The main objective of this Accounting Standard is only to prescribe accounting principles for the accounting of borrowing cost.
- Nature & Scope
- Borrowing Cost
- Qualifying Assets
- Capitalization of Borrowing Cost
- Types of Borrowing
- Commencement of Capitalization
- Suspension of Capitalization
- Cessation of Capitalization
1. Nature & Scope
This Notified accounting standard is mandatorily applicable to all enterprises. It is specifically stated that this accounting standard is only related to External Borrowings and does not deal with the cost of raising Equity or Convertible Preference Shares.
Effective date: This standard came into effect from Financial Year starting on or after 1st April 2000
2. Borrowing Cost
As per ICAI “Borrowing Costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds”
The following points should be taken into consideration for borrowing costs:
a. Interest on short term loans or long-term debts should be included as part of borrowing cost. Ex: Interest paid to financial institutions for loan taken to acquire the asset.
b. If an enterprise has incurred any discounts or premiums related to the borrowing cost, then it will also be amortised. Ex: Amount paid to the financial institutions as loan processing cost
c. If an enterprise has incurred any finance/ancillary cost in connection with the borrowings, then it will also be amortised. Ex: Amount to the professionals for preparation of project reports, etc.
d. If an enterprise has acquired any asset under finance lease or any other similar arrangement, then those finance cost will also be amortised. Ex: Leasing cost paid to the lessor every year.
If an enterprise has taken any borrowing in foreign currency, then the exchange rate fluctuation will also be amortised to the extent they are regarded as an adjustment of interest costs. Ex: An enterprise has taken a loan from foreign financial institutions when the rate of US $ was 64, while at the end of the financial year the rate of US $ was 65. The rate difference of US $ 1 will be treated as Borrowing Cost.
3. Qualifying Assets
Qualifying Assets are those assets which take substantial time to be ready for the intent of sale or use.
Substantial period primarily depends on the facts and circumstances of the case. Generally, a period of 12 months is considered as a substantial period unless a shorter or longer period can be justified based on facts and circumstances of the case.
Borrowing costs are capitalized in the books of accounts with the qualifying assets when it is certain that it will have future economic benefits. Any other borrowing costs must be treated as an expense in the period in which they are incurred.
4. Capitalization of Borrowing Cost
The following conditions should be satisfied for capitalization of borrowing costs:
a. Those borrowings costs which are directly attributable to the acquisition, construction or production of qualifying asset, are eligible for capitalization. Directly attributable costs are those costs which would have been avoided if the expenditure on the qualifying assets has not been made.
b. Qualifying assets will give future benefit to the enterprises and the cost can be measured reliably
5. Types of Borrowings
The two types of borrowings which are detailed below in the table are:
a. Specific borrowings
b. General borrowings
Amount of borrowing cost to be capitalized is:
|Type of Borrowing||Amount to be Capitalized|
|The amount to be capitalized is:
Actual Borrowing Cost incurred during the period
Any income on temporary investment of borrowed funds(Ex: The excess money invested in Fixed Deposit will have interest gain)
|General Borrowing||The amount to be capitalized involves few steps:
a. Calculate Capitalization Rate. It will be weighted average of borrowing cost.
b. Cost to be Capitalized = Capitalization rate * Amount spent on qualifying asset out of general borrowingNote: Amount of borrowing cost capitalized during a period should not exceed the amount of borrowing cost incurred during the period.
6. Commencement of Capitalization
The Commencement of Capitalization of borrowing cost should commence when all the conditions below are fulfilled:
a. Expenditure for the acquisition, construction or production of a qualifying asset is being incurred. Here expenditure includes those expenditure in the nature of cash or transfer of any asset or the assumption of interest bearing liabilities
b. Borrowing Costs are being incurred.
c. Activities that are necessary to prepare the asset for its intended use or sale are in progress. The activities here need not be the physical activities, but the technical and administrative work related to the assets is also taken into consideration
7. Suspension of Capitalization
Capitalization of Borrowing cost are commenced when the above mentioned 3 points are satisfied. However, if there is a temporary delay in which the active necessary developments are interrupted then then there will be a suspension of capitalization.
However, if the temporary delay is necessary part of the process of getting an asset ready for its intended use or sale, then there will be no suspension of capitalization.
8. Cessation of Capitalization
Capitalization of borrowing cost ceases when all the activities necessary to prepare the qualifying assets are complete. If an asset has been completed in parts and a completed part is capable of being used while the construction for the other part continues then the capitalization for that completed part will cease.
Example: A business park consists of several buildings and each building can be treated as an individual part.
The Financial Statements should disclose the following:
a. The accounting policy adopted for borrowing costs
b. The amount of borrowing costs capitalized during the year
ABC Ltd. obtained a loan from a bank for Rs. 50 lakhs on 30th April 2017. ABC Ltd utilized the money:
Construction of Shed: Rs 50 Lakhs
Purchase of Machinery: Rs 40 Lakhs
Working Capital: Rs 20 lakhs
Advance for purchase of truck: Rs. 10 Lakhs
Construction of shed was completed in March 2018. The Machinery was installed on the same day. Truck was not yet received. Total interest charged by the bank for the year ending 31-03-2018 was Rs 18 lakhs.
The treatment will be:
Qualifying Asset as per AS 16 = Rs 50 Lakhs (Construction of Shed)
Borrowing Cost to be capitalized = 18 * 50/120 = Rs. 7.5 Lakhs
Interest to be debited to profit or loss account = (18-7.5) Lakhs = Rs. 10.50 Lakhs