Understanding Borrowing Costs
Borrowing cost can be defined as interest and other costs incurred by an enterprise in relation to the borrowing of funds. Explaining in a more technical way, borrowing costs refer to the expense of taking out loan expenses like interest payments incurred from a loan or any other kind of borrowing. Interest also counts amortization of premium/discount on debt. Other costs include amortization of debt issue costs and some foreign exchange differences which are treated as an adjustment of internal cost.
Besides, borrowing costs do not include imputed or actual cost of equity capital, counting any preferred capital which is not cataloged as a liability pursuant to. Borrowing costs are, generally, attributable to the acquisition, production or construction of a qualifying asset should be capitalized as a part of the asset’s cost.
Accounting treatment for borrowing costs
The standard accounting treatment for borrowing costs is that each borrowing cost should be expensed in the specific period in which they were incurred. The allowable alternative treatment is that the borrowing costs related to the acquisition, production, and construction of a qualifying asset should be treated as part of the relevant asset’s cost.
In cases where the allowed alternative is adopted, it should be applied consistently to all borrowing cost, as an accounting treatment, incurred for the acquisition, production, or construction of qualifying asset.
In cases where funds are borrowed specifically, eligible costs for capitalization are actual costs incurred minus any income earned on the temporary investment of such borrowings. In case of funds being a part of the general pool, the eligible amount is calculated by applying a capitalization rate to the expenses on that asset. The capitalization rate is the weighted average of the borrowing cost which is applicable to the general pool.As per IAS, capitalization should be suspended during periods which involve interruption in active development. Also, capitalization should close down when all the substantial activities, essential for preparing the asset for its intended use or sale, have been accomplished. If only small modifications are pending, this signifies that substantially all activities have been accomplished.