AS 16: BORROWING COSTS

an analysis

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Overview
About Borrowing Costs
About Qualifying Assets
Accounting of Borrowing Costs
Disclosures
Case studies

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About Borrowing Costs
Definition
Interest and other costs
Incurred by an enterprise
In connection with the
borrowing of funds

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About

Borrowing Costs
Examples of borrowing costs
 Interest and commitment charges
 Amortisation of discounts / premiums connected with borrowings
(Also refer AS 26)
 Amortisation of ancillary costs incurred in connection with
borrowing arrangements (Also refer AS 26)
 Finance charges in respect of assets acquired under financial leases
or under other similar arrangements
 Exchange differences from foreign currency borrowings to the
extent they are regarded as interest costs (Refer ASI 10)

Items not regarded as borrowing costs

 Costs of share holders’ funds. E.g. Dividend on preference share
 Costs that bear only an indirect relation with borrowings. E.g. salary
of personnel involved in borrowing of funds

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Meaning of ‘qualifying asset’
About Qualifying Assets
An asset
That necessarily takes a substantial period of time
To get ready for its intended use or sale

Meaning of ‘substantial period of time’

AS 16 has no mention about the length of time
As per ASI 1:
 What constitutes substantial period of time primarily depends
on the facts and circumstances of each case.
 Ordinarily a period of 12 months can be considered as substantial

period of time

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Accounting of Borrowing
General accounting Costs
treatment
Borrowing Costs that are directly attributable to the
acquisition, construction or production of a qualifying
asset shall be capitalised as part of the cost of that asset
Other borrowing costs should be recognised as an
expense in the period in which they are incurred

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Accounting of Borrowing Costs
Rules for capitalisation
The costs incurred shall be directly attributable to
acquisition, construction or production of a qualifying
asset
Costs shall be capitalised when it is probable that they
will result in future economic benefits to the enterprise
and the costs can be measured reliably

S. S. AYYAR AND CO. - AS 16 7

Accounting of Borrowing Costs
Specific borrowings
The amount of borrowing cost eligible for
capitalisation shall be determined as
actual borrowing cost incurred on that
borrowing during the period less any
income on the temporary investment of
those borrowings

S. S. AYYAR AND CO. - AS 16 8

Accounting of Borrowing Costs
General Borrowings
The amount of borrowing costs eligible for capitalisation
should be determined by applying the capitalisation
rate to the expenditure on that asset. (i.e. cost of the
asset x capitalisation rate)
Capitalisation rate shall be the weighted average of
the borrowing costs applicable vis-à-vis the general
borrowings of an enterprise
The amount of borrowing costs so capitalised shall not
exceed the total borrowing costs on general borrowings
incurred in that period
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Accounting of Borrowing Costs

A Ltd. Constructed a plant costing Rs. 1,200 crores,

which was spent evenly during the year. It had the
following borrowing during the year.
Term loan of Rs. 300 crores specifically for this purpose
@ 12% interest
General borrowings as shown below
 Loan from A bank – Rs. 450 crores @ 13%
 Loan from B bank – Rs. 600 crores @ 11%

Compute the borrowing costs to be capitalised?

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Accounting of Borrowing Costs
 Specific borrowing cost – Rs. 300 crores x 12% = Rs. 36 crores (A)
(presumed that the entire amount was drawn in one go)
 General borrowings used for constructing the qualifying asset = Rs.
1,200 crores – Rs. 300 crores = Rs. 900 crores. (It may be presumed that
expense for the first three months were met from specific borrowing and for
the remaining 9 months from general borrowings)
 Weighted average rate of interest on general borrowings
 A bank = Rs. 450 crores x 13% = Rs. 58.50 crores
 B bank = Rs. 600 crores x 11% = Rs. 66 crores
 Weighted average rate = (Rs. 58.50 crores + Rs. 66 crores) / (Rs. 450 crores +
Rs. 600 crores) = Rs. 124.50 crores / Rs. 1,050 crores = 11.86%
 It is said that Rs. 900 crores was evenly spent. Therefore average
borrowings = Rs. 450 crores. Interest thereon = Rs. 450 crores x 11.86%
x 9 / 12 = Rs. 40.03 crores (B)
 Total borrowing costs capitalised = (A) + (B) = Rs. 76.03 crores

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Accounting of Borrowing Costs
Commencement of capitalisation
Capitalisation can commence when the following
conditions are fulfilled:
 Expenditure on acquisition, construction or production of a
qualifying asset is being incurred
 Borrowing costs are being incurred (and)
 Activities necessary to prepare the asset for its intended use or
sale are in progress. The activities may also include technical and
administrative work prior to the commencement of physical
construction.
Illustration
 When land is acquired and allied developments are carried out,
the entire borrowing costs are capitalised. However, if land is
held for a long time without any development activity, no
borrowing cost is required to be capitalised because no activity is
undertaken to prepare the asset for its intended use or sale

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Accounting of Borrowing Costs
Suspension of Capitalisation
 When active development is interrupted , capitalisation of
borrowing costs can be suspended
 Example: protracted litigations, strike, lockout, natural disaster etc.
 However capitalisation of borrowing costs is not suspended when a
temporary delay is a necessary part of the activity e.g. high water
level while constructing a bridge
Cessation of capitalisation
 Capitalisation of borrowing costs shall cease when substantially
(and not wholly) all the activities necessary to prepare the
qualifying asset for its intended use or sale are complete. (actual
sale or use is immaterial)
 When the activities are completed in identifiable parts,
capitalisation shall cease part – wise. E.g. one villa completed out of
11 villas

S. S. AYYAR AND CO. - AS 16 13

Disclosures
The accounting policy adopted
for borrowing cost
The amount of borrowing costs
capitalised during the period

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 Case studies
Accounting treatment of waiver of interest which was
capitalised earlier
EAC – Vol. XVIII – Pg. 47
 Interest waived pursuant to a scheme of rehabilitation
 Waiver was on account of inability of the enterprise to repay its

loan and has no direct nexus with acquisition of asset (for e.g.
capital subsidy from govt.)
 Hence need not be credited to asset account

EAC – Vol. XXIII – Pg. 131

 Company repaid principal but could not repay interest fully
 Lender waived payment of interest, which was credited to Capital

reserve resulting in reduced depreciation

 When interest is waived, it means that the cost which was

capitalised earlier is never incurred and hence de-capitalisation

has to take place .

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Case studies
Whether borrowing costs are to be considered in
valuation of inventories

Interest cost shall be included if both the conditions are

fulfilled:
 The asset shall be a ‘qualifying asset’ (i.e. test of substantial time – e.g.
manufacture of wine) (and)
 It should fall within the exception stated in paragraph 12 of AS 2 (e.g.

substantial time required for manufacturing)

In the case of sugar industry the EAC has opined, not to charge
borrowing costs to the cost of inventories though interest is a
substantial cost for them

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Case studies
Whether AS 16 applies vis-à-vis acquisition of an
asset, which by itself is not a qualifying asset but
which is acquired for the construction of a
qualifying asset
E.g. a residential building purchased to accommodate
the staff in connection with construction of plant
Based on the principle of ‘substance over form’ the
entire project must be considered as a qualifying asset
and borrowing costs, including those attributable to
purchase of house, shall be capitalised till the plant is
ready for its intended use (Reference: CPE background
material of I C A I)

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Case studies
Whether the following expenses can be regarded
as borrowing costs as per AS 16
Item Yes / Remarks
No
Fee paid to pre-close a loan No No nexus between the expenditure
(EAC – XXIV Pg. 80) and the item of asset capitalised. It
is a Financial Management
expense
Discount on issue of debt Yes It is a cost incurred in connection
instruments (CPE background with borrowing of funds
material)
Cost for procuring finances like Yes It is a cost incurred in connection
advertisement, road show, with borrowing of funds
press meet etc. (CPE
background material)

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Case studies
Accounting treatment of income from temporary
investment of funds borrowed generally and also
income tax treatment thereof
Accounting treatment: income from short term
investments from
 Specific borrowings – income shall go to reduce the borrowing
cost to be capitalised as the standard explicitly says so.
 General borrowings – no such stipulation is made by the

standard. Hence it can be shown as income

Income Tax Treatment – In either case, the same shall be
taxed as income as per the decisions of the Apex Court in
Tuticorin Alkali Chemicals and Fertilizers Ltd. vs. CIT
(1997) 227 ITR 172 CIT vs. Autokast Ltd (2001) 248 ITR 110

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 Case studies
Proviso to Section 36(1)(iii) of the Income Tax Act vs. AS 16
IT Act AS 16
36(1)(iii) deals only with AS 16 covers interest as well
interest on capital borrowed for as other borrowing costs
business or profession
All assets are covered Only qualifying assets are
covered
Deals only with acquisition of Scope is wider as it covers
assets for extension of existing acquisition, construction or
business or profession production of a qualifying
asset vis-à-vis existing / new
entity

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AS 16: BORROWING COSTS
an analysis

THANK YOU

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