PAS 23 : BORROWING COST

BORROWING COST

is defined as interest and other cost that an entity incurs in connection with borrowing of
funds. (PAS 23, Paragraph 5)
are directly attributable to the acquisition, construction or production of a qualifying asset
shall form part of the cost of that asset. Other borrowing costs are recognized as an
expense.

a) Interest expense is calculated using effective interest method.

b) Finance charge with respect to finance lease.

c) Exchange difference arising from foreign currency borrowing to the extent that it is
regarded as an adjustment to the interest cost.

Qualifying Assets

an asset that necessarily takes a substantial period of time to get ready for the intended
use or sale.

Qualifying Asset for purpose of capitalization

1) Manufacturing plants
2) Power generation facilities
3) Intangible assets
4) Investment properties

Not included are the following:

1) Asset measured at fair value (biological assets)

2) Inventories that are produced in a repetitive basis even if it takes a substantial period of
time to get ready for sale
3) Assets that are ready for intended use or sale

Accounting for Borrowing Cost

PAS 23, Paragraph 8, mandates the following rules on borrowing cost:

If the borrowing is directly attributable to the acquisition, construction or production of a

qualifying asset, the borrowing cost is required to be capitalized as cost of the asset.
In other words, the capitalization of borrowing cost is mandatory for a qualifying asset.
All other borrowing cost shall be expensed as incurred.
In other words, if the borrowing is not directly attributable to a qualifying asset, the borrowing
cost is expensed immediately.

QUALIFYING ASSET is financed by:

 SPECIFIC BORROWING
the capitalizable borrowing cost is equal to the actual borrowing cost incurred
up to the completion of asset minus any investment income from the
temporary investment of the borrowing.

 GENERAL BORROWINGS
the capitalizable borrowing cost is equal to the average expenditures on the asset
multiplied by the average interest rate or actual borrowing cost incurred up to
completion, whichever is lower.
Shall not exceed the actual interest incurred.
Capitalization rate or actual interest rate is equal to the total annual borrowing
cost divided by the total general borrowings.
Asset Financed by Specific Borrowing

If the funds are borrowed specifically for the purpose of acquiring a qualifying asset, the
amount of capitalize borrowing cost is the actual borrowing cost incurred during the period less
any investment income from the temporary investment if those borrowings. (PAS 23, Paragraph
12)

Illustration:

At the beginning of the current year, an entity obtained a loan of Php 4,000,000 at an
interest rate at 10% specifically to finance the construction of new building. The building was
completed at the current year-end.
Availments from the loan were made quarterly in equal amounts. Total borrowing cost
incurred amounted to Php 250,000 for the current year.
Prior to the disbursement , the proceeds of the borrowing were temporarily invested and
earned interest income of Php 40,000.

Actual borrowing cost 250,000

Interest income from investment proceeds (40,000)
Capitalize borrowing cost 210,000

Asset Financed by General Borrowing

If funds are borrowed generally and used for acquiring a qualifying asset, the amount of
capitalize borrowing cost is equal to the average carrying amount of the asset during the period
multiplied by a capitalization rate or average interest rate.

The capitalize borrowing cost shall not exceed the actual interest incurred.

The capitalization rate or average interest rate is equal to the total annual borrowing cost divided
by the total general borrowings outstanding during the period.

No specific guidance is provided for general borrowing with respect to investment income.

Any investment income from general borrowing is not deducted from capitalize borrowing cost.
(PAS 23, Paragraph 14)

Illustration:

An entity had the following borrowings on January 1 of the current year. The borrowings were
made for general purposes and the proceeds were partly used to finance the construction of a new
building.

Principal Borrowing Cost

10% bank loan 3,000,000 300,000
12% short – term note 1,500,000 180,000
8% long – term loan 3,500,000 280,000
8,000,000 760,000
The construction of the building was started on January 1 and was completed on December
31 of the current year.

January 1 400,000
March 31 1,000,000
June 30 1,200,000
September 30 1,000,000
December 31 400,000
Total expenditures on the building 4,000,000

Average carrying amount of the building

(a) (b) (a x b)
Date Expenditures Months outstanding Amount
January 1 400,000 12 4,800,000
March 31 1,000,000 9 9,000,000
June 30 1,200,000 6 7,200,000
September 30 1,000,000 3 3,000,000
December 31 400,000 0 -------------
24,000,000
Average carrying amount (24,000,000/12) 2,000,000

Another approach
(a) (b) (a x b)
Date Expenditures Months outstanding Amount
January 1 400,000 12/12 400,000
March 31 1,000,000 9/12 750,000
June 30 1,200,000 6/12 600,000
September 30 1,000,000 3/12 250,000
December 31 400,000 - ------------
2,000,000
The capitalization rate is computed by dividing the total annual borrowing cost by the total
general borrowings.
The amount of capitalizable borrowing cost is the average carrying amount of the building
multiplied by the capitalization rate
Asset Financed both by Specific and General Borrowing

Actual borrowing cost on specific minus any investment income from temporary investment.

Average expenditures of asset minus the specific borrowing equals amountrelated to general
borrowing multiplied by the capitalization rate equals capitalizable borrowing cost.
 
At the beginning of the current year, an entity borrowed P1,500,000 at an interest of 10%
specifically for the construction of a new building. The actual borrowing cost on this loan is
P150,000.
The entity had also outstanding during the year and 5-year 8% general borrowing of
P7,000,000.
The construction of the building started on January 1 and was completed on December 31 of
the current year.
January 1 500,000
April 1 1,000,000
May 1 1,500,000
September 1 1,500,000
December 31 500,000
Total cost 5,000,000
(a) (b) (a x b)
Date Expenditures Months outstanding Amount
January 1 500,000 12/12 500,000
April 1 1,000,000 9/12 750,000
May 1 1,500,000 8/12 1,000,000
September 1 1,500,000 4/12 500,000
December 31 500,000 - -------------

2,750,000
Average expenditures 2,750,000
Specific borrowing (1,500,000)
Applicable to general borrowing 1,250,00
Capitalizable Interest
Specific borrowing (10% x 1,500,000) 150,000
General borrowing ( 8% x 1,250,000) 100,000
Total capitalizable interest 250,000

Commencement of Capitalization

a) The entity incurs expenditures for the asset.

b) The entity incurs borrowing cost.
c) The entity undertakes activities that are necessary to prepare the asset for the intended
use or sale.

Activities Necessary to Prepare

The activities necessary to prepare the asset for the intended use or sale encompass more than
the physical construction of the asset.

Those include technical and administrative work prior to the commencement of physical
construction, such as drawing up plans and obtaining permit for a building.

However, merely holding assets for use or development without any associated development
activity does not qualify for capitalization.

Suspension of Capitalization

Capitalization of borrowing cost shall be suspended during extended periods in which active
development is interrupted.

Capitalization of borrowing cost is not normally suspended during a period when substantial
technical and administrative work is being carried out.

Capitalization of borrowing cost is not also suspended when a temporary delay is necessary
part of the process of getting an asset ready for its intended use or sale.

Cessation of Capitalization

Capitalization of borrowing cost shall cease when substantially all the activities necessary to
prepare the qualifying asset for the intended use or sale are complete.

As asset normally ready for the intended use or sale when the physical construction of the
asset is complete even though routine administrative work might still continue.

Disclosures related to Borrowing Cost

a) The amount of borrowing cost capitalized during the period.

b) The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

Segregation of assets that are “qualifying assets” from other assets in the statement of
financial position is not required to be disclosed.
EXERCISES
LINKS

http://www.sec.gov.ph/wp-content/uploads/2015/10/pfrs-adopted-by-sec-as-of-12312011.pdf

https://www.academia.edu/7753770/CONCEPTUAL_FRAMEWORK_FOR_FINANCIAL_REPORTING?
fbclid=IwAR3bcGT0vjSvj4gB25qI7z1kU5l7lnM-FTEU-TKsvEx8fEBOyDQAGd-BX6s

https://www.academia.edu/36056841/Borrowing_Cost_PAS_23