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BORROWING COSTS

Under PAS 23, paragraph 5, borrowing costs are defined as interest and other costs that an entity incurs
in connection with borrowing of funds.

Paragraph 6 provides that borrowing costs specifically include:

a. Interest expense calculated using the effective interest method.

b. Finance charge with respect to a finance lease.

c. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as an
adjustment to interest cost.

Qualifying asset

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for the
intended use or sale.

Examples include the following:

a. Manufacturing plant

b. Power generation facility

c. Intangible asset

d. Investment property

Excluded from capitalization

PAS 23 does not require capitalization of borrowing costs relating to the following:

a. Asset measured at fair value, such as biological asset

b. Inventory that is manufactured in large quantity on repetitive basis, such as maturing whisky, even if it
take a substantial period of time to get ready for sale

c. Asset that is ready for the intended use or sale when acquired
Accounting for borrowing cost

PAS 23, paragraph 8, mandates the following rules on borrowing cost:

1. If the borrowing is directly attributable to the acquisition, construction or production of a qualifying


asset, the borrowing cost is required to be capitalized as cost of the asset.

In other words, the capitalization of borrowing cost is mandatory for a qualifying asset.

Borrowing cost can be capitalized when the asset is a qualifying asset and it is probable that the
borrowing cost will result to future economic benefit and the cost can be measured reliably

2. All other borrowing costs shall be expensed as incurred.

In other words, if the borrowing is not directly attributable to a qualifying asset, the borrowing cost is
expensed immediately.

Asset financed by specific borrowing

PAS 23, paragraph 12, provides that if the funds are borrowed specifically for the purpose of acquiring a
qualifying asset, the amount of capitalizable borrowing cost is the actual borrowing cost incurred during
the period less any investment income from the temporary investment of those borrowings.

Asset financed by general borrowing

PAS 23. paragraph 14. provides that if the funds are borrowed generally and used for acquiring a
qualifying asset, the amount of capitalizable borrowing cost is equal to the average carrying

amount of the asset during the period multiplied by a capitalization rate or average interest rate.

However, the capitalizable borrowing cost shall not exceed the actual interest incurred

The capitalization rate or average interest rate is equal to the total annual borrowing cost divided by the
total general borrowings outstanding during the period.

No specific guidance is provided for general borrowing with respect to investment income

Accordingly, any investment income from general borrowing is not deducted from capitalizable
borrowing cost.
Commencement of capitalization

The capitalization of borrowing costs as part of the cost of a qualifying asset shall commence when the
following three conditions are present:

a. When the entity incurs expenditures for the asset.

b. When the entity incurs borrowing costs

c. When the entity undertakes activities that are necessary to prepare the asset for the intended use or
sale.

Activities necessary to prepare

The activities necessary to prepare the asset for the intended use or sale encompass more than the
physical construction of the asset.

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