Accounting for Borrowing Cost
AS – 16
Contents
Ø Applicability & Nature
Ø Objective
Ø Meaning of Borrowing Cost
Ø Meaning of Qualifying Assets
Ø Recognition / Treatment of Borrowing Cost
Ø Types of Borrowings
Ø Conditions of AS – 16
Ø Disclosures
Ø Difference between International Accounting Standard / AS / US GAAP
Applicability of Nature
Ø Applicable 01.04.2000 onwards
Ø Nature Mandatory (Compulsory)
Objective
The main objective of the statement is only to prescribe accounting principles for the accounting of borrowings cost. In addition, it is clearly specify that AS – 16 is not related with cost of Equity shares or Pref shares but only related to borrowing of funds.
Meaning of Borrowing Cost
Borrowing Cost is the interest and other cost which is incurred by an enterprise in relation to borrowing of funds.
The following points should be considered for the purpose of borrowing cost:-
A. Interest on short term loans or long term debts should be included as a part of borrowing cost.
B. If any enterprise has incurred ancillary cost (related) for the arrangement of funds than amortized part of such cost should also be included as a part of borrowing cost. (V. Imp)
For example:- Brokerage, commission, stamp duty charges and any other related cost.
Amortized Cost = Total Cost
Usages Am. During the year
C. Discounts / Premiums which are incurred by an enterprise in relation to arrangement of fund, such amount should not be taken in total but amortised part of Discount & Premium should be included as a part of borrowing cost. (V.V. Imp)
On the basis of above explanation, premium is also considerable for the purpose of borrowing cost. Such premium can be taken as a part of exp only if it is related to Redemption of funds because premium related to receipt of securities should be considered as Reserve & Surplus not as an exp.
D. Amount of Interest should also be included as a part of borrowing cost which is paid or payable for finance lease agreement (AS – 19).
E. Exchange Diff related to Foreign Currency Loans.(AS – 11)
Meaning of Qualifying Assets
Qualifying assets are those that take substantial period of time to keep ready for use or sale. As per Accounting Standard Interpretation No. 1, substantial period of time is the period of 12 months. But longer period or short term period than specified period may also be considerable as per the interpretation issued by Institute. On the basis of interpretation, it can be said that a fixed period is not explained by interpretation but reasonable judgment based on circumstances should be applied.
The following are the examples of Qualifying Assets.
i). Fixed assets can be taken in the definition of Qualifying assets if these assets are taking substantial period to get ready for the purpose of use.
ii). Investments:– As per AS – 16, Investment can also be recognized as Qualifying assets only if the investments are taking substantial period of time to get ready for the purpose of use or sale on the basis of such explanation only investment properties can be included under the heading of Qualifying assets because condition of substantial period can be satisfied only be these investments.
Investment in shares or debentures can not be recognized as Qualifying assets because conditions of substantial period is not applicable on securities.
iii). Stocks:– Inventories can also be Qualifying assets only if conditions of substantial is satisfied. Regular inventories should not be recognized as qualifying assets because there is no connection between regular inventory and substantial period.
Recognition
As per AS – 16, amount of borrowing cost should be recorded or recognized in the financial statement as follows:-
a). if any borrowing cost is incurred for qualifying assets than amount of borrowing cost should be capitalized in the cost of Q.A.
b) if any borrowing cost is not having any connection with Q.A. than such amount should be transfer to P/L a/c as an exp.
The following journal entries may be considerable:-
|
Normal Borrowing Cost |
Borrowing Cost related to Q.A. |
|
Interest A/c Dr. To Bank To O/s Interest |
Same |
|
P/L A/c Dr. To Interest |
Q.A. Dr. To Interest |
Conditions of AS – 16
As per AS – 16, there are three situations or conditions which are specified in relation to capitalization of borrowing cost.
- Commencement of Capitalization
- Suspension of Capitalization
- Cessation of Capitalization
A. Commencement of Capitalization
As per the provision of accounting standard, any enterprise can capitalized it’s borrowing cost only if the following three conditions are satisfied.
(i). Expenditure should be incurred – As per the statement if any enterprise wants to capitalized borrowing cost than it is very necessary that all the borrowed funds have been incurred for Q.A. If any amount is still pending for expenditure purpose out of borrowing funds than the pending amount will not be considered for capitalization purposes.
(ii). Interest cost should be actual – As per the statement borrowing cost can not be capitalized on assumption basis but it should be payable on actual basis outside the enterprise.
(iii). Activities should be continued which are required to complete the production, construction, acquisition of Q.A.
*As per the statement activities may be in the nature of physical or administrative but activities should be related to completion of Q.A.
B. Suspension
If any enterprise has discontinued the necessary activities then capitalization of borrowing cost can not be made from the date of discontinuation of required activities. Such period of discontinuation should be recognized as Suspension period.
Exception: If any stoppage of necessary activities is of temporary in nature then such stoppage can not be covered under suspension of capitalization of borrowing cost. Temporary reason means the enterprises is having proper judgment about continuation of discontinued activities.
Note:- Borrowing cost which are related to the suspension period should be transferred to P/L a/c as an exp.
Borrowing cost can be capitalized from the date from which the necessary activities are continued after discontinuation.
C. Cessation
As per Accounting Standard, borrowing cost can be capitalized in the cost of Q.A. till the date of completion of construction, acquisition or production. It can be also said that if any assets is ready for use or sale, no capitalization can be made after the date of specified purpose of use or sale.
If any Q.A. is completed in parts then it will be recognized that the completed part are dependent or independent from the point of view of their use or sale. The following points may be considerable in relation to capitalization of borrowing cost of specified parts.
a. If any part of asset is completed first without completion of others then borrowing cost related to such part should be transferred to P/L a/c if the completed part is independent from the point of view of use or sale.
b. If any part of assets is completed first without completion of others than borrowing cost related to such part can be capitalized only if such part is dependent on others from the point of view of use or sale.
Important points to be considered
- If any enterprise has to recognize any Govt grant in relation to construction, production or acquisition of Q.A. then expenditure on Q.A. will be calculated after deducting such grant out of total expenditure.
- If any enterprise has received any progress payment in relation to completion of Q.A. then such progress payment should be adjusted for the calculation of exp incurred.
- As per AS 19, if any enterprise has earned temporary income by investment of unused borrowed funds that amount of temporary income should be adjusted against total borrowing cost and only thereafter principals of recognition should be applied.
Types of Borrowing (Imp for Practical Ques.)
Two types of borrowing are specified in the statement as follows:-
a. Specific Borrowing
b. General Borrowing
- Specific Borrowing:- If any enterprise can recognize direct relationship between Qualifying assets and amount of loan then the situation will be covered under the heading of specific borrowing. In such case the entire borrowing cost can be capitalized to the related assets.
Exp (1). A ltd has taken5,00,000/- for the construction of building for interest rate 10% and the loan was taken in the beginning of the year. The company has to repay the entire amount of loan after 5 years on the date of arrangement of fund the company has incurred20,000/- as commission and10,000/- as agreement charges. Calculate borrowing cost for the 1st year and also pass journal entries assuming that the entire amount of loan has been incurred during the period.
Ans:-
W.N.1 Calculation of borrowing cost
Interest = 5,00,000 x 10% = 50,000
Other Cost (Amortized Part)
→ Commission (20,000/5) = 4,000
→ Agreement Charges (10,000/5) = 2,000
56,000
Journal Entries
1) Comm A/c Dr. 20,000
Agreement Charges Dr. 10,000
To Bank 30,000
2) Int A/c Dr. 50,000
To Bank 50,000
3) Building A/c Dr. 56,000
To Interest 50,000
To Comm. Exp 4,000
To A/c Charges Exp. 2,000
Comment: - In the given example there is direct relationship between loan & building. So the entire borrowing cost should be capitalized to the cost of building as per the provisions of AS – 16 as specified in the situation of specific borrowings.
Exp (2) With the help of given information in above exp, calculate amount of capitalization in case the enterprise has incurred30,000/- out of the borrowed funds.
Ans:- Statement showing capitalized ratio
Total Borrowing Cost = 56,000
(as calculated above)
a) Borrowing cost for exp incurred
(56,000 / 5,00,000 X 3,00,000) = 33,600
b) Borrowing cost for pending amount
(56,000 / 5,00,000 X 2,00,000) = 22,400
Journal Entries
1) Comm A/c Dr. 20,000
Agreement Charges Dr. 10,000
To Bank 30,000
2) Int A/c Dr. 50,000
To Bank 50,000
3) Building A/c Dr. 33,600
P/L A/c Dr 22,400
To Interest 50,000
To Comm. Exp 4,000
To A/c Charges Exp. 2,000
Comments:- In the given example the total borrowing cost can not be capitalized because the enterprise has not incurred entire amount of borrowed funds. So we have capitalized personate borrowing cost with reference to exp incurred to borrowed funds.
- General Borrowings
In case of General Borrowings there will be no direct relationship between qualifying assets and borrowed funds. In case of general borrowings, there may be more than one Q.A. or more than one type of loan.
In such case capitalization of borrowing cost should be made in the ratio od exp incurred on Q.A.
Exp (3) A Ltd has taken10,00,000/- @ 15% in the beginning of the year for the construction of building. In addition to above loan, the company has taken multiple borrowings as follows-
a) 10% Debentures 5,00,000
b) 20% Term Loan 10,00,000
c) 15% Other Loans 5,00,000
The above funds have been utilized by the company in the following assets.
1) Building 25,00,000
2) Furniture 10,00,000
3) Plant 40,00,000
4) Factory Shed 15,00,000
Calculate borrowing cost and also passed journal entries related to the situation.
Ans:
W.N.1:-Calculation of borrowing cost (specific)
Loan related to building 10,00,000
% of interest 15%
Interest Cost 1,50,000
W.N.2:-Calculation of borrowing cost (general
a) Debentures (5,00,000 x 10%) 50,000
b) Term Loan (10,00,000 x 20%) 2,00,000
c) Other Loan (5,00,000 x 15%) 75,000
3,25,000
Treatment of Borrowings
A) Specific Borrowings cost
Borrowing cost of1,50,000 which is directly related to building should be capitalized to the cost because it is clearly specified in the provisions of AS-16 that specific borrowing cost should be capitalized to the specific assets.
B) General Borrowing cost
As per the provisions AS, general borrowing cost should be allocated over Q.A. in the ratio of expenditure incurred the following statement should be prepared.
Statement showing allocation of General Borrowing Cost
Assets Expenses Incurred Share in Borrowing Cost
Building 15,00,000 (10,00,000 specific Cost) 3,25,000 x 10/80 = 60,937
Furniture 10,00,000 3,25,000 x 10/80 = 40,625
Plant 40,00,000 3,25,000 x 40/80 = 1,62,500
Factory Shed 15,00,000 3,25,000 x 15/80 = 60,938
3,25,000
Ques 6
As per the provisions of As – 16, Q.A. is the assets that takes substantial period of time to get ready for the intended use or sale.
The following assets are covered in the definition of Q.A.
a) Fixed Assets
b) Investment Properties
c) Inventories
On the basis of above explanation, it is clearly specified that investment properties are covered but other investments are not covered in the definition of Q.A.
In the above example R Ltd has invested in shares which are not covered in the meaning of Qualifying Assets.
So interest can’t be capitalized in the cost of shares because AS – 16, is not applicable on shares. On the basis of above explanations resolution of Director’s of R Ltd is totally incorrect.
Ques 3
As per the Provisions of AS – 16, Borrowing cost can be capitalized till the date of completion of work of Q.A. No other interest or other cost can be capitalized after the date on which Q.A. is ready for use or sale.
In the given example captive power plant is already used for commercial production. It means that Q.A. is already in use for the business activities and definations of Q.A. are not applicable on the used assets.
On the basis of above explanantions the arguments of managements is totally incorrect. Borrowing cost related to the power plant should be transferred to profit & Loss A/c in place of capitalization.
Ques 2
Interest =22,00,000 X 12%
=2,64,000
Note on Exp: - As per AS – 16, Expenditure should be incurred out of borrowed funds for the purpose of capitalization of borrowing cost. Further expenditure shall include payment in cash for qualifying assets or use of assets which are held by the enterprise internally and not purchased from outside.
In the Ques 2, expenditure incurred shall include both the amounts of cash payments as well as transfer of assets.
Statement showing allocation of Interest over the Phases
Particulars Expenditure Share in the Borrowing Cost
Interest = 2,64,000
Phase I 10,00,000 97,778
Phase II 9,00,000 88,000
Phase III 8,00,000 78,222
2,64,000
Treatment of Borrowing cost
(i) Phase II & III are still in progress and not ready for use or sale. So borrowing cost related to these parts should be capitalized till the date of completion. Borrowing cost of88,000 and of78,222 should be capitalized in the cost of Phase II & III respectively.
(ii) As per question specification phase I is complete. So borrowing cost related to Phase I should not be capitalized but to be transferred to P & L A/c.
Assumptions
a) Date of completion of Phase I is not mentioned in the question. So we have assumed that date of completion of respective part is the first day in the beginning of year. Alternative assumption can also be taken.
b) We have also assumed that completed part is independent in nature.
Ques 8
(i) We have assumed that accounting year is calendar year.
(ii) We have also assumed that related expenses are given on amortised basis because period of use of borrowing is not mentioned in the question.
Working Notes
(i) Calculation of Specific borrowing cost
Interest on 10 % Term Loan = 200 x 10/100 = 15 Lakh
Add : - Related Expenses = 2 Lakh
17 Lakh
(ii) Calculation of General borrowing cost
Interest on 15 % Debentures = 400 x 15/100 = 60 Lakh
Interest on 12 % Term Loan = 300 x 15/100 x 2/12 = 6 Lakh
Add : - Related Expenses (1 Lakh + 2.5 Lakh) = 3.50 Lakh
69.50 Lakh
Treatment of Borrowing Cost
Specific Borrowing Cost: - Borrowing cost of17 Lakh should be capitalized to the cost of plant & machinery because 10 % Term Loan is directly related with Plant & Machinery.
General Borrowing Cost: - As per AS – 16, General Borrowing cost should be allocated over qualifying assets in the ratio of expenditure. For the application for such provisions the following Statement will be considered.
Statement showing allocation of general Borrowing Cost
Factory Shed 100 Lakh 1/9 7.72 Lakh
Plant 700 Lakh (900-200) 7/9 54.05 Lakh
Other Fixed Assets 100 Lakh 1/9 7.72 Lakh
69.50 Lakh
Ques 9
(i) In the given question, amount of general borrowing cost is higher than expenditure incurred on qualifying asset. So full capitalization will not be allowed but proportionate capitalization according to the expenditure should be made.
(ii) General Borrowing cost related to unused borrowed funds should be transferred to P&L A/c.
Working Note
Statement showing calculation of General Borrowing Cost
Total General Borrowing Cost = 28 Lakh + 36 Lakh = 64 Lakh
(a) General Borrowing Cost related to expenditure = 64 Lakh x 400 / 500 = 57.20 Lakh
(b) General Borrowing Cost related to unused amount = 64 Lakh x 100 / 500 = 12.80 Lakh
Capital A/c = Part (a)
P&L A/c = Part (b)
Statement showing allocation of G.B. Cost
Plant 200 Lakh 25.60 Lakh
Internal Road 100 Lakh 12.80 Lakh
Plant II 100 Lakh 12.80 Lakh
400 Lakh 51.20 Lakh
Comment: - Borrowing cost related to 16% Secured Loan should be capitalized directly to the cost of factory building.
Ques 10
As per AS – 16, Qualifying Asset are those assets which are related to substantial period of time for their completion for the purpose of use of sale. On the basis of such explanation, Inventories can also be covered in the definition of Qualifying Assets. In addition it is also considerable that such inventories should take substantial period of time to get ready for the purpose of sale.
In the given situation, the sugar company has already produced sugar and the specified items are ready for sale. So the produced inventories can’t be covered in the meaning of Q.A.
As per the provisions of AS – 16, Interest can be capitalized only if it is related with expenditure on Q.A. So the company can’t capitalize to the cost of inventories because the provision of AS – 16, are not applicable on the given situation.
Ques 13
Statement showing Calculation of cost of Asset
Period Op. WIP New Exp Amount of Loans B. Cost Cl. WIP
I ---- 100 Lakh 60 Lakh 7.20 Lakh 107.20 Lakh
II 107.20 Lakh 100 Lakh 120 Lakh 14.40 Lakh 221.60 Lakh
III 221.60 Lakh 80 Lakh 160 Lakh 19.20 Lakh 320.80 Lakh
IV 320.80 Lakh 60 Lakh 200 Lakh 24.00 Lakh 404.80 Lakh
V 404.80 Lakh 50 Lakh 230 Lakh 26.00 Lakh 482.40 Lakh
Assumption: - In the given ques, date of borrowing is not specified. So we have assumed that borrowings are made by enterprise in the beginning of year.
Ques 1
W.N.1
(i) Calculation of expenditure incurred till 31-03-2001
Op. WIP (450 Lakh + 24 Lakh) on 01-04-2000 = 474 Lakh
Add: Expenditure during the Period
In Cash 78 Lakh
In Asset 100 Lakh
Less: Progress payment Received (300 Lakh)
Total Cost 352 Lakh
(ii) Statement showing Capitalization of Borrowing cost
Expenditure incurred till 31-03-2001 = 352 Lakh
Total Borrowing till 31-03-2001 = 400 Lakh
Total Borrowing cost (400 x 12 %) = 48 Lakh
Capitalization of Borrowing Cost = 48 x 352/400 = 42.24 Lakh
Expenses of Borrowing Cost = 48 x 48/400 = 5.76 Lakh
Notes
(i) As per the provisions of AS – 16, if any progress payment or Govt grants is recognized by the enterprises during the period then the recognized amount should be deducted out of expenditure incurred.
(ii) In the given question date of progress payment is not specified. So we have assumed that date of progress payment is the first day of financial year.
(iii) In the given question, interest of current year is clearly specified of48 Lakh. Such amount is calculated on the amount of borrowing of400 Lakh @ 12%. It means that interest of previous year has already been paid and not included in the amount of borrowings. So assumptions of outstanding interest will be totally incorrect.
Ques 4
In the given example, there are multiple assets which are purchased out of single borrowed fund. It means that situation will be covered under the heading of General Borrowing and ratio of expenditure should be applied for the allocation of General Borrowing Cost.
Statement showing Allocation of General Borrowing Cost
Building 120 Lakh 10.80 Lakh
Plant 350 Lakh 31.50 Lakh
Capital WIP 70 Lakh 6.30 Lakh
Working Capital 110 Lakh 9.90 Lakh
650 Lakh
Treatment: -
(a) Interest of10.80 Lakh and 31.50 Lakh should be capitalized in the cost of building and plant respectively. Because these assets are ready for use at the end of the year.
(b) Interest of6.30 Lakh should be also be capitalized in the name of Capital WIP because advance payment for installation of plant has been made and it can be assumed that administrative activities which are required to complete have been in progress.
(c) Working capital is not qualifying asset so interest related to working capital should be transferred to P&L a/c.
Note: Wherever in any ques there is difference in the amount of expenditure as well as period of progress then gross borrowing cost should not be allocated in the ratio of expenditure but the following steps should be applied.
Step1:
First of all average capitalization rate should be calculated on average basis.
Capitalization rate = Total Borrowing cost X 100
Total used amount during the period
Step 2:
After calculation of capitalization rate, such rate should be applied on the expenditure of qualifying assets directly with reference to period of construction or progress.
Disclosures: (Notes to Account)
1. Accounting policy should be disclosed separately.
2. Amount of borrowing cost which is capitalized during the period should be disclosed separately.
Difference between AS – 16, IAS – 23 and US GAAP – 34
Difference between the three Statement is not important because such difference is not related to accounting of borrowing cost but it is related to disclosure only.
1. As per IAS – 23, amount of interest expense which is capitalized or not capitalized during the period should be disclosed separately.
2. As per US GAAP – 34, amount of capitalization is not required but capitalization rate should be disclosed separately.
3. As per AS – 16, if any interest cost is not capitalized during the period then no disclosure will be required. It means that disclosure requirements are applicable only if capitalization of borrowing cost has been made during the period.
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