Scope of IAS 23
IAS 23 covers accounting for borrowing costs which are interest and other costs that an entity incurs in connection with the borrowing of funds (IAS 23.5).
Actual or imputed cost of equity instruments as classified under IAS 32 is excluded from the scope of IAS 23 (IAS 23.3).
Recognition of borrowing costs
Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are capitalised as part of the cost of that asset. Other borrowing costs are recognised in P/L as incurred (IAS 23.8).
Additionally, borrowing costs are capitalised as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably (IAS 23.9).
Commencement of capitalisation
Entity begins capitalising borrowing costs as part of the cost of a qualifying asset on the commencement date, which is the date when the entity first meets all of the following conditions (IAS 23.17):
(a) it incurs expenditures for the asset;
(b) it incurs borrowing costs; and
(c) it undertakes activities that are necessary to prepare the asset for its intended use or sale.
Activities necessary to prepare the asset for its intended use or sale should be understood rather broadly and include not only physical construction, but also prior technical and administrative work (e.g. obtaining permits). On the other hand, when an asset (e.g. land) is acquired for further development, but no associated activities have started, borrowing costs are expensed in P/L as incurred (IAS 23.19).
Suspension of capitalisation
Capitalisation of borrowing costs should be suspended during extended periods in which active development of a qualifying asset is suspended (IAS 23.20).
Capitalisation of borrowing costs is suspended when, for example:
- entity need to redirect its workforce and efforts to development of another asset
Capitalisation of borrowing costs is NOT suspended when, for example (IAS 23.21):
- physical construction of an asset is suspended because the entity carries out substantial technical and administrative work
- any delays in direct works are necessary part of the process of getting an asset ready for its intended use or sale (e.g. high water levels during construction of a bridge)
End of capitalisation
General requirements for the end of capitalisation
Borrowing costs are no longer capitalised when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete (IAS 23.22). Examples of activities given by IAS 23 that are not substantial in preparing the qualifying asset for its intended use are routine administrative work at the end of the project (e.g. formal inspections) and minor modifications still to be finalised (IAS 23.23).
Parts of a qualifying asset
When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity ceases capitalising borrowing costs for each part when it completes substantially all the activities necessary to prepare that part for its intended use or sale (IAS 23.24). See IAS 23.25 for more discussion.
Expenditures on an asset to which a capitalisation rate is applied are reduced by any progress payments received and grants received in connection with the asset (IAS 23.18).
Borrowing costs eligible for capitalisation
IAS 23 covers accounting for borrowing costs which are interest and other costs that an entity incurs in connection with the borrowing of funds (IAS 23.5). Examples of borrowing costs given by IAS 23 include interest expense calculated using the effective interest method under IFRS 9, interest in respect of lease liabilities recognised under IFRS 16 and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs (IAS 23.6).
These are examples only and other borrowing costs are also eligible for capitalisation provided that they are incurred in connection with the borrowing of funds (IAS 23.5) and would have been avoided if the expenditure on the qualifying asset had not been made (i.e. are directly attributable) (IAS 23.10). See also section on general borrowings later on.
Unwinding of discount
Finance costs relating to unwinding of discount for liabilities outside of scope of IFRS 9 are generally not eligible for capitalisation as they are not incurred in connection with the borrowing of funds. This concerns unwinding of discount for e.g. employee benefits (IAS 19) or provisions (IAS 37).
General requirements relating to specific borrowings
When an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the borrowing costs eligible for capitalisation are the actual borrowing costs incurred on that borrowing during the period (IAS 23.12).
If an entity earns any investment income on the temporary investment of those borrowings, such an investment income is deducted from the amount of borrowing costs eligible for capitalisation (IAS 23.13). IAS 23 is silent on investment losses, but it would be against the general definitions of borrowing costs to capitalise investment losses incurred on temporary investment of funds borrowed specifically for the purpose of obtaining a qualifying asset.
Requirements relating to general borrowings
Usually entities have general borrowings that are also used to finance assets. It is therefore difficult to identify a direct relationship between particular borrowings and a qualifying asset and to determine the borrowings that could otherwise have been avoided (IAS 23.11). It nevertheless needs to be done. Entities need to determine a capitalisation rate which is then applied to expenditures on qualifying asset (IAS 23.15). The average carrying amount of the asset during a period, including borrowing costs previously capitalised, is normally a reasonable approximation of the expenditures to which the capitalisation rate is applied in that period (IAS 23.18).
Capitalisation rate is the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset (IAS 23.15).
Example: capitalisation rate
On 1 March 20X1, Entity A begins the construction of a property. Entity incurs the following expenditures on this property during year 20X1:
1 March 20X1 – $100,000
1 June 20X1 – $300,000
1 October 20X1 – $600,000
On 1 January 20X1, Entity A had $500,000 of general borrowings which increased by $1 million to $1.5 million in total on 1 June 20X1. Interest expense on these borrowings calculated under IFRS 9 amounted to $50,000 for full year 20X1.
The capitalisation rate amounts to 5% and was calculated as follows:
($50,000)/($500,000 x 0.5 years + $1,500,000 x 0.5 year) = 5%
Therefore, Entity A capitalises $20,417 of borrowing costs which was calculated as follows:
($100,000 x 10/12 + $300,000 x 7/12 + $600,000 x 3/12) x 5% = $20,417
IAS 23 is silent (unlike for specific borrowings) on how investment income earned on borrowed funds impacts the capitalisation rate computed for general borrowings. Entities need therefore to develop their accounting policy if such an investment income is significant.
Foreign exchange differences and hedging derivatives
Paragraph IAS 23.6(e) states that borrowing costs may include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. Unfortunately, IAS 23 does not provide any guidance in this area. January 2008 IFRIC update includes a short discussion on this topic, but the conclusion is that an entity needs to develop its own accounting policy, which will often require judgement as stated in paragraph IAS 23.11.
It is generally accepted that exchange differences arising from foreign currency borrowings, including impact of derivatives hedging foreign currency exposure (e.g. swaps), can be included in borrowing costs eligible for capitalisation. However, care is needed when determining to what extent exchange differences are regarded as an adjustment to interest costs and when other circumstances may be cause of exchange differences. Here entities need to bear in mind that, as a rule, exchange differences on monetary assets are immediately recognised in P/L. Entities with significant exchange differences arising from foreign currency borrowings should disclose the accounting policy applied.
Entity A has EUR as its functional currency. It borrows USD 1 million on 1 January 20X1 with a repayment date on 31 December 20X1. The interest on the loan is fixed at 3% and is payable on 31 December 20X1 together with principal amount. The EUR/USD rate on 1 January 20X1 is 1.1 (i.e. 1 EUR = 1.1 USD) and 1.2 on 31 December 20X1. An equivalent loan in EUR would bear an interest of 4%.
Entity determines exchange differences eligible for capitalisation as follows.
Note: you can scroll the table horizontally if it doesn’t fit your screen
|Loan of USD 1m (principal) translated to EUR on 1 Jan 20X1 (EUR/USD = 1.2)||A||833,333|
|Loan of USD 1m (principal) translated to EUR on 31 Dec 20X1 (EUR/USD = 1.1)||B||909,091|
|Exchange losses on principal||C=(B-A)||75,758|
|Interest paid on principal at 3% (EUR/USD = 1.1)||D||27,273|
|Interest that would be paid on equivalent principal in EUR at 4% (EUR 833,333)||E||33,333|
|Interest paid capitalised||F=D||27,273|
|Capitalised foreign exchange impact regarded as an adjustment to interest costs||G=E-D||6,061|
|Exhchange lossess recognised in P/L||I=C-G||69,697|
You can download an excel file with the calculations above.
Definition of a qualifying asset
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale (IAS 23.5). Examples of qualifying assets are inventories, PP&E, intangible assets, investment properties, bearer plants (IAS 23.7).
‘Substantial period of time’ is defined in IFRS, so entities need to apply judgement and develop their own accounting policy in this respect. It is rather widely accepted that periods exceeding 12 months are substantial periods of time.
Paragraph IAS 23.18 states that ‘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.’ So, strictly speaking, entities cannot capitalise borrowing costs with respect to assets for which entities only incurred trade payables, unless there are interest-bearing. Capitalisation may commence once the payment is made. In practice, the time difference between assumption of a liability and related payment may often be insignificant.
Asset constructed by a third party
Assets constructed by a third party can also be a qualifying asset provided that general IAS 23 criteria are met. Entities can capitalise borrowing costs when there are upfront payments relating to assets being constructed by a third party. This matter, however, is not dealt with in IAS 23 specifically.
Scope exemptions for certain qualifying assets
Entities are not required to apply IAS 23 for financial assets (IAS 23.7), qualifying assets measured at fair value and for inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis, even if they take a substantial period of time to get ready for sale (IAS 23.4, BC6).
Examples of inventories covered by this scope exemption include maturing food or various equipment produced in large quantities on a repetitive basis.
It is worth noting that paragraph IAS 16.77e requires the disclosure for each revalued class of PP&E the carrying amount that would have been recognised had the assets been carried under the cost model. So effectively, entities still need to track borrowing costs that were not capitalised in the cost of PP&E carried at revalued amount.
An entity discloses (IAS 23.26):
(a) the amount of borrowing costs capitalised during the period; and
(b) the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.
© 2018-2019 Marek Muc
Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.