BORROWING COST - IAS 23

BORROWING COST - IAS 23

Borrowing cost refers to the interest and other cost incurred by an entity in connection to the borrowing of funds. Companies borrow funds from financial institutions for different reasons. Some of them are:

1. To purchase real estate and expand operations

2. To purchase machinery

3. To purchase inventory

4. To improve working capital

5. To construct buildings. E.g Office building, factories etc.

An entity can borrow funds from financial institutions and individual investors. The entity can go for bank loan, bonds, debentures, etc., to raise funds.

How is the cost of borrowing accounted for?

The standard accounting treatment for borrowing costs is that each borrowing cost should be expensed in the specific period in which they were incurred. To expense an item means to recognize it in the income statement. 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.

Before we move, let learn the definition of a qualifying asset.

A qualifying asset are those assets which take substantial time to be ready for the intent of sale or use.  Generally, a period of 12 months is considered as a substantial. Examples of qualifying assets are:

--Inventories (that are not produced over a short period of time)

- Manufacturing plants

- Power generation facilities

- Intangible assets

- Investment properties.

Types of borrowing cost

1. Interest on short term loans or long-term debts should be included as part of borrowing cost. Example: Interest paid to financial institutions for loan taken to acquire the asset.

2. If an enterprise has incurred any discounts or premiums related to the borrowing cost, then it will also be amortised. Ex: Amount paid to the financial institutions as loan processing cost

3. If an enterprise has incurred any finance/ancillary cost in connection with the borrowings, then it will also be amortised. Ex: Amount to the professionals for preparation of project reports, etc.

4.  If an enterprise has acquired any asset under finance lease or any other similar arrangement, then those finance cost will also be amortised. Ex: Leasing cost paid to the lessor every year.

5. If an enterprise has taken any borrowing in foreign currency, then the exchange rate fluctuation will also be amortised to the extent they are regarded as an adjustment of interest costs. Ex: An enterprise has taken a loan from foreign financial institutions when the rate of US $ was 64, while at the end of the financial year the rate of US $ was 65. The rate difference of US $ 1 will be treated as Borrowing Cost.