BORROWING COSTS. Jeremiah Oliech Thursday, 4 th May Uphold public interest

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1 BORROWING COSTS Jeremiah Oliech Thursday, 4 th May 2017 Uphold public interest

2 Learning objectives Presentation agenda Scope, objectives and definitions Identify qualifying assets and borrowing costs eligible for capitalization Assess when capitalization should start and stop Disclosure requirements for the notes to financial statements

3 Learning objectives Introduction Describe the scope, objectives and definitions Identify qualifying assets and borrowing costs eligible for capitalization Assess when capitalization should start and stop Discuss disclosure requirements for the notes to financial statements.

4 Related Standards IAS 2 Inventories IAS 16 Property, plant and equipment IAS 38 Intangible assets IAS 40 Investment property 4

5 Objective and Scope Principle The cost of an asset should include all costs incurred that are necessary to get it ready for its intended use. IAS 23 sets out requirements for capitalizing financing costs related to the acquisition, construction, or production of a qualifying asset. 5

6 Core Principle Core principle of IAS 23 entity should capitalize borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset other borrowing costs are recognised as an expense. Recognize borrowing costs (during construction or production) on qualifying assets as part of the cost of those assets as long as: 1. they will result in future benefits 2. they can be measured reliably

7 Definitions Borrowing costs are interest and other expenses incurred by an entity 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

8 Scope Apply in accounting for borrowing costs No requirement to apply to borrowing costs related to : a qualifying asset measured at fair value; or inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis

9 Scope Benchmark Treatment Recognition Borrowing costs shall be recognized as an expense in the period in which they are incurred. Under the benchmark treatment, borrowing costs are recognized as an expense in the period in which they are incurred, regardless of how the borrowings are applied. Disclosure The financial statements shall disclose the accounting policy adopted for borrowing costs.

10 Scope Scope Allowed Alternative Treatment Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset shall be capitalized as part of the cost of that asset. The amount of borrowing costs eligible for capitalization shall be determined in accordance with this Standard.

11 Borrowing costs Core Principle Interest and other costs incurred by an entity in connection with the borrowing of funds Borrowing costs may include: Interest expense calculated using the effective interest rate method as described in IAS 39; finance charges in respect of finance leases; and exchange differences to the extent that they are regarded as an adjustment to interest costs No actual or imputed cost of equity

12 Borrowing costs Core Principle Borrowing costs are interest and other expenses incurred by an entity in connection with the borrowing of funds. Borrowing costs may include:- Interest on overdraft facilities or 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 for finance leases; and Exchange differences arising from foreign currency borrowings to the extent that they qualify as an adjustment to interest costs.

13 Core Principle Qualifying assets Asset that necessarily takes a substantial period of time to get ready for its intended use or sale Depending on the circumstances, any of the following may be qualifying assets: inventories manufacturing plants power generation facilities intangible assets investment properties

14 Measurement Borrowing costs Directly attributable Would have been avoided Specific borrowings Actual borrowing costs less any investment income on the temporary investment of borrowed funds General borrowings Weighted average borrowing rate

15 Period of capitalisation Expenditure begins Borrowing costs incurred Activities in progress Activities suspended Funds borrowed Activities suspended, but substantial technical or admin work Asset is ready for intended use Start to use % to deduct Start Continue Suspend Stop

16 Core Principle Commencement of capitalization Commence capitalisation when: Expenditures for asset are being incurred, AND Borrowing costs are being incurred, AND Activities necessary to prepare asset for intended use or sale are in progress

17 Core Principle Suspension of capitalization Suspend capitalisation during extended periods in which active development interrupted However, continue to capitalise during: temporary delay that is caused by external event interruption caused by technical or legal obstructions that are a typical part of process activities suspended, but substantial technical or admin work to be carried out

18 Cessation of capitalisation Cease capitalization when substantially all activities necessary to prepare qualifying asset for intended use or sale complete

19 Disclosure Disclosures 1. The amount of borrowing costs capitalized during the period, and 2. The capitalization rate used to determine the costs eligible for capitalization

20 Example EXAMPLE Question: On 1st May 2016, UON took a loan of KShs from a bank at the annual interest rate of 5%. The purpose of this loan was to finance a construction of a production hall. The construction started on 1 June UON temporarily invested KShs borrowed money during the months of June and July 2016 at the rate of 2% p.a. What borrowing cost can be capitalized in 2016? (Assume all interest was paid).

21 Example EXAMPLE Although the funds were withdrawn on 1st May, the capitalization can start only on 1st June 2016 when all criteria were met (the construction had not started until 1st June).

22 Example EXAMPLE Calculation: Interest expense: KShs x 5% x 7/12 = KShs Note: this is very simplified calculation and if the loan is repayable in instalments, then you need to take the real interest incurred (by the effective interest method). Less investment income: KShs x 2% x 2/12 = KShs Total borrowing cost to capitalize in 2016: KShs Just don t forget that the borrowing cost in May 2016 is expensed in profit or loss, as the capitalization criteria were not met in that period.

23 Thank you

24 Interactive Session

SLAS 20. Sri Lanka Accounting Standard SLAS 20. Borrowing Costs

SLAS 20. Sri Lanka Accounting Standard SLAS 20. Borrowing Costs Sri Lanka Accounting Standard SLAS 20 Borrowing Costs 290 Contents Sri Lanka Accounting Standard SLAS 20 Borrowing Costs Objective Scope Paragraphs 1-2 Definitions 3-5 BORROWING COSTS - BENCHMARK TREATMENT