Borrowing Costs

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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.

IAS 23 Borrowing Costs provides guidance on the accounting for borrowing costs incurred by an entity in connection with the acquisition, construction or production of a qualifying asset. According to IAS 23, borrowing costs are all costs that are directly attributable to the borrowing of funds, such as interest on loans, bank charges and other costs incurred in connection with the borrowing of funds.

IAS 23 requires borrowing costs to be recognized as an expense in the period in which they are incurred. However, it also provides an option for an entity to capitalize borrowing costs as part of the cost of a qualifying asset. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

Borrowing costs may only be capitalized if it is expected that the borrowing costs will be recovered through the use of the asset. The amount of borrowing costs eligible for capitalization is the amount that is directly attributable to the acquisition, construction or production of a qualifying asset. The capitalization of borrowing costs shall be based on the specific borrowing costs incurred during the period and the capitalization period shall not exceed the expected useful life of the qualifying asset.

It's important to note that IAS 23 is an older standard and has been superseded by IFRS 9 and IFRS 16, which provide more comprehensive guidance on accounting for borrowing costs.

Borrowing Costs Disclosure According to IFRS 9 and IFRS 16

According to IFRS 9 and IFRS 16, entities are required to disclose information about their borrowing costs, including the amount of borrowing costs capitalized and the method used to determine the capitalization rate.

IFRS 9 requires entities to disclose the amount of borrowing costs capitalized during the period, as well as the carrying amount of the assets to which the borrowing costs have been capitalized. It also requires entities to disclose the method used to determine the capitalization rate, and any changes in that method.

IFRS 16 requires entities to disclose the amount of borrowing costs capitalized during the period, as well as the carrying amount of the assets to which the borrowing costs have been capitalized. It also requires entities to disclose the method used to determine the capitalization rate, and any changes in that method.

In addition to these specific disclosures, entities are also required to disclose information about their borrowing costs in the notes to the financial statements. This information should include the amount of borrowing costs recognized as an expense during the period, the weighted average interest rate of the entity's borrowings, and any other information that is relevant to an understanding of the entity's borrowing costs.

It's important to note that these requirements for disclosure apply to both financial statement of a period and also for comparative information.