capitalising the interest of an asset would appear in the P and L account and Balance sheet compared to if it wasn’t capitalised under a different standard? I’m specifically looking at FRS 105 for micro-entities where capitalisation is not permitted? Would this have an effect on profits and different ratios?
Hi sylvia
Please do we less any investment income in relation to general pool of loans to get the eligible borrowing cost to be capitalized?
Hi
How I can depreciate capitalised asset over the useful life of asset? How to treat interest costs which added on fixed assets anually in accounting records? For example, Asset $ 100,000+$ 2000 (interest expense) for 2017. $ 3500 interest expense for 2018.
Hi silivia,
Can I capitalize the processing fees (upfront processing fee ) of (say for eg 1% of the loan amount) as borrowing cost under IAS 23. Please note that the processing fees was included as a part of the borrowing (Eg 10 Million loan+ 1 million Processing fees) repayable over a period of 10 years.
Hi Silvia,
This article were really helpful during the course of my work it may just be the best elaboration of the standard. However i just wanna confirm on one issue regarding inter-company loan. If my company got a loan from the parent entity which happens to be not interest free, should i capitalized the borrowing cost/ incurred interest as part of the qualifying asset? or should it be expense as incurred as the interest expense would be eliminated at a consolidation level.
Thank you in advance!
Hi Adimas,
strictly speaking – if a subsidiary presents individual, separate financial statements under IFRS, the interest (if conditions are met) has to be capitalized, there is no option to expense it. Upon consolidation, this would be eliminated – which means that yes, the cost of an asset in question will be different in consolidated statements from individual subsidiary’s statements. S.
Hello there,
I am currently facing a dilemma where by my company(parent) obtained a loan from its subsidiary which is a bank and we capitalised the interest expense. Now am trying to consolidate the financial statements for both the parent and the bank but I do not know how to make the necessary adjustment.
Hi Abdul,
I have explained it in some other answer here – you need to remove all entries related to that loan since the loan has not happened from the point of external users. Thus, the cost of an asset will be different in consolidated financial statements from the cost in individual parent’s statements. S.
Hi Silvia
Can loan processing/structuring fees be capitalised over and above the interest to the cost of a building under construction?
Hi Sylvia;
Thank you for all the great articles. I have a question, we obtained a loan “specific finance” for the construction of an asset. However meeting all requirements for the loan per the loan agreement has resulted in us incurring some legal costs – will these legal costs be regarded as an initial cost and hence be capitalised to the cost of an asset as a borrowing cost?
Hi Elizabeth,
I guess that legal cost was directly attributable to obtaining of the loan and therefore it is a part of the effective interest method when it comes to measurement of your loan. If this is so, then you should capitalize the interest incurred as calculated by the effective interest method.
Hi Sylvia
Capitalized interest costs arising from intercompany loan are depreciated over useful life of assets in subsidiary’s financial statements. Should the depreciation charges be eliminated upon consolidation?
Yes, at least the portion of depreciation related to capitalized interest cost.
Hi everyone!
I need some help from you. 🙂
“ABC” started the construction of an asset on 1 January 2018 with a loan of USD 40,000 borrowed at an interest rate of 9% per annum. Payments of construction costs are as follows: 1 January 2018 USD 15,000; 1 May 2018, USD 20,000; 1 October 2018 USD 5,000. The construction of the asset was completed on 31 December 2018. However, during the accounting period “ABC” has invested the excess funds at an interest rate of 3% in short-term bank deposit.
What is the amount of external financing that can be capitalized?
(The correct answear is probably: USD 3 287,50 but I don’t know how to get to this amount).
I would be very grateful for any help 😀
HI Silvia,
Good day.
I need a clarification on borrowing cost.
One of our company handling the property development and management services. In our case we have purchased the land with borrowed funds and sold the same to group of customers and they have assigned us the property development responsibilities and agreed to reimburse the development cost + agreed % of make management service fee.
Due to abnormal devaluation of currency, we have incurred the exchange losses and the customers are agreed to pay the same as part of development cost. Can we consider the same part of construction and development cost as it is the loan amount is directly used for the cost of development or to take into the P&L A/c. Please let me the appropriate accounting treatment as per IFRS. It would be a great help if you can clarify the same.
Is it applicable to banks? If yes, and considering that no specific loan receveid in relation to this asset construction. should I assume average cost of funds for customer deposits as a capitalization rate? If no can I use supportive loan rate as the capitalization rate?
I need clarification on a qualifying asset acquired with a loan. The asset is being put to use immediately after purchase. However, the interest is paid throughout the year. Should the interest be capitalized or expended in line with the guidance of IAS 23 borrowing cost.
Wahab Lawal
I need clarification on a qualifying asset acquired with a loan. The asset is being put to use immediately after purchase. However, the interest is paid throughout the year. Should the interest be capitalized or expended in line with the guidance of IAS 23 borrowing cost.
I also have the same question
No , first of all if the asset is used immidiatly used in operation it is not a qualifaying asset. According to ias 23 a qualifying asset is the one which requres substential period of time to become ready for use.
So the interest is exepensed in the period incured
Hi Silvia, thanks a lot for this amazing website! If the borrowing costs has been capitalized as it is used to construct an investment property, then will this non current asset (capitalized borrowing cost) have to be amortized over the life of the loan?
Dear Silvia,
could you please help me with the question how to understand capitalisation of borrowing costs related to interest in respect of lease liabilities under IFRS 16 (IAS 23.6(d))? Our company will sign a contract as a lessee for a lease of solar panels. Should the interests related to the lease liability be capitalised into the right of use asset in one of 2 possible scenarios: a) substantial period to get ready for use (say 1 year), b) no substantial period (say 2 months for instalation of panels). How would the capitalisation work in ad a)? Does it mean that during the first year no lease interests will be exepnsed and the amount will be capitalised into the right of use asset? Thank you a lot!
Hi Silvla, we have purchased 2 apartments for our company and the seller gave us a payment plan. We started paying for those apartments early 2019 until the last payment was done in Jan 2020. When can we captalise the total cost of the apartments, is it in 2019 or 2020?
A renowned cellular and telecommunication company has acquired 5G license for PKR 50 million. The company’s management has two options as under:
1. The Company may develop 5G wireless network to expand their customer base. This project is expected to complete within 5 years. For this, the company must acquire a bank loan of PKR 100 million for a period of 5 years.
2. The company has another option to further sell the 5G license to any third party.
What is accounting treatment on capitalization of the license and the related borrowing cost under the related IASs.
Hello Sylvie, well done.
Some technical assistance needed here.
If there’s a delay to commence construction of a qualifying asset and the delay was due to delay in approval of the plan by government. Do you capitalise during this period?
If the qualifying asset is in progress, what can be it’s valuation at a year end date? Is the initial cost of the asset + the borrowing costs capitalised to date??? Thanks
Hi Kapala, I don’t think so, because in order to start capitalizing, you must meet 3 conditions (IAS 23.17). One of them is that the expenditures for the asset need to be incurred (i.e. you must actually incur some transfer of cash or other asset in order to construct the qualifying asset). I guess you did not incur these expenditures since the government did not give an approval. S.
Yes we’re not incurring costs. In fact the three conditions were not met. However now mi worry is on how to value the asset at the year end. It is still in progress. Should I get it’s initial cost + the costs capitalised to date. Or it should not be presented because of not yet being fully completed. Thanks
Cost; and test it for impairment. If you cannot capitalize interest due to conditions not met, then you cannot include it in the “valuation” of your asset (i.e. in the carrying amount).
Hi Silvia
I have question. What about third party loan origination fees, for instance from a lawyer? Could they be capitalizable?
Hi Dave, if they are a part of EIR calculation (meaning they are initial transaction cost), then yes.
Hi Silvia. Under IAS 16 is it possible to have a loan that is specific for two or more qualified assets? If so, how would you distribute the actual loan cost among the assets for capitalization? Thank you.
Yes, on a pro-rata basis.
Hi Silvia. I am purchasing flats as investment property. Can i capitalize borrowing cost?
If you are purchasing it, then no, because it does not take substantial period to complete (thus it does not meet the condition of IAS 23 for capitalization).
Silvia, my company is about to acquire a new plant, which will be financed by a bank loan.
How to treat the finance cost? shall I capitalize it or charge it to P&L.?
Hi Silvia, Could you please clarify the following doubt,
The IAS 23 mention as below “Two types of assets that would otherwise be qualifying assets are excluded from the scope of IAS 23:
1.qualifying assets measured at fair value, such as biological assets accounted for under IAS 41 Agriculture 2.Inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis and that take a substantial period to get ready for sale (for example, maturing whisky):
My questions are
1.As per your explanation , you mention that the borrowing cost incurred for whisky can be capitalized but standard mention as can not capitalize?
2.As per the IAS 23 standard, Qualifying asset measured at FV can not capitalize borrowing cost. If a building measured at revaluation model, do they can capitalize borrowing cost?
Thanks in Advance
Sajith
What if the activities dor the development of an asset are stopped due to some uncertain situation kike covid-19 as of now.Will the cost incurred during this period on borrowing be eligible for capitalization?
Hi Silivia,
What would be treatment in consolidated financials?? As we are preparing the consolidated financials, all specific borrowings will become general borrowings at group level, for new projects, whether we need consider all borrowings??
Hi Silvia, In the below question, what should be the Cost to be recorded for the purchase of 10 units Peugeot.
Question : XYZ paid CU 450,000 to WorldCom Bank for financing purchase of 10 Peugeot 206 of CU 375,000 on June 30 20×1?
Thank you in advance for your reply.
I don’t understand this situation at all. XYZ paid 450 000 to purchase for 375 000? You should frame your question a bit clearer.
Hello Mam, You are amazing.
I have a question regarding IAS-23 & I hope I’ll get my answer.
If we raise loan from 3 different banks at different rates specifically for the construction of a qualifying asset which will take a year to complete and we also invest unused funds at different rates for short term & earn income.
Is this still possible to calculate net borrowing cost without using ‘Weighted Average Capitalization Rate’ (which we use in General Borrowing) ?
If Yes, then please share how will it be possible to ascertain Net Borrowing Cost?
If No, then shall we still call it Specific Borrowing? Should not we call it General Borrowing then? And if we call it General Borrowing then isn’t it opposing its definition (i.e Raising borrowing for multiple things, utilities, wages, taxes etc & somehow for Qualifying Asset also)
Please also shed light on ‘Is WARC only used in General Borrowing’
Thanks A Million Mam!
Hi,
Really liked the article and the way you respond to the query.
I have one query, let say the general cap rate is 5%. Expenditure incurred in year-1 is 6 Mn and in year-2 is 2 Mn, then in year 2 the borrowing cost is 5% of 2 Mn or 8Mn (6+2) assuming the loan is still outstanding.
Also, i want to know is there any subscription available just to discuss the queries on technical matters.
Regards,
Hello everyone here, I have a question about capitalization of borrowing costs!
The company made two contracts to have loan from a bank, one of them is for financing the construction of the manufacturing factory, one of them is for financing ten different import contracts to buy machines of 20.
1. Situation is clear about capitalizing the interest of 1st contract
2 Is not clear there are 20 different types of Machines which we can’t use until the construction is not finished yet,
Can anyone help me with the situation, please.
Hello, how would you treat a RCF loan which is general borrowing and interest rate changes each month?
e.g.
Project cost incurred 1st January of £200,000 and further costs incurred 2nd February. Project completion 31st December.
RCF loan already drawn on 1st January of £1,000,000 @1%
RCF loan rolled on 1st February @ £900,000 and new interest rate is 0.9%
RCF loan fluctuates up or down each month and each month a new interest rate is applied.
How would general borrowing costs in this scenario be applied?
Hi Silvia, I would like to ask on how to treat the on investment income in which the company has invested for RM2 M from the amount borrowed with interest rate 3% per annum during suspension phase.
Hello Silvia. I would like to ask about borrowing treatment which was received for acquiring CGU. Can i capitalize borrowing costs on CGU? Or is it scope of IFRS 9?
Hi Sandro,that’s outside of scope of IFRS 9, it is within the scope of IAS 23. As soon as your assets qualify under IAS 23, you can do so. However, IAS 23 says nothing about CGU though – that’s the term used in connection with impairment testing.
Thank you very much
Hello Silvia, When a loan is specifically obtained for a qualifying asset, then why do we stop capitalizing interest cost when the asset is ready and not when the loan is repaid?
Thank you.
Hello Silvia, What is the best way of treating Interest which was deflated. Accrue to Interest Accrual or capitalize to loan balance?
Could you please explain what you mean by “deflated interest”?
Sorry Silvia i meant defaulted interest.
I see. Well, you should really be looking at the difference between a liability/an accrual; or a receivable/a deferred income on the other hand. If you have a contractual right to receive that interest, then it is Debit Loan receivable (maybe some sub-account for better records) / Credit Interest revenue.