Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset are included as part of the cost of that asset. Other borrowing costs, which do not meet this criterion, are recognized as expenses in the period in which they are incurred. This distinction is crucial because it affects the timing of cost recognition and the reported financial position of an entity.
Scope of Ind AS 23
Ind AS 23 applies to accounting for borrowing costs incurred by an entity. It specifically excludes the actual or imputed cost of equity, including preferred capital that is not classified as a liability. This means entities need to carefully distinguish between debt and equity financing to apply the standard properly. Ind AS 23 is not mandatory for borrowing costs that are directly attributable to the acquisition, construction, or production of certain types of assets. These include qualifying assets measured at fair value, such as biological assets under Ind AS 41, and inventories produced in large quantities on a repetitive basis. Entities are not required to capitalize borrowing costs for these categories, although they may choose to do so as a matter of accounting policy.
Definitions under Ind AS 23
Borrowing costs are defined as interest and other costs incurred by an enterprise in connection with the borrowing of funds. This definition encompasses a variety of cost elements. Interest expense calculated using the effective interest method under Ind AS 109, interest on lease liabilities as per Ind AS 116, and exchange differences arising from foreign currency borrowings that qualify as adjustments to interest costs are all included. Thus, borrowing costs are broader than mere interest payments; they may involve multiple financial components depending on the borrowing structure and applicable accounting standards.
Components of Borrowing Costs
Borrowing costs may include several specific types of expenses. Interest on bank overdrafts and loans, including short-term and long-term borrowings, is a basic component. Interest related to lease liabilities, especially in the context of right-of-use assets under lease agreements, is also covered. Another key component is exchange differences on foreign currency borrowings, provided they are considered adjustments to interest costs. This treatment is permitted only to the extent that such exchange differences do not exceed the differential between interest costs in functional and foreign currency terms. By incorporating these components, Ind AS 23 ensures a comprehensive approach to identifying and capitalizing borrowing costs.
Meaning of Qualifying Assets
A qualifying asset is one that necessarily takes a substantial period to get ready for its intended use or sale. This definition is functional and depends on the specific characteristics of the asset and its preparation timeline. Examples of qualifying assets include inventories requiring a long production cycle, large-scale manufacturing plants, power generation facilities, intangible assets under development, investment properties undergoing construction or redevelopment, and bearer plants. These are assets for which the capitalization of borrowing costs is typically relevant due to the extended duration of their development or construction. On the other hand, assets that are ready for use or sale when acquired do not qualify. Similarly, financial assets and inventories produced quickly in large batches do not qualify under Ind AS 23.
Exchange Differences Treated as Borrowing Costs
Ind AS 23 contains specific provisions on when exchange differences on foreign currency borrowings can be treated as borrowing costs. According to paragraph 6A of the standard, adjustments can be made only under certain conditions. First, the adjustment must be limited to the extent that the exchange loss does not exceed the difference between borrowing costs in the functional currency and the foreign currency. This ensures that only exchange losses equivalent to a higher interest rate are treated as adjustments. Second, if an unrealised exchange loss is treated as an adjustment to interest and a corresponding realised or unrealised gain occurs subsequently, the gain must also be recognized as an adjustment to interest to the extent of the previous adjustment. These provisions aim to prevent inconsistent treatment of exchange differences that may distort borrowing cost recognition.
Recognition of Borrowing Costs
Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset must be capitalized as part of the cost of that asset. All other borrowing costs are recognized as expenses in the period in which they are incurred. This principle ensures that only borrowing costs that contribute directly to the enhancement of a long-term asset are included in its cost. Recognition of borrowing costs begins only when the asset qualifies and borrowing costs have been incurred alongside expenditures on the asset. This helps match the cost of financing with the period of asset development and ensures that expense recognition is not premature or delayed beyond the asset’s productive life.
Borrowing Costs Eligible for Capitalization
To determine which borrowing costs are eligible for capitalization, the source and purpose of the borrowing must be examined. If the borrowing is specifically for acquiring or constructing a qualifying asset, then the actual borrowing costs incurred, less any temporary investment income, are eligible for capitalization. In contrast, if funds are borrowed generally and used to acquire a qualifying asset, a capitalisation rate must be applied to the expenditures on the asset. This capitalisation rate is the weighted average of the borrowing costs applicable to all borrowings outstanding during the period, excluding any specifically borrowed funds. The amount capitalised cannot exceed the total borrowing costs incurred during the period. This restriction ensures that the capitalised cost is reasonable and avoids the overstatement of asset values.
Commencement of Capitalization
Capitalisation of borrowing costs begins when three conditions are simultaneously met. First, the entity must have incurred expenditures for the asset. Second, borrowing costs must also have been incurred. Third, the entity must be actively engaged in activities necessary to prepare the asset for its intended use or sale. These conditions ensure that capitalisation does not begin prematurely and align with the actual start of asset development. The commencement date for capitalisation plays a vital role in determining the total amount of borrowing costs that will be included in the asset’s cost, and incorrect timing can lead to a misstatement of either the asset or the expense.
Suspension of Capitalization
Capitalisation of borrowing costs must be suspended during extended periods of interruption in the development of the qualifying asset. Borrowing costs incurred during such interruptions are treated as expenses rather than part of the asset cost. However, capitalisation continues if the delay is temporary and a normal part of the development process, such as seasonal construction halts due to weather conditions or time required for technical or administrative procedures. For example, construction delays due to high water levels, if common in the region, do not require suspension of capitalisation. Similarly, ongoing technical work during a delay does not halt capitalisation. These guidelines ensure that only genuine interruptions impact capitalisation and prevent manipulation of cost recognition.
Cessation of Capitalization
Capitalisation of borrowing costs should stop when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. This completion can refer to the entire asset or a significant part of it if that part is independently functional. For example, in the case of a business park with multiple buildings, capitalisation can cease for each building as it becomes usable, even if other buildings are still under construction. Conversely, for a fully integrated industrial plant like a steel mill, capitalisation continues until all units are completed and the facility is operational. Proper timing of cessation is critical for accurate financial reporting and ensures that borrowing costs are not inappropriately deferred or overcapitalised.
Process of Capitalizing Borrowing Costs
The process of capitalizing borrowing costs involves identifying qualifying assets, determining the commencement date, tracking eligible expenditures, applying the correct capitalisation rate, and recognising cessation of capitalization. An entity must maintain detailed records of both specific and general borrowings, expenditures on the qualifying asset, and income from temporary investment of borrowed funds. These records support the accurate application of the effective interest method and ensure that only borrowing costs meeting the recognition criteria are capitalised. Capitalisation is reviewed periodically to ensure compliance with the standard and consistency across reporting periods. This process demands a disciplined approach to accounting and a thorough understanding of the applicable guidance under Ind AS 23.
Accounting for Borrowing Costs
Borrowing costs can be accounted for in two ways. They can either be recognised as an expense in the period they are incurred or capitalised as part of a qualifying asset’s cost. The capitalisation approach is permitted only when the borrowing costs are directly attributable to the acquisition, construction, or production of a qualifying asset and when it is probable that future economic benefits will flow to the entity. Additionally, the borrowing costs must be measurable reliably using the effective interest rate method under Ind AS 109. This method takes into account all fees, premiums, and discounts that are part of the borrowing cost and allocates them over the expected life of the liability. The choice between expensing and capitalising borrowing costs must align with the substance of the transaction and be applied consistently in financial reporting.
Disclosure Requirements under Ind AS 23
Ind AS 23 mandates specific disclosure requirements to ensure transparency and consistency in financial reporting. Entities must disclose the total amount of borrowing costs capitalised during the period. This disclosure allows users of financial statements to assess how much cost has been included in the carrying amount of qualifying assets. Additionally, the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation must be disclosed. The rate could either be the actual rate on specific borrowings or the weighted average rate on general borrowings. This information is crucial for evaluating the accounting assumptions and judgments made by the entity. Detailed and accurate disclosure enables better comparability between entities and provides insight into the impact of borrowing costs on asset values and profitability.
Convergence with IAS 23
Ind AS 23 is broadly aligned with IAS 23, the corresponding international standard. However, there are important differences to note. IAS 23 does not provide detailed guidance on the treatment of exchange differences related to foreign currency borrowings. In contrast, Ind AS 23 includes paragraph 6A, which explains how exchange differences can be considered adjustments to interest costs under certain conditions. This clarification ensures that Indian entities have clear rules for handling such transactions and reduces ambiguity in financial reporting. The addition of paragraph 6A represents a significant divergence from IAS 23, introduced to address practical issues observed in the Indian economic context, where entities often borrow in foreign currency due to interest rate differentials.
Additional Clarifications on Exchange Differences
Under Ind AS 23, if an exchange loss arises on foreign currency borrowings, the amount to be treated as an adjustment to interest must be limited. The adjustment is allowed only to the extent that the loss does not exceed the difference between the interest cost in the functional currency and the foreign currency. This ensures that only the economic cost difference is capitalised and prevents overstatement of asset costs. Moreover, if a gain arises subsequently—either realised or unrealised—it must be recognised as an adjustment to interest to the extent of the previously capitalised exchange loss. This symmetrical treatment ensures consistency in the application of borrowing cost capitalisation rules and promotes faithful representation in financial statements.
Importance of Identifying Qualifying Assets
The classification of an asset as qualifying or non-qualifying under Ind AS 23 is pivotal. Qualifying assets are those that take a substantial time to get ready for use or sale. Misclassification can lead to either premature expensing or improper capitalisation of borrowing costs. Proper assessment involves evaluating the duration and complexity of the development or construction process. For example, a power generation facility or a toll road may take years to build and will qualify. Conversely, inventories manufactured within a short cycle or assets acquired ready for use do not qualify. Accurate identification affects cost allocation, income recognition, and ultimately the financial results presented to stakeholders.
Distinction between Specific and General Borrowings
When an entity borrows funds specifically for a qualifying asset, the interest and related costs from that loan are directly capitalized. However, entities often use general borrowings for multiple purposes, including investment in qualifying assets. In such cases, Ind AS 23 requires the use of a capitalisation rate calculated as the weighted average of borrowing costs applicable to general borrowings outstanding during the period. This approach ensures that capitalisation reflects the broader cost of financing when specific borrowings cannot be traced directly. Exclusion of costs from specific borrowings from the average calculation prevents duplication and ensures the accuracy of cost allocation.
Application of the Effective Interest Rate Method
The effective interest rate method plays a critical role in calculating borrowing costs under Ind AS 23. This method spreads all borrowing-related fees, premiums, and discounts over the expected life of the financial liability. It results in a constant periodic rate of return on the carrying amount of the liability. For capitalisation purposes, this method ensures that borrowing costs included in the asset’s cost reflect the true cost of finance rather than nominal interest rates. This is especially important in cases involving complex financing arrangements with upfront fees or balloon payments. Consistent application of the effective interest rate method aligns with the overall objective of faithful representation in accounting.
Case Study Analysis on Capitalisation Timing
Consider an entity constructing a stadium. As of 31 October, most of the construction is complete, except for the ticket booking office and entry gates. The auditor suggests stopping capitalisation at this stage. However, under Ind AS 23, capitalisation should continue until the asset is substantially ready for its intended use. Since the stadium cannot function without the ticket office and gates, it is not ready for use. Therefore, borrowing costs should continue to be capitalised. This example highlights the importance of assessing readiness for intended use from a functional rather than a physical completion perspective.
Case Study on Mixed Borrowings
A company is constructing a building using a specific loan of 6 million and additional general borrowings. The specific loan carries an interest rate of 11 percent, while the general borrowings consist of long-term debentures at 9 percent and subordinated debentures at 10 percent. The total interest incurred is calculated based on the rates and loan amounts. The interest on the specific loan is capitalised directly. For the remaining expenditures funded from general borrowings, a weighted average capitalisation rate is applied. The final capitalised interest is the sum of the interest from the specific loan and the portion from general borrowings applied to the asset. The remaining interest is recognised as an expense. This example demonstrates how Ind AS 23 accommodates complex financing structures while maintaining accurate cost attribution.
Role of the Ind AS Transition Facilitation Group
The Ind AS Transition Facilitation Group (ITFG) provides clarifications on practical issues in the implementation of Ind AS standards, including Ind AS 23. In one case, a company incurred loan processing charges for a loan used to finance the construction of a factory building. The question was whether the entire processing fee should be capitalised or only the portion amortised during the capitalisation period. The ITFG clarified that only the amortised portion of the fee up to the period of capitalisation should be included in the cost of the asset. This is consistent with the effective interest rate method, which allocates fees over the loan’s life. This guidance ensures that capitalisation aligns with the accounting treatment of the borrowing cost under Ind AS 109 and supports accurate financial reporting.
Treatment of Processing charges
Under Ind AS 109, which is applicable for calculating the effective interest rate, fees that are an integral part of borrowing must be included in the cost of borrowing. These fees are spread over the loan’s life and affect the amount of interest recognised each period. Processing charges incurred to obtain a loan are considered part of the effective interest rate when the loan is measured at amortised cost. Therefore, in the context of Ind AS 23, only the portion of the processing charges amortised during the capitalisation period should be included in the asset’s cost. This treatment ensures consistency in the application of standards and prevents overstatement of asset values.
Impact of Capitalisation on Financial Statements
Capitalisation of borrowing costs significantly affects the financial statements of an entity. It increases the carrying amount of qualifying assets, which in turn affects depreciation or amortisation expenses over the asset’s useful life. At the same time, capitalising borrowing costs reduces the finance costs recognised in the income statement in the short term. This can lead to higher reported profits during the development period of the asset. However, in the long run, the impact reverses as the capitalised cost is depreciated. Users of financial statements need to be aware of the capitalisation policy and the related disclosures to properly evaluate financial performance and position.
Importance of Consistent Application
Consistency in applying the principles of Ind AS 23 is essential for comparability and transparency. Once an entity determines its policy for identifying qualifying assets and selecting a capitalisation rate, it should apply the same principles consistently across similar projects and periods. Any change in policy or significant estimate should be disclosed with sufficient explanation to help users understand the rationale and impact. Consistent application avoids manipulation of borrowing costs to influence reported profits or asset values and upholds the integrity of financial reporting.
Challenges in Implementation
Implementing Ind AS 23 can pose challenges, especially for entities with complex borrowing structures or multiple projects in progress. Identifying qualifying assets, tracking expenditures, applying capitalisation rates accurately, and distinguishing between specific and general borrowings require robust systems and internal controls. Moreover, the requirement to suspend capitalisation during extended interruptions adds complexity to project monitoring and accounting. Entities must train finance personnel and deploy appropriate accounting software to ensure compliance with the standard. In large organisations, cross-functional coordination between project managers, finance teams, and auditors becomes essential.
Judgement and Estimates in Capitalisation
The application of Ind AS 23 often involves significant judgement. For example, determining whether an asset is substantially complete requires an assessment of its readiness for use rather than physical completion. Estimating the weighted average capitalisation rate requires an accurate understanding of the borrowing profile and outstanding balances. Similarly, evaluating whether a delay constitutes an extended interruption or a normal part of construction is a matter of judgment. These estimates and assumptions must be reviewed regularly and disclosed where material. Transparency in making and revising estimates promotes trust and enhances the credibility of financial statements.
Components of Borrowing Costs
Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds. Ind AS 23 provides detailed guidance on what constitutes borrowing costs. The following components are typically included: interest expense calculated using the effective interest method; finance charges in respect of finance leases recognized by Ind AS 116; exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. Other components can include amortization of discounts or premiums relating to borrowings, amortization of ancillary costs incurred in connection with the arrangement of borrowings, and certain lease liabilities recognized under Ind AS 116 where the interest component is significant. Understanding the detailed components is crucial for proper recognition and capitalization.
Effective Interest Rate Method
The effective interest rate (EIR) method is a key concept in determining the borrowing cost to be capitalized. It is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the net carrying amount of the financial asset or financial liability. Under Ind AS 23, the borrowing costs that are eligible for capitalization are those calculated using the EIR method, not just the nominal rate of interest. This method ensures that all borrowing costs, including fees and transaction costs, are considered. This approach provides a more accurate reflection of the cost of borrowing and ensures that the capitalized amount aligns with the actual economic cost incurred by the entity.
Exchange Differences as Borrowing Costs
Ind AS 23 allows the capitalization of exchange differences arising from foreign currency borrowings under specific conditions. These differences can be considered borrowing costs to the extent that they are regarded as an adjustment to interest costs. This typically happens when the exchange differences are directly attributable to the cost of borrowing and occur during the construction of a qualifying asset. For example, if an entity takes a foreign currency loan to finance the construction of a plant, any exchange loss during the construction phase may be capitalized. However, exchange gains are not capitalized but are recognized in profit or loss unless they reverse a previously capitalized exchange loss. The treatment of exchange differences requires careful analysis and documentation to ensure compliance with Ind AS 23.
Exclusions from Borrowing Costs
Not all costs associated with borrowings qualify for capitalization under Ind AS 23. For example, equity dividends, preferred dividends, and other distributions to shareholders are not borrowing costs. Similarly, foreign exchange losses that are not considered an adjustment to interest costs are not capitalized. Costs related to raising equity finance, such as underwriting fees and legal fees for share issues, are also excluded. Administrative and general overheads, even if incurred during the construction period, do not qualify unless they are directly attributable to the acquisition or construction of a qualifying asset. Understanding these exclusions helps ensure that only appropriate costs are capitalized, maintaining the integrity of financial reporting.
Period of Capitalization
The capitalization of borrowing costs begins when three conditions are met: expenditures for the asset are being incurred, borrowing costs are being incurred, and activities necessary to prepare the asset for its intended use or sale are in progress. These three conditions must be satisfied simultaneously. Once they are met, capitalization continues as long as the activities to prepare the asset are in progress. Capitalization should be suspended during extended periods in which active development is interrupted. It ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. This timeline ensures that borrowing costs are matched to the period in which the benefits of the qualifying asset are expected to accrue.
Suspension of Capitalization
Ind AS 23 requires the suspension of capitalization of borrowing costs during extended periods in which active development of a qualifying asset is interrupted. Suspension is necessary to avoid capitalizing interest that does not relate to the construction or acquisition process. For instance, if construction of a factory is halted due to a strike or lack of funding, borrowing costs incurred during this idle period should not be capitalized. The definition of an “extended period” is not explicitly provided in the standard and depends on the facts and circumstances of each case. Judgment is required to determine whether a period of interruption is extended enough to warrant suspension. Documentation and proper disclosure are critical to support the rationale behind the suspension or continuation of capitalization during periods of reduced activity.
Cessation of Capitalization
Capitalization of borrowing costs ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. This applies even if the asset has not yet been put into use. For example, if a building has been completed but is not yet occupied, capitalization should stop once the construction is substantially complete. Final touches, such as decorating or minor modifications, do not justify continued capitalization. In the case of parts of an asset being completed and ready for use while construction continues on other parts, capitalization ceases for the completed parts. This rule ensures borrowing costs are not overstated and are matched appropriately with the economic benefits of the asset.
Disclosures Required by Ind AS 23
Ind AS 23 requires entities to disclose the amount of borrowing costs capitalized during the period and the capitalization rate used to determine the amount of borrowing costs eligible for capitalization. These disclosures help users of financial statements understand the extent to which borrowing costs have affected the financial results and the methods used to calculate them. If an entity uses funds borrowed generally and applies a capitalization rate, it should disclose how that rate was determined. Transparent disclosures enhance comparability and help stakeholders assess the impact of capitalized borrowing costs on assets and profits. Entities should ensure compliance with the disclosure requirements of Ind AS 23 to promote transparency and accountability.
Borrowing Costs on General Borrowings
When funds are borrowed generally and used to obtain a qualifying asset, the amount of borrowing costs eligible for capitalization is determined by applying a capitalization rate to the expenditures on that asset. The capitalization rate is the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, excluding borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs capitalized during a period should not exceed the amount of borrowing costs incurred during that period. Proper allocation and documentation of general borrowings are essential to ensure accurate capitalization and compliance with Ind AS 23.
Interaction with Other Ind AS Standards
Ind AS 23 interacts with several other Indian Accounting Standards, such as Ind AS 16 on Property, Plant and Equipment, Ind AS 38 on Intangible Assets, and Ind AS 116 on Leases. The recognition of a qualifying asset under Ind AS 23 must align with the recognition criteria under these related standards. For example, if an asset does not meet the recognition criteria of Ind AS 16, then even if borrowing costs are incurred, they cannot be capitalized. Similarly, in the case of lease liabilities under Ind AS 116, the interest component of the lease payments may qualify as borrowing costs. The consistent application of related standards ensures the reliability and comparability of financial statements.
Borrowing Costs in Group Scenarios
In consolidated financial statements, borrowing costs incurred by a parent or a subsidiary may be capitalized at the group level only when the borrowing is directly attributable to the construction or acquisition of a qualifying asset within the group. The assessment must consider whether the borrowing is used for the qualifying asset and whether the terms reflect an arm’s length arrangement. Transfer pricing and intra-group arrangements must be evaluated carefully. For example, if a parent lends money to a subsidiary for constructing a factory and charges interest, the group must assess whether the borrowing costs incurred at the group level are capitalizable. Transparency, documentation, and adherence to group policies are essential in such cases.
Impact of Government Grants
When an entity receives a government grant specifically for financing the construction of a qualifying asset, the net borrowing cost may be reduced by the amount of the grant received. Ind AS 20 on Accounting for Government Grants provides guidance on how to account for such situations. If the grant is provided as an interest subsidy or a loan at below-market interest rates, the benefit received is treated as a government grant and is accounted for as per Ind AS 20. This may affect the amount of borrowing costs capitalized under Ind AS 23. It is important for entities to evaluate the terms and conditions of government grants and apply the correct accounting treatment in conjunction with Ind AS 23.
Differences with IFRS and AS 16
Ind AS 23 is largely converged with IAS 23 (the corresponding IFRS standard), but there may be differences in practice due to interpretation or local regulatory guidance. Compared to AS 16 (the older Indian GAAP standard), Ind AS 23 brings significant changes, particularly in the treatment of exchange differences and the application of the effective interest rate method. AS 16 allowed capitalization of all exchange differences on foreign currency borrowings, while Ind AS 23 allows only those regarded as adjustments to interest costs. This transition requires entities to update their accounting policies and practices to align with Ind AS. Understanding the differences is essential for companies transitioning from AS 16 or reporting under both Ind AS and IFRS.
Disclosures Under Ind AS 23
Ind AS 23 requires disclosures that enable users of financial statements to understand the impact of borrowing costs. An entity must disclose:
- The amount of borrowing costs capitalized during the period.
- The capitalization rate is used to determine the borrowing costs eligible for capitalization.
The standard ensures transparency and comparability by mandating these disclosures. Entities should present this information in the notes to the financial statements for better clarity.
Ind AS 23 vs. IAS 23
Ind AS 23 is primarily based on IAS 23 issued by the International Accounting Standards Board (IASB). However, there are minor differences:
- Under IAS 23, the capitalization of borrowing costs is mandatory. Ind AS 23 also mandates capitalization, but earlier versions had options before convergence.
- Indian companies must consider guidance from Indian regulatory bodies like ICAI and SEBI, which may affect implementation nuances.
- The treatment of qualifying assets may differ slightly due to practical and jurisdictional considerations.
Despite these minor differences, the core principle of capitalizing borrowing costs incurred in the construction of qualifying assets remains consistent.
Examples of Borrowing Costs and Capitalization
To understand Ind AS 23 practically, consider the following examples:
Example 1: Construction of a Manufacturing Plant
ABC Ltd. is constructing a new manufacturing facility. It has taken a term loan of INR 10 crore at an interest rate of 10% per annum. The construction takes two years to complete.
Borrowing costs for the year: INR 1 crore
Assuming the entire loan was used for construction, and all conditions for capitalization are met, ABC Ltd. will capitalize INR 1 crore each year as borrowing cost into the cost of the plant.
Example 2: Purchase of Inventory
XYZ Ltd. purchases inventory on credit and incurs finance charges. Since inventories are generally not qualifying assets, these finance charges should be expensed in the period incurred and not capitalized.
Example 3: Construction Delayed Due to Strike
DEF Ltd. is constructing a corporate office using a loan of INR 50 crore. The interest for the year is INR 5 crore. However, during the year, construction is suspended for two months due to a labor strike.
According to Ind AS 23, capitalization of borrowing costs should be suspended during extended periods of inactivity. DEF Ltd. will exclude borrowing costs for the two-month suspension period from capitalization.
Practical Considerations for Implementation
Entities implementing Ind AS 23 should consider the following:
- Establish clear documentation and tracking of funds used for qualifying assets.
- Regularly review construction or development progress to ensure the appropriateness of capitalization.
- Segregate general borrowings from specific borrowings for proper computation of the capitalization rate.
- Engage auditors early to align interpretations and avoid disputes.
Effective internal controls and documentation help ensure compliance and prevent misstatements in financial reporting.
Common Challenges and Errors
Some challenges entities face while implementing Ind AS 23 include:
- Incorrect identification of qualifying assets.
- Capitalizing borrowing costs for periods of inactivity.
- Improper allocation of borrowing costs to multiple qualifying assets.
- Lack of adequate documentation to support capitalization decisions.
These issues can lead to audit qualifications or restatement of financial statements. Companies should train their finance teams and establish SOPs to mitigate such risks.
Industry-Specific Applications
Real Estate Sector:
Borrowing costs are frequently capitalized into the cost of projects. Project-specific loans are easy to track, but delays or unsold inventory can complicate accounting.
Infrastructure Projects:
Long gestation periods mean borrowing costs can be substantial. Careful tracking and suspension rules during delays are critical.
Manufacturing Sector:
When expanding production capacity, entities may capitalize borrowing costs related to the construction of new plants or machinery.
IT Sector:
Capitalization is less common unless developing a large software platform is expected to take significant time and resources.
Conclusion
Borrowing costs play a significant role in financial reporting, especially for entities engaged in the development or acquisition of long-term assets. Ind AS 23 ensures that such costs are treated consistently by requiring capitalization when they are directly attributable to qualifying assets. This not only aligns expenses with the periods in which the related benefits are realized but also enhances the reliability and comparability of financial statements.
Understanding the definition of qualifying assets, the conditions under which capitalization should begin, continue, or pause, and the treatment of both specific and general borrowings is essential for accurate implementation. Entities must also ensure they make appropriate disclosures and maintain robust documentation to support their accounting decisions.