Borrowing Costs

Chapter 12 HKAS 23 Borrowing Costs

1. Objectives

1.1       Discuss the criteria for capitalization of borrowing costs
1.2       Determine the capital costs when the borrowings are specific and when the borrowings are general.
1.3       Determine the commencement, suspension and cessation of capitalization of borrowing costs.
1.4       Explain the accounting treatment for borrowing costs.
1.5       Describe the disclosure requirements under HKAS 23.

2. Definition

2.1 The Standard requires capitalization of borrowing costs that are directly attributable to the acquisition, construction or production of certain assets requiring a period of time to get them ready for their intended use or sale. These assets are referred to as qualifying assets.

2.2

DEFINITIONS

(a)        HKAS 23 defines borrowing costs as “interest and other costs incurred by an enterprise in connection with the borrowing of fund”. These may include:
(i)         interest on bank overdrafts and short-term and long-term borrowings;
(ii)        amortisation of discounts or premiums relating to borrowings;
(iii)       amortisation of ancillary costs incurred in connection with the arrangement of borrowings;
(iv)       finance charges in respect of finance leases;
(v)        exchange difference arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
(b)        Qualifying assets ( are defined as assets that necessarily take a substantial period of time to get ready for its intended use or sale. Examples include:
(i)         inventories that require a substantial period of time to bring them to a saleable condition;
(ii)        manufacturing plant, power generation facilities; and
(iii)       investment properties.

2.4 Stocks that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time, assets that are ready for their intended use or sale when acquired are specifically excluded from the definition of qualifying assets.
2.5 Assets that are ready for their intended use or sale when acquired also are not qualifying assets.

3. Capitalisation of Borrowing Costs

3.1	KEY POINT
	Effective from 1 January 2009, borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of that asset. Such borrowing costs are capitalized as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the costs can be measured reliably

3.2 If the borrowings are specific to a qualifying asset, the amount of borrowing costs eligible for capitalization is the actual borrowing costs incurred less income on the temporary investment of those borrowings.
3.3 In the case of funds that are borrowing generally, the amount of borrowing costs to be capitalized should be determined by applying a capitalization rate to the expenditure on the qualifying asset (reduced by any progress payment received). The capitalization rate should be the weighted average rate of general borrowings, excluding specific borrowings. The amount of borrowing costs capitalized during a period should not exceed the amount of borrowing costs incurred during that period.

3.4

EXAMPLE 1

On 2 January 2008 ABC Ltd, a ship manufacturer, started to construct a ship which would take two years to complete. To finance the project, ABC Ltd borrowed $300,000 and $200,000 from the bank on 2 January 2008 and 1 July 2008 respectively. Interest rates were chargeable at 10% per annum and 12% per annum respectively.

The following is an extract from the statement of financial position of ABC Ltd as at 31 December:

	2007	2008
8% Debenture	500,000	500,000
10% Loan Stock	100,000	100,000
10% Bank Loan		300,000
12% Bank Loan		200,000
	600,000	1,100,000

Expenditure incurred on the ship construction:

On 2 January 2008	$200,000
On 1 July 2008	$150,000

Since the borrowings from the bank were specific to the qualifying asset, the amount of interest capitalized for the year 2008 is as follows:

$200,000 x 10%	=	$20,000
$150,000 x 12% x 6/12	=	$9,000
		$29,000

3.5

EXAMPLE 2

Same information as in Example 1, except that the borrowings from the bank are general purpose. In such case, the capitalization rate would be the weighted average rate of general borrowings.

The capitalization rate will be calculated as below:

Interest charges for 2008:

		$
$500,000 x 8%	=	40,000
$100,000 x 10%	=	10,000
$300,000 x 10%	=	30,000
$200,000 x 12% x 6/12	=	12,000
		92,000

Capitalisation rate	=	$92,000/$(500,000 + 100,000 + 300,000 + 200,000 x 6/12)
	=	$92,000/$1,000,000
	=	9.2%

Annual of interest to be capitalized in 2008:

$200,000 x 9.2%	=	$18,400
$150,000 x 9,2% x 6/12	=	$6,900
		$25,300

3.6

EXERCISE 1

On 1 June 1998, Perfect Development Co. Ltd. engages in a property development project. The statement of financial positions (extract) at 31 December 1997 and 1998, are as follows:

	1998	1997
	$	$
Development property	500,000	-
12% debenture stock	1,000,000	1,000,000
Bank loan (10% per annum)	800,000	-
Other loan (14% per annum)	500,000	500,000
	2,800,000	1,500,000

The bank loan at 10% was taken out on 30 June 1998. Development expenditure incurred during 1998 was as follows:

	$
1 July 1998	300,000
1 October 1998	200,000
	500,000

Required:

(a)     Define the following terms in accordance with HKAS 23:
(i)      Borrowing costs; and                                                                         (2 marks)
(ii)     Qualifying asset.                                                                                (2 marks)
(b)     Explain standard accounting treatment for borrowing costs in accordance with HKAS 23.                                                                                                             (3 marks)
(c)     Calculate the amount of interest to be capitalized in 1998 if:
(i)      the new bank loan at 10% per annum is specifically taken to finance the project.
(2 marks)
(ii)     all the loans are borrowed generally and used for the project.                (8 marks)
(d)     List the disclosure requirements on borrowing costs in accordance with HKAS 23.
(8 marks)
(Total 25 marks)
(Adapted HKAAT Paper 7 Financial Accounting II December 1999 Q6)

4. Commencement, Suspension and Cessation of Capitalisation

4.1       Capitalisation of borrowing costs should commence when:
(i)         expenditure for the asset is being incurred; and
(ii)        borrowing costs are being incurred; and
(iii)       activities that are necessary to prepare the asset for its intended use or sale in progress.

4.2

EXERCISE 2

Before the construction of a property on a land, Entity ABC has to prepare the construction plan and get government approval. Borrowing costs have been incurred during the above period.

Are these borrowing costs eligible for capitalization under HKAS 23?

4.2 Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.
4.3 Capitalisation of borrowing costs should cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.

4.4

EXAMPLE 3

On1 January 2008, X began to construct a supermarket which had an estimated useful life of 40 years. It purchased a leasehold interest in the site for $25 million. The construction of the building cost $9 million and the fixtures and fittings cost $6 million. The construction of the supermarket was completed on 30 September 2008 and it was brought into use on 1 January 2009.

X borrowed $40 million in order to finance this project. The loan carried interest at 10% per annum. It was repaid on 30 June 2009.

X capitalizes borrowing costs in accordance with HKAS 23.

Required:

To calculate the total amount to be included in property, plant and equipment in respect of the development at 31 December 2008.

Solution:

Total amount to be include in property, plant and equipment at 31 December 2008:

	$000
Lease	25,000
Building	9,000
Fittings	6,000
Interest capitalized (40,000 × 10% × 9/12)	3,000
	43,000
Less: Depreciation [(43,000 ÷ 40) × 3/12]	(269)
	42,731

Only nine months’ interest can be capitalized, because HKAS 23 states that capitalization of borrowing costs must cease when substantially all the activities necessary to prepare the asset for its intended use or sale are complete.

Depreciation is charged from when construction was complete, because that is when the supermarket is available for use.

5. Disclosure Requirements

5.1       The financial statements should disclose:
(i)         the accounting policy adopted for borrowing costs;
(ii)        the total borrowing costs incurred during the period;
(iii)       the amount of borrowing costs capitalized during the period; and
(iv)       the capitalization rate used to determine the amount of borrowing costs eligible for capitalization.

Examination Style Questions

Question 1
(a) Apex is a publicly listed supermarket chain. During the current year it started the building of a new store. The directors are aware that in accordance with HKAS 23 Borrowing costs certain borrowing costs have to be capitalised.

Required:

Explain the circumstances when, and the amount at which, borrowing costs should be capitalised in accordance with HKAS 23. (5 marks)

(b) Details relating to construction of Apex’s new store:

Apex issued a $10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1 April 2009. The loan is redeemable at a premium which means the loan has an effective finance cost of 7·5% per annum. The loan was specifically issued to finance the building of the new store which meets the definition of a qualifying asset in HKAS 23. Construction of the store commenced on 1 May 2009 and it was completed and ready for use on 28 February 2010, but did not open for trading until 1 April 2010. During the year trading at Apex’s other stores was below expectations so Apex suspended the construction of the new store for a two-month period during July and August 2009. The proceeds of the loan were temporarily invested for the month of April 2009 and earned interest of $40,000.

Required:

Calculate the net borrowing cost that should be capitalised as part of the cost of the new store and the finance cost that should be reported in the income statement for the year ended 31 March 2010. (5 marks)
(Total 10 marks)
(ACCA F7 Financial Reporting June 2010 Q5)

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Borrowing Costs

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Borrowing Costs

Borrowing Costs

DEFINITIONS

KEY POINT

EXAMPLE 1

EXAMPLE 2

EXERCISE 1

EXERCISE 2

EXAMPLE 3

Borrowing Costs

Borrowing Costs

Borrowing Costs