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AS 16: BORROWING COSTSan analysis

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OverviewAbout Borrowing CostsAbout Qualifying AssetsAccounting of Borrowing Costs

DisclosuresCase studies

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About Borrowing Costs

DefinitionInterest and other costsIncurred by an enterprise

In connection with the borrowing of funds

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About Borrowing CostsExamples of borrowing costs

Interest and commitment chargesAmortisation of discounts / premiums connected with

borrowings (Also refer AS 26)Amortisation of ancillary costs incurred in connection

with borrowing arrangements (Also refer AS 26)Finance charges in respect of assets acquired under

financial leases or under other similar arrangementsExchange differences from foreign currency borrowings

to the extent they are regarded as interest costs (Refer ASI 10)

Items not regarded as borrowing costsCosts of share holders’ funds. E.g. Dividend on

preference shareCosts that bear only an indirect relation with

borrowings. E.g. salary of personnel involved in borrowing of funds

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About Qualifying AssetsMeaning of ‘qualifying asset’An assetThat necessarily takes a substantial period of

timeTo get ready for its intended use or sale

Meaning of ‘substantial period of time’AS 16 has no mention about the length of timeAs per ASI 1:

What constitutes substantial period of time primarily depends on the facts and circumstances of each case.

Ordinarily a period of 12 months can be considered as substantial period of time

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Accounting of Borrowing CostsGeneral accounting treatmentBorrowing Costs that are directly attributable

to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset

Other borrowing costs should be recognised as an expense in the period in which they are incurred

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Accounting of Borrowing CostsRules for capitalisation

The costs incurred shall be directly attributable to acquisition, construction or production of a qualifying asset

Costs shall be capitalised when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably

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Accounting of Borrowing CostsSpecific borrowings

The amount of borrowing cost eligible for capitalisation shall be determined as actual borrowing cost incurred on that borrowing during the period less any income on the temporary investment of those borrowings

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Accounting of Borrowing CostsGeneral Borrowings

The amount of borrowing costs eligible for capitalisation should be determined by applying the capitalisation rate to the expenditure on that asset. (i.e. cost of the asset x capitalisation rate)

Capitalisation rate shall be the weighted average of the borrowing costs applicable vis-à-vis the general borrowings of an enterprise

The amount of borrowing costs so capitalised shall not exceed the total borrowing costs on general borrowings incurred in that period

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Accounting of Borrowing Costs

A Ltd. Constructed a plant costing Rs. 1,200 crores, which was spent evenly during the year. It had the following borrowing during the year.Term loan of Rs. 300 crores specifically for this

purpose @ 12% interestGeneral borrowings as shown below

Loan from A bank – Rs. 450 crores @ 13% Loan from B bank – Rs. 600 crores @ 11%

Compute the borrowing costs to be capitalised?

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Accounting of Borrowing CostsSpecific borrowing cost – Rs. 300 crores x 12% = Rs. 36

crores (A) (presumed that the entire amount was drawn in one go)

General borrowings used for constructing the qualifying asset = Rs. 1,200 crores – Rs. 300 crores = Rs. 900 crores. (It may be presumed that expense for the first three months were met from specific borrowing and for the remaining 9 months from general borrowings)

Weighted average rate of interest on general borrowings A bank = Rs. 450 crores x 13% = Rs. 58.50 crores B bank = Rs. 600 crores x 11% = Rs. 66 crores Weighted average rate = (Rs. 58.50 crores + Rs. 66 crores) /

(Rs. 450 crores + Rs. 600 crores) = Rs. 124.50 crores / Rs. 1,050 crores = 11.86%

It is said that Rs. 900 crores was evenly spent. Therefore average borrowings = Rs. 450 crores. Interest thereon = Rs. 450 crores x 11.86% x 9 / 12 = Rs. 40.03 crores (B)

Total borrowing costs capitalised = (A) + (B) = Rs. 76.03 crores

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Accounting of Borrowing CostsCommencement of capitalisation

Capitalisation can commence when the following conditions are fulfilled: Expenditure on acquisition, construction or production

of a qualifying asset is being incurred Borrowing costs are being incurred (and) Activities necessary to prepare the asset for its

intended use or sale are in progress. The activities may also include technical and administrative work prior to the commencement of physical construction.

Illustration When land is acquired and allied developments are

carried out, the entire borrowing costs are capitalised. However, if land is held for a long time without any development activity, no borrowing cost is required to be capitalised because no activity is undertaken to prepare the asset for its intended use or sale

S. S. AYYAR AND CO. - AS 16 13

Accounting of Borrowing CostsSuspension of Capitalisation

When active development is interrupted , capitalisation of borrowing costs can be suspended

Example: protracted litigations, strike, lockout, natural disaster etc.

However capitalisation of borrowing costs is not suspended when a temporary delay is a necessary part of the activity e.g. high water level while constructing a bridge

Cessation of capitalisationCapitalisation of borrowing costs shall cease when

substantially (and not wholly) all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. (actual sale or use is immaterial)

When the activities are completed in identifiable parts, capitalisation shall cease part – wise. E.g. one villa completed out of 11 villas

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Disclosures

The accounting policy adopted for borrowing cost

The amount of borrowing costs capitalised during the period

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Case studiesAccounting treatment of waiver of interest

which was capitalised earlierEAC – Vol. XVIII – Pg. 47

Interest waived pursuant to a scheme of rehabilitation Waiver was on account of inability of the enterprise to

repay its loan and has no direct nexus with acquisition of asset (for e.g. capital subsidy from govt.)

Hence need not be credited to asset accountEAC – Vol. XXIII – Pg. 131

Company repaid principal but could not repay interest fully

Lender waived payment of interest, which was credited to Capital reserve resulting in reduced depreciation

When interest is waived, it means that the cost which was capitalised earlier is never incurred and hence de-capitalisation has to take place .

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Case studiesWhether borrowing costs are to be considered

in valuation of inventories

Interest cost shall be included if both the conditions are fulfilled: The asset shall be a ‘qualifying asset’ (i.e. test of

substantial time – e.g. manufacture of wine) (and) It should fall within the exception stated in paragraph 12 of

AS 2 (e.g. substantial time required for manufacturing)

In the case of sugar industry the EAC has opined, not to charge borrowing costs to the cost of inventories though interest is a substantial cost for them

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Case studiesWhether AS 16 applies vis-à-vis

acquisition of an asset, which by itself is not a qualifying asset but which is acquired for the construction of a qualifying assetE.g. a residential building purchased to

accommodate the staff in connection with construction of plant

Based on the principle of ‘substance over form’ the entire project must be considered as a qualifying asset and borrowing costs, including those attributable to purchase of house, shall be capitalised till the plant is ready for its intended use (Reference: CPE background material of I C A I)

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Case studiesWhether the following expenses can be

regarded as borrowing costs as per AS 16Item Yes /

NoRemarks

Fee paid to pre-close a loan (EAC – XXIV Pg. 80)

No No nexus between the expenditure and the item of asset capitalised. It is a Financial Management expense

Discount on issue of debt instruments (CPE background material)

Yes It is a cost incurred in connection with borrowing of funds

Cost for procuring finances like advertisement, road show, press meet etc. (CPE background material)

Yes It is a cost incurred in connection with borrowing of funds

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Case studiesAccounting treatment of income from

temporary investment of funds borrowed generally and also income tax treatment thereofAccounting treatment: income from short term

investments from Specific borrowings – income shall go to reduce the

borrowing cost to be capitalised as the standard explicitly says so.

General borrowings – no such stipulation is made by the standard. Hence it can be shown as income

Income Tax Treatment – In either case, the same shall be taxed as income as per the decisions of the Apex Court in Tuticorin Alkali Chemicals and Fertilizers Ltd. vs. CIT (1997) 227 ITR 172 CIT vs. Autokast Ltd (2001) 248 ITR 110

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Case studiesProviso to Section 36(1)(iii) of the Income Tax Act vs.

AS 16IT Act AS 16

36(1)(iii) deals only with interest on capital borrowed for business or profession

AS 16 covers interest as well as other borrowing costs

All assets are covered Only qualifying assets are covered

Deals only with acquisition of assets for extension of existing business or profession

Scope is wider as it covers acquisition, construction or production of a qualifying asset vis-à-vis existing / new entity

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AS 16: BORROWING COSTSan analysis

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