Pre closure of bank loan

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

07 February 2012 Dear expert ,
Our company obtained TL from from SB bank during 2009-10.During the year 2011-12 we transferred our term loan from SBI to Another Bank.At the time of transfer SBI charged 25 lacs as pre closure int charges.
My doubt is how to treat that pre-closure interest charges in books of accounts.
Can we capitalize such charges.

Thanks in advance.

CA. Hari Kishan

CA. Hari Kishan (Expert)
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07 February 2012 I am of the view that the pre-closure interest charges have to be expensed off and also liable for TDS under section 194A pre closure INTEREST charges. (Please examine the provision laid u/s 194A). Should the term loan be granted for regular working capital of the business the same is to be expensed off.

Bhaskaran Chackrapani Warrier

Bhaskaran Chackrapani Warrier (Expert)
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07 February 2012 Can't be capitalized because it was not a case of the borrower that there was an enduring benefit and effect thereof was over a period of years.

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Querist : Anonymous

Querist : Anonymous (Querist)

08 February 2012 Chakrapani sir, the purpose of TL is construction of Factory Building & acquisition of Plant & Machinery.

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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10 August 2024 When dealing with pre-closure interest charges on a term loan (TL) that was used for capital purposes such as construction of a factory building or acquisition of plant and machinery, it's important to understand the accounting treatment for such costs.

### **Accounting Treatment for Pre-Closure Interest Charges**

1. **Capitalization vs. Expense:**
- **Capitalization:** Generally, interest charges related to the acquisition or construction of qualifying assets (such as a factory building or plant & machinery) can be capitalized. However, pre-closure charges (or prepayment penalties) are treated differently from regular interest.
- **Expense:** Pre-closure interest charges are typically treated as an expense rather than capitalized. This is because these charges are considered a penalty for early repayment rather than a cost directly attributable to the construction or acquisition of assets.

2. **Treatment in Books of Accounts:**
- **Expense Account:** Pre-closure charges are generally recognized as an expense in the profit and loss account. This expense should be shown under a relevant head such as "Finance Charges" or "Pre-closure Charges."
- **Capitalization Justification:** Since the pre-closure charges are related to the early settlement of a loan, they do not directly contribute to the cost of the asset itself. Thus, they are not capitalized as part of the cost of the factory building or plant & machinery.

3. **Journal Entry Example:**
- To record the pre-closure charges, you would typically make the following journal entry:
```
Dr. Finance Charges (Expense) ₹25,00,000
Cr. Bank Account (or Loan Account) ₹25,00,000
```

### **Accounting Standards and Guidance**

- **Accounting Standards:** According to accounting standards such as Ind AS or IFRS, interest charges related to financing activities are generally recognized as expenses unless they are directly attributable to the construction of a qualifying asset (as per Ind AS 23 or IAS 23). Pre-closure charges are not considered directly attributable to the construction of an asset.

- **Income Tax Treatment:** For tax purposes, the treatment may also follow the accounting treatment where such pre-closure charges are usually allowed as a deduction from taxable income as finance expenses.

### **Conclusion**

- **Pre-closure charges should be treated as an expense** and not capitalized into the cost of the asset.
- **Record the pre-closure charges** in the profit and loss account under finance charges or a similar category.
- **Consult with your accountant or tax advisor** to ensure compliance with specific accounting standards and tax regulations applicable to your jurisdiction.