EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT

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Advance Financial Accounting (FIN-611)

LESSON # 32

EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER

RECOVERABLE AMOUNT:

When the carrying amount or the expected ultimate cost of the qualifying asset

exceeds its recoverable amount or net realizable value, the carrying amount is written

down or written off in accordance with the requirements of other Standards. In certain

circumstances, the amount of the write down or write-off is written back in accordance

with those other Standards.

Commencement of capitalization:

The capitalization of borrowing costs as part of the cost of a qualifying asset shall

commence when:

(a)

Expenditures on the asset are being incurred;

(b)

Borrowing costs are being incurred; and

(c)

Activities that are necessary to prepare the asset for its intended use or sale are

in progress.

Solved problem #7:

Silver Star (Private) Limited engaged in manufacturing of surgical items.

Currently the company is manufacturing its power plant. The company started the

project on February 01, with its own funds. Later on due to shortage of funds, the

company takes a loan to sponsor the project on May 01. The first payment out of the

loan on the plant is made on June 01.

Required:

When should the company commence capitalization of borrowing cost on the plant?

Solution:

The necessary three conditions for commencement of capitalization are fulfilled on

June 01, so capitalization should commence on June 01.

Treatment of Subsidies by the Government:

Expenditures on a qualifying asset include only those expenditures that have resulted

in payments of cash, transfers of other assets or the assumption of interest bearing

liabilities. Expenditures are reduced by any progress payments received and grants

received in connection with the asset. The average carrying amount of the asset during

a period, including borrowing costs previously capitalized, is normally a reasonable

approximation of the expenditures to which the capitalization rate is applied in that

period.

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Advance Financial Accounting (FIN-611)

Solved problem #8:

Pak Solutions Limited is engaged in the production of plants. The company is

currently manufacturing a plant for internal use.

Following expenditures were made:

Rupees

Payment to vendors for material

500,000

Depreciation of equipment used for manufacturing of plant

20,000

Wages paid

300,000

Utilities to be paid

80,000

Government granted a subsidy to the company for manufacturing of plant amounting

to Rs.200, 000.

Required:

Assuming that the company funds the project by obtaining a loan, calculate the

amount to be used as cost of the asset for computing the borrowing cost eligible for

capitalization.

Solution:

Amount on which capitalization should be made:

Rs.

Payment to vendors for materials

500,000

Wages paid

300,000

Depreciation of equipment

20,000

Utilities to be paid

80,000

900,000

Less: Govt. subsidy

(200,000)

700,000

The activities necessary to prepare the asset for its intended use or sale encompass

more than the physical construction of the asset. They include technical and

administrative work prior to commencement of physical construction, such as the

activities associated with obtaining permits prior to the commencement of the physical

construction.

Suspension of capitalizing borrowing cost:

Capitalization of borrowing costs shall be suspended during extended periods in

which active development is interrupted.

Capitalization is not suspended when a temporary delay is a necessary part of the

process of getting an asset ready for its intended use or sale e.g. the extended period

during which high water level delay construction of a bridge.

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Advance Financial Accounting (FIN-611)

Solved problem # 9:

Shahid and company is constructing an asset for their own use in the business.

The production of asset started on September 30, 2006. Due to some internal problems

of the company, the construction remained suspended from November 01 to

November 31. The asset was completed on December 31. The asset was constructed by

utilizing the borrowed funds.

Required:

Calculate the period for which capitalization should be made.

Solution:

The active development started on September 30, and continued till October 31, and

then after stoppage construction again started on December 1 till December 31.

Therefore, the borrowing cost should be capitalized for two months and shall remain

suspended for one month.

Cessation of Capitalization:

Capitalization of borrowing costs shall cease when substantially all the activities

necessary to prepare the qualifying asset for its intended use or sale are complete.

Solved problem #10:

Haroon Limited is constructing an asset for its internal use. The construction started

on March 01, 2009. The asset was completed on July 31, 2009. It was put into use on

September 15. The production was started from such asset on November 1.

Required:

You are required to state when capitalization of borrowing cost should be ceased.

Solution:

The asset was completed on July 31, 20x9. It was ready for use although the

production from such asset was not started. Thus capitalization of borrowing cost

should cease on July 31, 2009.

Modification work after completion:

An asset is normally ready for its intended use or sale when the physical construction

of the asset is complete even though routine administrative work might still continue.

If minor modifications, such as the decoration of a property to the purchaser's or

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Advance Financial Accounting (FIN-611)

user's specification, are all that are outstanding, this indicates that substantially all the

activities are complete.

Solved problem #11:

Zeshan Limited is engaged in production of an asset. The production started on July

31, 2007. The production completed on July 31, 2008.

The works manager checked the asset and requested some minor modifications. These

modifications were completed on August 30, 2008. The asset delivered to works

manager on September 10, 2008. The production started from such asset on October

01, 2008.

Required:

When should capitalization cease.

Solution:

The capitalization should cease on July 31, 2008, as substantially the activities have

been completed on this date.

Completion of work in parts:

When the construction of qualifying asset is completed in parts and each part is

capable of being used separately while construction continues on other parts,

capitalization of borrowing costs shall cease when substantially all the activities

necessary to prepare that part for its intended use or sale are completed.

A business centre comprising several buildings, each of which can be used

individually is an example of a qualifying asset for which each part is capable of being

used while construction continues on other parts.

An example of a qualifying asset that needs to be completed in full, before any other

part can be used, is an industrial plant involving several processes which are carried

out in sequence at all parts of the plant within the same site, such as a steel mill.

Solved problem #12:

Sialkot (Pvt.) Limited contracted with B Limited to build a group of factory buildings.

Each building is capable of being used separately.

Sialkot (Pvt.) Limited capitalizes its borrowing costs in accordance with Allowed

Alternative Treatment of IAS-23, Borrowing Costs.

Required:

Advice the company to capitalize its borrowing costs based on the period when all the

buildings are ready for use or based on the period when each building is ready for use.

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Advance Financial Accounting (FIN-611)

Solution:

As each component of the contract is capable of being used separately, the borrowing

costs should be capitalized based on the period of construction of each building.

Disclosures:

Following should be disclosed in the financial statements:

(a)

The accounting policy adopted for borrowing costs;

(b)

The amount of borrowing costs capitalized during the period; and

(c)

The capitalization rate used to determine the amount of borrowing costs

eligible for capitalization.

Solved problem # 13:

Disclosure:

(i)

Borrowing costs are recognized as an expense in the period in which these are

incurred, except to the extent that borrowing costs that are directly attributable

to the acquisition, construction or production of a qualifying asset is capitalized

as part of the cost of that asset.

(ii)

The amount of borrowing costs capitalized during the period is Rs. 75,145.

(iii)

Capitalization rate for the year used to capitalize borrowing costs is 9.15%.

PRACTICE QUESTIONS

QUESTION #1:

On 1st Jan 2006, Sparkle Co borrowed Rs. 1.5 million to finance the production of two

assets both of which were expected to take a year to build. Production started during

2006. The loan facility was drawn down on 1 Jan 2006 and was utilized as follows,

with the remaining funds invested temporarily

Asset A

Asset B

1 Jan 2006

250,000

500,000

1 Jul 2006

250,000

500,000

1,000,000

The loan rate was 8 % and Sparkle Co can invest surplus funds at 5 %.

Required:

Calculate the borrowing costs which may be capitalized for each of the asset and

consequently the cost of each asset as at 31 Dec 2006.

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Advance Financial Accounting (FIN-611)

QUESTION #2:

AUM engineering limited has been engaged in construction business and wins a

contract to construct Kalabhag Dam work Rs. 120 million with a completion period of

one year.

Progress payments made by the government are as under

1st April

30 M

1st July

30 M

31st December

60 M

The company's bankers agree to finance the project @ 9 % mark up per annum as per

following schedule.

1st January

40 M

1st April

40 M

1st July

40 M

The company realizes at the end of third month that second installment of

disbursement by the bankers needs to be paid to the company's creditors a month

later. Therefore, on receipt of second installment, it is temporarily invested to fetch

return of 2 % per month to the company.

Required:

Compute the amount of borrowing cost to be capitalized as per IAS-23.

QUESTION #3:

Loan worth of Rs. 300,000 taken on 1st January 2006 for construction of X and Y blocks.

Interest Rate is 10% per annum and surplus funds are invested @ 7% per annum.

Detail of Expenditure

Year 2006

1st January

100,000

50,000

30th June

60,000

_______

______

110,000

100,000

Block X was completed on June 30, 2006.

Required:

Calculate total expenditure on X and Y Blocks as on December 31, 2006, applying

allowed alternative treatment under IAS-23 is adopted.

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