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Advance Financial Accounting (FIN-611)
VU
LESSON # 31
BORROWING COST (IAS 23)
This standard deals with the cost (interest/financial charges) of such borrowings that
are made for purchase, acquisition or construction/production of assets.
DEFINITIONS:
Two very important terminologies of this standard need explanation, before going
into the further details.
1) Borrowing Costs:
These are interest and other costs incurred by an entity in connection with the
borrowing of funds.
Examples of Borrowing Costs:
(a)
Interest on bank overdrafts and short-term and long term borrowings;
(b)
Amortization of discounts or premiums relating to borrowings;
(c)
Amortization of ancillary costs incurred in connection with the arrangement of
borrowings (e.g. processing fee, lawyer's consultation etc.);
(d)
finance charges in respect of finance leases recognized in accordance with IAS
17, Leases; and
(e)
Exchange difference arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest cost.
2) A qualifying asset:
It is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale.
Examples of Qualifying Assets:
a)
Manufacturing plants
b)
Power generation facilities
c)
Investment properties
d)
Those inventories which are routinely manufactured or produced in large
quantities on a repetitive basis and assets ready for their intended use or sale
when acquired are not qualifying assets.
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Advance Financial Accounting (FIN-611)
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Solved Problem #1:
Identify which of the followings are qualifying assets:
(a)
Power plant being in the process of manufacturing.
(b)
Inventories routinely manufactured;
(c)
Asset ready for use;
(d)
Inventories requiring a substantial period for manufacturing.
(e)
Special order for a special inventory that will be manufactured in 5 months.
Solution:
(a)
Qualifying Asset;
(b)
Not Qualifying Asset;
(c)
Not Qualifying Asset;
(d)
Qualifying Asset;
(e)
Qualifying Asset.
Accounting for borrowing costs:
1) Benchmark Treatment:
Recognition:
Under the benchmark treatment borrowing costs are recognized as an expense in the
period in which they are incurred regardless of how the borrowings are applied.
Disclosure:
The financial statements shall disclose the accounting policy adopted for borrowing
costs (e.g. Interest, markup, profit and other charges on borrowings are charged to income).
2) Allowed Alternate Treatment:
Recognition:
Borrowing costs shall be recognized as an expense in the period in which they are
incurred, except to the extent that borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset shall be capitalized as part
of the cost of that asset.
Borrowing costs eligible for capitalization:
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
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Advance Financial Accounting (FIN-611)
VU
avoided had the expenditure on the qualifying asset not been made. When an entity
borrows funds specifically for the purpose of obtaining a particular qualifying asset,
the borrowing costs that directly relate to that qualifying asset can be readily
identified.
Solved Problem #2:
Mega Limited is engaged in the production of power generation plants, which is to be
used by the company.
The company borrows Rs.20, 000,000 @ 10% for construction of the plant.
The company wants to adopt the policy for accounting treatment of interest expense
on such borrowings.
What options are available to the company under IAS-23, Borrowing Costs.
Solution:
Benchmark Treatment:
Interest expense is recognized as an expense in the period in which it is
incurred. Therefore, the company under benchmark treatment should recognize
the interest of Rs. 2,000,000 as an expense.
Allowed Alternative Treatment:
Under allowed alternative treatment, the interest expense of Rs. 2,000,000 shall
be capitalized in the cost of the asset.
Specific Borrowings:
Where funds are borrowed specifically for a qualifying asset, the amount of borrowing
cost (less temporary investment income if any) shall be capitalized as a cost of such
asset.
Temporary Investment Income:
When all of the borrowed funds are not utilized at once for acquisition, development
or construction of qualifying asset, the unutilized amount of the borrowed fund is
invested temporarily(for a little time period) in some securities. The return on such
investments is known as temporary investment income.
Solved problem #3:
Swan Limited borrowed a loan from bank @ 12% per annum amounting to Rs.1,
000,000 for the construction of power generation facilities of the company. The loan
was received on January 01 and utilized Rs. 300,000 on Qualifying Asset. On January
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Advance Financial Accounting (FIN-611)
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01, the company deposited the remaining amount in a bank yielding interest @ 6%.
Whole of the amount is withdrawn and paid to contractor on March 01. The company
returned the loan to bank after 9 months i.e. on October 01. You are required to
calculate the amount of borrowing cost eligible for capitalization.
Hint:
Borrowing period  9 months
Investment period 2 months
Solution:
Rs.
Interest paid to bank
9
1,000,000 x 12% x
90,000
12
Less: Interest income
2
700,000 x 6% x
(7,000)
12
Borrowing cost eligible for capitalization
83,000
Capital expenditure (Rs. 1,000,000 + 83,000)
1,083,000
General Borrowings:
The amount to be capitalized shall be computed on the basis of capitalization rate, which shall
be the weighted average of the borrowing costs applicable to the outstanding borrowing during
the period, i.e.
Total Borrowing Cost incurred
Capitalization rate =
x 100
Weighted Borrowings Outstanding
This rate when applied on the expenditure incurred on Qualifying Asset on a time
basis gives the amount of borrowing cost to be capitalized.
The capitalization should not exceed the amount of borrowing costs actually incurred,
Solved problem #4:
MCQ (Private) Limited has the following loans outstanding as at December 31, 2005.
Rs.
Loan ­ 1 @ 6% (Due since opening date)
300,000
Loan ­ 2 @ 8% (Taken on 1 April, 2005)
200,000
Loan ­ 3 @ 9% (Taken on 1 July, 2005)
150,000
The company spent following amounts on construction of an asset.
January 31, 2005
70,000
April 1, 2005
80,000
December 1, 2005
10,000
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Advance Financial Accounting (FIN-611)
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Calculate
(i) Capitalization Rate
(ii) Borrowing cost eligible for capitalization.
Solution:
(i)
Capitalization rate
7% (W-1)
(ii)
Borrowing cost eligible for capitalization Rs.9, 136 (W-2)
Working:
(W-1) Capitalization Rate.
Loan
Amount
W Avg.
Rate
Interest
Rs.
Rs.
Rs.
Loan ­ 1
300,000
300,000
6%
18,000
Loan ­ 2
200,000 (9/12)150,000
8%
12,000
Loan ­ 3
150,000 (6/12) 75,000
9%
6,750
650,000
525,000
36,750
Total Interest
Capitalization rate =
x100
Weighted Average Loan
36,750
=
x100
525,000
Capitalization rate =
7%
(W-2) Borrowing cost eligible for capitalization.
Expenditure Incurred on
Rate
Period Capitalization
70,000
January 31, 2005
7%
11/12
4,492
80,000
April 01, 2005
7%
9/12
4,200
December 01, 2005
7%
1/12
58
10,000
160,000
8,750
Rupees
Total borrowing cost
36,750
Borrowing cost eligible for capitalization
(8,750)
Borrowing cost chargeable as expense
28,000
Capital Expenditure
Incurred cost
160,000
Borrowing cost eligible for capitalization
8,750
Total
168.750
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Advance Financial Accounting (FIN-611)
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Solved problem #5:
MCQ (Private) Limited has the following loans outstanding as at December 31, 2005.
Rs.
Loan ­ 1 @ 6% (Due since opening date)
300,000
Loan ­ 2 @ 8% (Due since opening date)
200,000
Loan ­ 3 @ 9% (Due since opening date)
150,000
The company spent following amounts on construction of an asset.
January 31, 2005
70,000
April 1, 2005
80,000
December 1, 2005
10,000
Calculate (i) Capitalization Rate
(ii) Borrowing cost eligible for capitalization.
Solution:
(i)
Capitalization rate
7.31% (W-1)
(ii)
Borrowing cost eligible for capitalization
Rs.9, 136 (W-2)
Working:
(W-1) Loan
Amount
Rate
Interest
Rs.
Rs.
Loan ­ 1
300,000
6%
18,000
Loan ­ 2
200,000
8%
16,000
Loan ­ 3
150,000
9%
13,500
650,000
47,500
Total Interest
Capitalization rate =
x100
Total Loan
47,500
=
x100
650,000
Capitalization rate =
7.31%
(W-2) Borrowing cost eligible for capitalization.
Expenditure
Incurred on
Rate
Period Capitalization
Rupees
Rupees
70,000
January 31, 2005
7.31%
11/12
4,689
80,000
April 1, 2005
7.31%
9/12
4,386
10,000
December 1, 2005
7.31%
1/12
61
160,000
9,136
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Advance Financial Accounting (FIN-611)
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Rupees
Total borrowing cost
47,500
Borrowing cost eligible for capitalization
(9,136)
Borrowing cost chargeable as expense
38,364
Capital Expenditure
Incurred cost
160,000
Borrowing cost eligible for capitalization
9,136
Total
169,136
Solved problem #6:
Sublime Sports Limited is currently manufacturing its power plants.
Up-to December 31, 2003, the company has incurred costs totaling Rs.500, 000 on
production of one of its plant.
The following loans are outstanding:
Rs.
Loan from MCB @ 9%
500,000
Loan from HBL @ 10%
625,000
Loan from UBL @ 11%
375,000
Loan from HBL was taken on July 1, 20x3 other loan were brought forward from
previous year.
Expenditure on plant incurred as follows:
Rs.
May 31, 2003
300,000
July 31, 2003
200,000
You are required to calculate:
(a)
Capitalization rate of the company;
(b)
Total borrowing cost to be capitalized for the year 2003.
Solution:
(a)
Capitalization rate
9.8947% (W-1)
(b)
Total borrowing cost eligible for capitalization
Rs. 25,562 (W-2)
Workings:
(W-1)
Principal
W Avg. Loan
Rate
Interest
Loan from MCB 500,000 12/12
500,000
9%
45,000
Loan from HBL 625,000 6/12
312,500
10%
31,250
Loan from UBL 375,000 12/12
375,000
11%
41,250
1,187,500
117,500
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Advance Financial Accounting (FIN-611)
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Total interest
Capitalization rate =
x100
Weighted average loan
117,500
=
x100
1,187,500
Capitalization rate =
9.8947%
(W-2) Total borrowing cost to be capitalized.
Expenditure Incurred on
Rate
Period Capitalization
300,000
May 31, 2003
9.8947%
7/12
17,316
200,000
July 31, 2003
9.8947%
5/12
8,246
500,000
25,562
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Table of Contents:
  1. ACCOUNTING FOR INCOMPLETE RECORDS
  2. PRACTICING ACCOUNTING FOR INCOMPLETE RECORDS
  3. CONVERSION OF SINGLE ENTRY IN DOUBLE ENTRY ACCOUNTING SYSTEM
  4. SINGLE ENTRY CALCULATION OF MISSING INFORMATION
  5. SINGLE ENTRY CALCULATION OF MARKUP AND MARGIN
  6. ACCOUNTING SYSTEM IN NON-PROFIT ORGANIZATIONS
  7. NON-PROFIT ORGANIZATIONS
  8. PREPARATION OF FINANCIAL STATEMENTS OF NON-PROFIT ORGANIZATIONS FROM INCOMPLETE RECORDS
  9. DEPARTMENTAL ACCOUNTS 1
  10. DEPARTMENTAL ACCOUNTS 2
  11. BRANCH ACCOUNTING SYSTEMS
  12. BRANCH ACCOUNTING
  13. BRANCH ACCOUNTING - STOCK AND DEBTOR SYSTEM
  14. STOCK AND DEBTORS SYSTEM
  15. INDEPENDENT BRANCH
  16. BRANCH ACCOUNTING 1
  17. BRANCH ACCOUNTING 2
  18. ESSENTIALS OF PARTNERSHIP
  19. Partnership Accounts Changes in partnership firm
  20. COMPANY ACCOUNTS 1
  21. COMPANY ACCOUNTS 2
  22. Problems Solving
  23. COMPANY ACCOUNTS
  24. RETURNS ON FINANCIAL SOURCES
  25. IASBíS FRAMEWORK
  26. ELEMENTS OF FINANCIAL STATEMENTS
  27. EVENTS AFTER THE BALANCE SHEET DATE
  28. PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
  29. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1
  30. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 2
  31. BORROWING COST
  32. EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
  33. EARNINGS PER SHARE
  34. Earnings per Share
  35. DILUTED EARNINGS PER SHARE
  36. GROUP ACCOUNTS
  37. Pre-acquisition Reserves
  38. GROUP ACCOUNTS: Minority Interest
  39. GROUP ACCOUNTS: Inter Company Trading (P to S)
  40. GROUP ACCOUNTS: Fair Value Adjustments
  41. GROUP ACCOUNTS: Pre-acquistion Profits, Dividends
  42. GROUP ACCOUNTS: Profit & Loss
  43. GROUP ACCOUNTS: Minority Interest, Inter Co.
  44. GROUP ACCOUNTS: Inter Co. Trading (when there is unrealized profit)
  45. Comprehensive Workings in Group Accounts Consolidated Balance Sheet