Hi guys!
How are you doing?
We shall consider Borrowing Costs today.
We all know that businesses borrow money for different purposes like acquiring or constructing an asset or even for the simple reason of running the business.
When we borrow we have interest rates attached. For example, N1m at 10% interest rate, the 10% attached is the cost of borrowing. It also implies that, if the company does not borrow the N1m, the cost of N100,000 (10%) would not be incurred by it. In strategic financial management, we say its the duty of the financial manager to find cheaper borrowing sources i.e. sources with reduced borrowing costs for the business.
In simple terms, the standard defines borrowing costs as, interests or other costs incurred in connection with borrowing funds.
Borrowing costs are guided by the following:
• Borrowing costs are EXPENSED in the period they are incurred.
• However, costs that are directly associated or attributed to the construction, acquisition or production of a qualifying asset are CAPITALIZED.
Let's explain:
When you incur borrowing costs they are expensed in the profit and loss account in the period they are incurred. Hence, in the earlier example, the N100,000 (10% interest rate) would be expensed.
However, companies could borrow money to construct or produce an asset. These assets often take a substantial period of time to be completed. (This is known as a qualifying asset). Such borrowing costs are to be capitalized.
For example(1), A company borrows N10m at 10% to build a new factory which takes 3years to be fully completed. How would the borrowing cost of N1m be treated?
It will be capitalized in the statement of financial position till the asset is completed. In simple terms, it will be added to the cost of the asset. Hence, if the factory costs N15m, then N16m (N15m ~ cost of factory + 1m ~ borrowing cost) will be recorded in the statement of financial position as the cost of the asset.
Consider another example(2), a company borrows N10m at 10% to BUY a factory which is already completed for its intended use, the borrowing cost of N1m will be simply expensed.
Difference between example 1 & 2:
There is no substantial time involved for the asset in example 2, as the asset is ready for use, unlike the example 1 that requires 3years to complete it to its intended use.
Note: You only capitalize borrowing costs if it takes a substantial period of time for the asset to be completed or developed to its intended use and not because the asset is expensive or involves a huge amount of money.
Commencement of Capitalization:
IAS 23 specifies that capitalization should commence:
• When expenditure for the asset is being incurred.
• When the borrowing cost is being incurred.
• When activities necessary to prepare the asset have started. Some of these activities include: physical, technical and administrative activities etc
Suspension of Capitalization:
• Capitalization of borrowing costs may be suspended if the development of the asset is suspended temporarily.
• However, if the development of the asset is suspended as a result of substantial technical and administrative work or any other temporary delay which is a necessary part of getting the asset ready for its intended use, the capitalization of the asset may not be suspended.
For example, a construction that involves the use of clay and involves a period in which the clay is left to dry, hence construction is stopped, capitalization won't be suspended.
Cessation of Capitalization:
• The capitalization of borrowing cost stops when the asset is substantially complete. Subsequent expenses are taken to the profit or loss account.
• An asset is deemed complete for its intended use, when its physical construct is complete even though there may be outstanding routine administrative work or minor modifications.
• If the construction is in parts and a part is completed and can be used separately, capitalization for that part will be stopped.
Final Notes:
• If an entity borrows money specifically for a qualifying asset, the borrowing cost to be capitalized is, the actual borrowing cost incurred less any investment income from the temporary investment of the borrowing.
• When general borrowings are used, the borrowing cost to be capitalized, is based on a capitalization rate gotten based on a weighted average of the entire borrowing cost.
DAILY CHALLENGE: Note any arguments for and against the capitalization of borrowing costs
For further clarifications, mail: nneomakristen@gmail.com
Have a blessed day!
How are you doing?
We shall consider Borrowing Costs today.
We all know that businesses borrow money for different purposes like acquiring or constructing an asset or even for the simple reason of running the business.
When we borrow we have interest rates attached. For example, N1m at 10% interest rate, the 10% attached is the cost of borrowing. It also implies that, if the company does not borrow the N1m, the cost of N100,000 (10%) would not be incurred by it. In strategic financial management, we say its the duty of the financial manager to find cheaper borrowing sources i.e. sources with reduced borrowing costs for the business.
In simple terms, the standard defines borrowing costs as, interests or other costs incurred in connection with borrowing funds.
Borrowing costs are guided by the following:
• Borrowing costs are EXPENSED in the period they are incurred.
• However, costs that are directly associated or attributed to the construction, acquisition or production of a qualifying asset are CAPITALIZED.
Let's explain:
When you incur borrowing costs they are expensed in the profit and loss account in the period they are incurred. Hence, in the earlier example, the N100,000 (10% interest rate) would be expensed.
However, companies could borrow money to construct or produce an asset. These assets often take a substantial period of time to be completed. (This is known as a qualifying asset). Such borrowing costs are to be capitalized.
For example(1), A company borrows N10m at 10% to build a new factory which takes 3years to be fully completed. How would the borrowing cost of N1m be treated?
It will be capitalized in the statement of financial position till the asset is completed. In simple terms, it will be added to the cost of the asset. Hence, if the factory costs N15m, then N16m (N15m ~ cost of factory + 1m ~ borrowing cost) will be recorded in the statement of financial position as the cost of the asset.
Consider another example(2), a company borrows N10m at 10% to BUY a factory which is already completed for its intended use, the borrowing cost of N1m will be simply expensed.
Difference between example 1 & 2:
There is no substantial time involved for the asset in example 2, as the asset is ready for use, unlike the example 1 that requires 3years to complete it to its intended use.
Note: You only capitalize borrowing costs if it takes a substantial period of time for the asset to be completed or developed to its intended use and not because the asset is expensive or involves a huge amount of money.
Commencement of Capitalization:
IAS 23 specifies that capitalization should commence:
• When expenditure for the asset is being incurred.
• When the borrowing cost is being incurred.
• When activities necessary to prepare the asset have started. Some of these activities include: physical, technical and administrative activities etc
Suspension of Capitalization:
• Capitalization of borrowing costs may be suspended if the development of the asset is suspended temporarily.
• However, if the development of the asset is suspended as a result of substantial technical and administrative work or any other temporary delay which is a necessary part of getting the asset ready for its intended use, the capitalization of the asset may not be suspended.
For example, a construction that involves the use of clay and involves a period in which the clay is left to dry, hence construction is stopped, capitalization won't be suspended.
Cessation of Capitalization:
• The capitalization of borrowing cost stops when the asset is substantially complete. Subsequent expenses are taken to the profit or loss account.
• An asset is deemed complete for its intended use, when its physical construct is complete even though there may be outstanding routine administrative work or minor modifications.
• If the construction is in parts and a part is completed and can be used separately, capitalization for that part will be stopped.
Final Notes:
• If an entity borrows money specifically for a qualifying asset, the borrowing cost to be capitalized is, the actual borrowing cost incurred less any investment income from the temporary investment of the borrowing.
• When general borrowings are used, the borrowing cost to be capitalized, is based on a capitalization rate gotten based on a weighted average of the entire borrowing cost.
DAILY CHALLENGE: Note any arguments for and against the capitalization of borrowing costs
For further clarifications, mail: nneomakristen@gmail.com
Have a blessed day!
Hi Nneoma. Will the effect of exchange rate difference be capitalized or expensed during the period of the qualifying asset?
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