WE (COMPANY) HAVE PURCHASED A FLAT IN MUMBAI FOR WHICH WE HAVE TAKEN A LOAN OF RS. 4 CR. NOW WE ARE PAYING INTEREST ON THE SAME. KINDLY LET ME KNOW HOW SHOULD I TREAT THE ABOVE EXP. ANY AMOUNT DO I NEED TO CAPITALISE OR FULL AMOUNT SHOULD BE EXPENSED OUT.
15 January 2014
DEAR SIR/MAM, WE (COMPANY) HAVE PURCHASED A FLAT IN MUMBAI FOR WHICH WE HAVE TAKEN A LOAN OF RS. 4 CR. NOW WE ARE PAYING INTEREST ON THE SAME. KINDLY LET ME KNOW HOW SHOULD I TREAT THE ABOVE EXP. ANY AMOUNT DO I NEED TO CAPITALISE OR FULL AMOUNT SHOULD BE EXPENSED OUT.
18 July 2024
When a company borrows funds specifically to finance the acquisition, construction, or production of a qualifying asset (such as property), the accounting treatment for the borrowing costs is outlined in Accounting Standard (AS) 16 - "Borrowing Costs." Here’s how you should treat the interest expense incurred on the loan for purchasing the flat:
### Treatment of Borrowing Costs:
1. **Qualifying Asset Criteria:** - The flat in Mumbai qualifies as a "qualifying asset" because it takes a substantial period of time to get it ready for its intended use or sale.
2. **Capitalization of Borrowing Costs:** - According to AS 16, borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset should be capitalized as part of the cost of that asset. - Capitalization includes the interest on the borrowing during the period in which the company incurs expenditures for the asset. - The amount capitalized should not exceed the actual borrowing costs incurred during the relevant period.
3. **Period of Capitalization:** - Capitalization of borrowing costs commences when: - Expenditures for the asset are being incurred, - Borrowing costs are being incurred, and - Activities that are necessary to prepare the asset for its intended use or sale are in progress.
4. **Ceasing Capitalization:** - Capitalization of borrowing costs ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. - If there are any delays or interruptions that are clearly necessary to get the asset ready for its intended use, then capitalization can be temporarily suspended during such periods.
### Practical Application:
- **Identifying Borrowing Costs:** Calculate the amount of interest incurred on the specific loan (Rs. 4 crore) used to finance the flat acquisition.
- **Capitalization Period:** Start capitalizing borrowing costs from the time when expenditures for the flat's acquisition began and continue until the flat is substantially complete.
- **Accounting Entries:** Debit the cost of the flat (capital asset) with the capitalized borrowing costs and credit the interest expense in the profit and loss account with the same amount.
### Example: Assume the company borrows Rs. 4 crore at an interest rate of 10% per annum for 3 years. During this period, the company incurs Rs. 40 lakh as interest expense annually. If the flat takes 2 years to complete:
- **Year 1:** Capitalize Rs. 40 lakh (10% of Rs. 4 crore) as part of the flat’s cost. - **Year 2:** Capitalize another Rs. 40 lakh. - **Year 3:** Stop capitalizing once the flat is substantially ready.
### Conclusion: By capitalizing borrowing costs, you align the cost of the flat with the periods during which you are actively using the borrowed funds to finance its acquisition. This treatment reflects a more accurate representation of the flat's total cost over its useful life, adhering to accounting standards and providing clarity in financial reporting. Always ensure compliance with applicable accounting standards and consult with a professional accountant or financial advisor for specific guidance tailored to your company's circumstances.
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