NAS 08 and IAS 23

According to both the standards,borrowing costs is defined asinterest and other costs that anentity incurs in connection withthe borrowing of funds.

NAS 08 and IAS 23 does not dealwith the actual or imputed cost ofequity including preferred capitalnot classified as a liability.

NAS 08 IAS 23

Borrowing costs shall berecognized as an expense in theperiod in which they are incurred.

Borrowing costs that are directlyattributable to the acquisition,construction or production of aqualifying asset are part of thecost of that asset.

Alternatively, Borrowing coststhat are directly attributable to theacquisition, construction orproduction of a qualifying assetcan be capitalized as part of thecost of that asset.

Other Borrowing costs arerecognized as expense.

NAS 08 IAS 23

1. Interest on bank overdrafts andshort term and long termborrowings

2. Amortization of discounts orpremiums relating to borrowing

3. Amortization of ancillary costsincurred in connection with thearrangement of borrowing

4. Finance charges in respect of assetsacquired under finance leases orunder similar arrangements

5. Exchange difference arising formforeign currency borrowing to theextent that they are regarded as anadjustment to interest costs

1. Interest Expense computed undereffective interest rate methodunder IAS 39.

2. Finance Charge of a lessee of afinance lease transactions underIAS 17.

3. Exchange difference resulting fromborrowings in foreign currencythat can be treated as anadjustment to interest cost.

ABC Ltd issues 100 million 5 years 10% debentures of Rs 100 at 99.0583.Related issue expense are Rs 1 million. Suppose that issue expenses arepaid at the time of issue.

Solution

Measurement of fair value of debentures

(Rs in million)

Year Future Cash

Outflow

Discount factor at market yield of

10.025%

Discounted Cash Flow

1 1,000.00 0.907 907.03

2 1,000.00 0.8227 822.70

3 1,000.00 0.7462 746.22

4 1,000.00 0.6768 676.84

5 11,000.00 0.6139 6,753.05

Fair Value of the debentures 9,905.83

Less: Transaction Cost 1Fair Value at initial recognition 9,904.83

Year Cash flow

Borrowing cost chargeable to the Income Statement

under IAS 23

Interest Payment

Adjustment to Principal

Remaining Principal balance

0 9904.83

1 -1000 1,015.51 1,000.00 15.51 9,920.34

2 -1000 1,017.10 1,000.00 17.10 9,937.44

3 -1000 1,018.85 1,000.00 18.85 9,956.29

4 -1000 1,020.79 1,000.00 20.79 9,977.08

5 -11000 1,022.92 1,000.00 22.92 10,000.00

Effective Interest Rate 10.25%

Computation under amortized cost method(Rs in million)

Both the standards details out the following

Items of borrowing costs which are eligible for capitalization.

When should the capitalization commence

Circumstances leading to suspension of capitalization

When the process of capitalization should cease

The borrowing costs that are directlyattributable to the acquisition, construction orproduction of a qualifying asset are eligible forcapitalization.

Qualifying Assets are those assets thatnecessarily takes a substantial period of time toget ready for its intended use or sale

Borrowing costs associated with specificborrowing for funding qualifying assets iscapitalized on actual basis less any investmentincome on the temporary investment of thoseborrowings.

In case of general borrowing, borrowing costsare charged to a qualifying assets applying acapitalization rate which is a weighted averagegeneral borrowing cost to investment required.

Rs in Million QA 1 QA 2 QA 3

Investment till date 200 240 600

Specific borrowing 110 90 50Specific borrowing cost 10 8.5 4.7Investment Income from specific borrowing 0.8 1.01 0.35General Borrowing9% debentures outstanding for 6 months 500borrowing cost 228.5% loans outstanding for 4 months 480borrowing cost 13.6Total borrowing cost of general borrowing 35.6Total amount of general borrowing 980

Case

QA 1 QA 2 QA 3 Total

Investment requirement in qualifying assets net of specific borrowing 90 150 550 790General borrowing 980Borrowing cost relating to general borrowing 35.6Capitalization Rate (35.60/980) 3.63%Total borrowing cost of general borrowing to be capitalized 790x3.63%=28.68Allocation on the basis of investment required 3.27 5.45 19.96 28.68Specific borrowing cost net of investment income 9.2 7.49 4.35 21.04

Borrowing cost to be capitalized 12.47 12.94 24.31 49.72

Analysis

Commencement date for capitalization ofborrowing costs regarding qualifying assets is adate when the entity fulfills all the followingthree conditions :

1. It incurs expenditure for the asset

2. It incurs borrowing cost

3. It undertakes activities that are necessary toprepare the asset for it’s intended use or sale

An entity may incur borrowing costs during an extended period in which it suspends the activities necessary to prepare an asset for it’s intended use or sale. Borrowing cost are not eligible for capitalization in such cases. For example, borrowing cost incurred for holding partially completed assets.

However capitalization is notsuspended in the following cases:• When substantial technical andadministrative work is carried out• When a temporary delay is anecessary part of the process ofgetting an asset ready for it’s intendeduse or sale.

The following events take place:

An entity buys some land on 1 December. Planning permission is obtained on 31 January. Payment for the land is deferred until 1 February. The entity takes out a loan to cover the cost of the land and the construction ofthe building on 1 February. Due to adverse weather conditions there is a delay in starting the buildingwork for six weeks and work does not commence until 15 March.

In the above scenario the key dates are:

Expenditure on the acquisition is incurred on 1 February when constructioncommences. Borrowing costs start to be incurred from 1 February. Although work was being undertaken on planning permission etc. duringDecember and January, no borrowing costs were incurred during this period. During the six-week inactive period borrowing costs should not be capitalized. Capitalization of borrowing costs should commence from 15 March.

Case

Capitalization of borrowing cost is ceasedwhen substantially all the activitiesnecessary to prepare the qualifying asset forit’s intended use or sale are complete.

If minor modifications or routineadministrative work is to be continued thenalso it signifies that substantially all theactivities are complete and capitalization ofborrowing cost should be ceased.

NAS 08 IAS 23

a) Accounting policyadopted for borrowingcosts.

b) Amount of borrowingcost capitalized duringthe period.

c) Capitalization rate used

a) Amount of borrowingcost capitalized duringthe period.

b) Capitalization rate used

Sachet Lal Shrestha