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ACCOUNTING STANDARD- 16. BORROWING COSTS. DEFINITIONS (Para 3). Borrowing Costs are interests and other costs incurred by an enterprise in connection with the borrowing of funds.
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ACCOUNTING STANDARD- 16 BORROWING COSTS
DEFINITIONS(Para 3) • Borrowing Costs are interests and other costs incurred by an enterprise in connection with the borrowing of funds. • Qualifying Asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
SUBSTANTIAL PERIOD • Depend upon circumstances of each case • Ordinarily a period of 12 month is considered as substantial period of time. • A shorter or longer period which can be justified on the basis of circumstances of the case. …continued
SUBSTAINTIAL PERIOD CONT. • In estimating the period which an asset takes technologically and commercially to get it ready for its intended use or sale is considered.
Para 4. Borrowing Costs may include: Interest and commitment charges on bank borrowings and other short term and long term borrowings; Amortization of discounts or premiums relating to borrowings; Amortization of ancillary costs incurred in connection with the arrangement of borrowings; Finance charges in respect of assets acquired under finance leases or under similar arrangements; and Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
The Standard requires that the amount of borrowing costs capitalized during a period should not exceed the amount of borrowing costs incurred during the period.
ISSUE Para 4(e) in which foreign exchange differences are covered . CONSIDERATIONS (A.) Foreign Exchange Differences on amount of principal foreign currency borrowings + Interest on foreign currency borrowings COMPARED WITH (B.) Interest on local currency borrowings (enterprise capable to borrow locally) If (B.) is higher, then exchange difference would become part of borrowing cost.
EXPLANATION PARA 4(e) • Exchange difference arising from foreign currency borrowings only in respect of principal amount. • For this purpose interest rate of local currency borrowing as the fund would have been raised locally had the enterprise not to decide to raise foreign currency borrowing.
QUALIFYING ASSETS (Para 5) Qualifying assets include: • Manufacturing plants • Power generation facilities • Inventories that requires substantial periods of time to bring them to saleable condition.
RECOGNITION OF COST All Borrowing Costs Borrowing costs directly attributable to the acquisition, construction or production of a qualifying assets Other Borrowing costs Future economic benefits Charge to P&L Measurement possible Capitalize as apart of the cost of qualifying asset
a. In case of funds specifically borrowed for qualifying assets: Borrowing Costs = Actual borrowing - Income on temporary to be capitalized cost incurred investment of funds b. In case of general borrowings: Borrowing Costs = Capitalization Rate * Expenditure on the asset • Capitalization rate = Weighted Average of outstanding borrowing • cost (excluding cost of specific borrowings)
SPECIFIC BORROWING VS. GENERAL BORROWING • Para 10 deals with funds borrowed specifically. • Utilization of fund can be liked from project to project or asset to asset. • Identification of projects/assets at the time of taking borrowings. • Para12 deals with funds borrowed generally. • Funds used for the purpose of obtaining qualifying assets • Cost of qualifying assets whenever incured to be utilized out of funds generally borrowed.
INTEREST ON WORKING CAPITAL • Para 8 of AS-16 • The borrowing cost that are directly attributable on construction or production of qualifying asset is entitle for cost of such asset. • It is not necessary that loan should be taken separatly.
COMMENCEMENT(Para 14) The capitalization of borrowing cost is to be commenced when all the three conditions are satisfied: • expenditure for the acquisition, construction or production of a qualifying asset is being incurred; • Borrowing costs are being incurred; and • Activities that are necessary to prepare the asset for its intended use or sale are in progress.
EXPENDITURE ON QUALIFYING ASSETS (Para 15) It includes expenditures which results in: • Payment of cash • Transfer of other assets • Incurrence of interest bearing liabilities Deduct: • Progress Payments • Grant received in connection with asset *Consider Average carrying cost during reporting period
SUSPENSION(Para 17) Capitalization of borrowing costs are should be suspended during extended periods in which active development is interrupted. • Except when: • Substantial technical/ administrative work being done. • Temporary delay is inherent in the process.
ACCOUNTING OF INTEREST WAIVER • Query: Can interest waived that was earlier capitalized can be de-capitalized? EAC Volume XVIII Page 47 EAC Volume XII Query 23
CESSATION Para 19 When substantially all the activities necessary to prepare the qualifying assets for its intended use or sale are completed. Para 21 In case of completion of parts, when completed part is capable of being used independently or no substantial activity necessary for its intended use or sale.
DISCLOSURE The financial statements should disclose: • the accounting policy adopted for borrowing costs; and • the amount of borrowing costs capitalized during the period.
ILLUSTRATIVE ACCOUNTING POLICY “ The Company capitalizes interest and other costs incurred by it in connection with funds borrowed for the acquisition of fixed assets. Where specific borrowings are identified to a fixed asset, the Company uses the interest rates applicable to that specific borrowing as the capitalization rate. Where borrowings cannot be specifically identified to fixed assets , the capitalization rate applied is the weighted average of the interest rates applicable to all the borrowings of the Company. Capitalization of borrowing costs ceases when all the activities necessary to prepare the fixed assets for their intended use are substantially complete.”
