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Chapter 16
BORROWING COSTS (IAS 23)
BACKGROUND
IAS 23, Borrowing Costs, prescribes the criteria for determining whether borrowing costs can be capitalized as part of the cost of acquiring, constructing, or
producing a “qualifying asset.” The Standard prescribes the capitalization of borrowing costs into the cost of a qualifying asset.
IAS 23 has been revised to eliminate the option available hitherto to recognize borrowing costs as an expense. This amendment to the standard was made as part of
the efforts of the IASB and the US FASB towards convergence of their standards.
SCOPE
The Standard is to be applied in accounting for (i.e., recognizing) borrowing costs. Not all kinds of borrowing costs are to be capitalized. Borrowing costs that are
directly attributable to the acquisition, construction, or production of a qualifying asset are to be capitalized as part of the cost of that asset.
The Standard applies only to borrowing costs relating to external borrowings and not to equity. Therefore, the Standard does not deal with the imputed or actual cost
of equity, including preferred capital not classified as equity.
(in accordance with IAS 23)
DEFINITIONS OF KEY TERMS
Borrowing costs. Include interest and other costs incurred by an entity in relation to borrowing of funds.
Qualifying asset. An asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
PRACTICAL INSIGHT
The concept of “qualifying asset” is difficult to understand and comprehend in the spirit of the Standard. Some entities inadvertently apply (or at least insist
on applying) this Standard to borrowing costs relating to assets that are expensive to purchase. These entities get confused because to them the quantum of
the borrowing costs relating to the cost of the asset probably justifies such accounting treatment. For instance, if an expensive machine is bought (as
opposed to being built by the entity) and the cost of the machine is quite substantial, entities inadvertently apply the Standard and argue that it is appropriate
to capitalize borrowing costs along with the cost of the plant. Their justification is that since the machine is very expensive, the borrowing costs relating to
the purchase of the machine are also quite significant. Thus it would not be right on their part to expense these costs. These entities further argue that in
expensing such borrowing costs, they are able to capture only part of the cost of the asset. The cost of financing is to be included in the cost of the purchase
of the asset because without incurring that cost, the entity would not have been in a position to purchase such an expensive asset.
In practice, auditors face such situations quite often, especially in developing countries, where the costs of borrowing are quite high compared to other
economies.
BORROWING COSTS
Borrowing costs, as understood generally, refer to interest costs. However, borrowing costs as envisaged by the Standard are not just interest costs on short-term
borrowings, such as bank overdrafts and notes payable, or long-term borrowings, such as term loans and real estate mortgages. Rather, borrowing costs also include
other related costs, such as
• Amortization of discounts or premiums relating to borrowings
• Amortization of ancillary costs incurred in connection with the arrangement or borrowings
• Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs
• Finance charges in respect of finance leases recognized in accordance with IAS 17, Leases
Facts
CASE STUDY 1