We have a client who have purchased a land from a ECB loan borrowed for this purpose. Can the Interest on ECB loan be capitalised? Is "Land" a qualifying asset under AS 16 for capitalisation of Borrowing Cost?
12 November 2007
under no circumstances, ECB proceeds will be utilised for- Investment in stock market; and Speculation in real estate.(govt. of india policy guidelines for end use of ECB ) . SO IF THE PURPOSE IS NOT SPECULATIVE ,WE ARE WELL WITHIN THE GUIDELINES. AS FAR AS LAND AS QUALIFYING ASSET UNDER AS 16, ICAI GUIDE LINES SAY THAT ANY TYPE OF TANGIBLE FIXED ASSETS WHICH ARE IN CONSTRUCTION PROCESS OR ACQUIRED TANGIBLE FIXED ASSETS WHICH ARE NOT YET READY FOR USE OR RESALE LIKE PLANT AND MACHINERY. EVEN INVESTMENT PROPERTIES UNDER AS 16 ARE QUALIFYING ASSETS . UNDER AS 16 BORROWING COSTS ARE DEFINED AS INTEREST AND OTHER COSTS INCURRED BY AN ENTERPRIDSE RELATING TO BORROWING OF FUNDS. SO IN YOUR CASE, IF LAND IS NOT READY FOR USE,IT QUALIFIES UNDER AS 16 FOR CAPITALISATION OF BORROWING COSTS. R.V.RAO
12 November 2007
BORROWING COSTS (AS 16) Exchange difference arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Interpretation of paragraph 4(e) of AS 16 "Borrowing Costs" provides that borrowing costs may include "exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs". The issue is which exchange differences are covered under paragraph 4(e) of AS 16. The ICAI vide its ASI -10 has clarified the issue as under : Paragraph 4(e) of AS 16 covers exchange differences on the amount of principal of the foreign currency borrowings to the extent of differences between interest on local currency borrowings and interest on foreign currency borrowings. For this purpose, the interest rate for the local currency borrowings should be considered as that rate at which the enterprise would have raised the borrowings locally had the enterprise not decided to raise the foreign currency borrowings. If the difference between the interest on local currency borrowings and the interest on foreign currency borrowings is equal to or more than the exchange difference on the amount of principal of foreign currency borrowings, the entire amount of exchange difference is covered under paragraph 4(e) of AS 16. Example : X Ltd has taken a loan of US$ 100,000 on 01.04.2003 for a specific project at an interest rate of 5% pa, payable annually. On 01.04.03, the exchange rate was Rs.45. On 31.03.2004 is Rs.48. The corresponding amount could have been borrowed by X Ltd in local currency at an interest rate of 11% pa. The following computation would be made to determine the amount of borrowings costs for the purposes of paragraph 4(e) of AS 16 1) Interest for the period 100000USD Rate Rs.48 INR 48,00,000/- Interest @ 5% (Rs.2,40,000) 2) Increase in liability towards principal USD 1,00,000 (rate 48-45=3) INR 3,00,000/- 3) Interest that would have resulted if the loan was taken in Indian currency USD 1,00,000 @ Rs.45/- INR 45,00,000/- Interest 11% 4,95,000/- 4) Difference between interest on local currency borrowing and foreign currency borrowing ie (3-1) Rs. 2,55,000/- Therefore out of Rs.3,00,000/- increase in the liability towards principal amount, only Rs.2,55,000/- will be considered as the borrowing cost. Thus, total borrowing cost would be Rs. 4,95,000/- being the aggregate or interest of Rs.2,40,000/- on foreign currency borrowings (covered by paragraph 4(a) of AS 16) plus the exchange difference to the extent of difference between interest on local currency borrowing and interest on foreign currency borrowing of Rs.2,55,000/- Thus, Rs.4,95,000/- would be considered as the borrowing cost to be accounted for as per AS 16 and the remaining [i.e. Rs.3,00,000-2,55,000] Rs.45,000/- would be considered as the exchange difference to be accounted for as per AS -11 "The effects of changes in Foreign Exchange Rates" In the above example, if the interest rate on the local currency borrowings is assumed to be 13% instead of 11% the entire exchange difference of Rs.3,00,000/- would be considered as borrowing costs, since in that case the difference between the interest on local currency borrowings and foreign currency borrowings [ i.e. Rs.3,45,000 (Rs.5,85,000 - 2,40,000] is more than the exchange difference of Rs.3,00,000/- Therefore in such a case, the total borrowing cost would be Rs.5,40,000/- (Rs.2,40,000+Rs.3,00,000) which would be accounted for under AS 16 and there would be no exchange difference to be accounted for under AS 11.
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