A Refresher Course on Current Financial Reporting Standards 2013 (Day 2) HKAS 23 Borrowing Costs

Transcription

1 A Refresher Course on Current Financial Reporting Standards 2013 (Day 2) HKAS 23 Borrowing Costs 1

2 COOPERATION REQUESTED Please make sure that your mobile phones and pagers have been switched off or turned to the vibration mode 2

3 DISCLAIMER The Hong Kong Institute of Certified Public Accountants and the speakers DO NOT accept any responsibility or liability, and DISCLAIM all responsibilities and liabilities, in respect of the contents of this workshop and any consequences that may arise from any person acting or refraining from action as a result of any materials in this course. Any reliance on the materials in this workshop is solely at the user s risk. 3

4 HKAS 23 Borrowing Costs 4

5 Agenda Core principle of HKAS 23 Borrowing costs Qualifying assets Costs eligible for capitalisation Period of capitalisation of directly attributable costs and borrowing costs Disclosures 5

6 Agenda Core principle of HKAS 23 6

7 HKAS 23 Core principle Capitalise borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset Exceptions: (i) qualifying assets measured at fair value (ii) inventories that are manufactured or produced in large quantities on a repetitive basis Other borrowing costs are recognised as an expense Borrowing costs are reduced by interest income from the temporary investment of borrowings [HKAS 23.4,8] 7

8 HKAS 23 Core principle Questions: Has the entity incurred borrowing costs? Does the entity have a qualifying asset? Has the entity incurred expenditure on the qualifying asset? Are activities undertaken that are necessary to prepare the asset for its intended use or sale? 8

9 Agenda Core principle of HKAS 23 Borrowing costs 9

10 Borrowing costs Borrowing costs are defined in HKAS 23 as "Interest and other costs that an entity incurs in connection with the borrowing of funds" Borrowing costs may include: Interest expense calculated using the effective interest method Finance charges in respect of finance leases recognised in accordance with HKAS 17 Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs [HKAS 23.5,6] 10

11 Agenda Core principle of HKAS 23 Borrowing costs Qualifying assets 11

12 Qualifying asset A qualifying asset is defined as "an asset that necessarily takes a substantial period of time to get ready for its intended use or sale" There is no specific guidance on how long a "substantial period of time" is. Judgment required. The term "necessarily" is included in the definition of a qualifying asset to indicate that the nature of the asset should be such that it takes a long time to get it ready for its intended use or sale. Therefore, an asset that takes a long time to prepare for use or sale only because of inefficiencies in the development process is not a qualifying asset 12

13 Qualifying asset (cont'd) Qualifying assets are not limited to property, plant and equipment, but also include assets such as inventories that require a 'substantial period of time' to bring them to a saleable condition (e.g. Whisky or property held for sale) Assets that are ready for their intended use or sale when acquired are not qualifying assets, even if expenditure subsequently is incurred on the asset [HKAS 23.5,7] 13

14 Examples of qualifying assets Assets that may be qualifying assets inventories; intangible assets; Non-qualifying assets assets that are ready for their intended use or sale when acquired; investment properties; manufacturing plants; and power generation facilities financial assets; and inventories that are manufactured, or otherwise produced, over a short period of time 14

15 Example: whether an equity-accounted investment can be a qualifying asset Background Company X invests in construction contracts via participating interests in single-purpose entities. The entities are generally either associates or jointly controlled entities of Company X, which accounts for all such investments using the equity method of accounting. Where Company X borrows funds for the purpose of funding its investments, should it capitalise borrowing costs as part of the carrying amount of the equity-accounted investments? Answer Borrowing costs should not be capitalised in these circumstances. HKAS 23.7 states that financial assets are not qualifying assets. 15

16 Example: Whether an asset being refurbished can be a qualifying asset? Background An entity owns and manages a hotel. The hotel is closed down for a major refurbishment. The refurbishment costs will be capitalised and the refurbishment will take 18 months. Answer There is no guidance in HKFRSs regarding whether an asset that is being refurbished can be a qualifying asset. An asset being refurbished can be a qualifying asset if the refurbishment costs qualify for capitalisation, and the refurbishment will take a substantial period of time 16

17 Agenda Core principle of HKAS 23 Borrowing costs Qualifying assets Costs eligible for capitalisation 17

18 Borrowing costs eligible for capitalisation Borrowing costs eligible for capitalisation may include: Interest expense calculated using the effective interest method, include: Interest on specific borrowings to obtain the qualifying asset Interest on general borrowings Finance charges in respect of finance leases 18

19 Costs eligible for capitalisation Directly attributable borrowing costs should be capitalised Directly attributable means that those borrowing costs that would have been avoided if there had been no expenditure on the asset Specific borrowings versus general borrowings The amount of borrowing costs to be capitalised is calculated on a pre-tax basis. Borrowing costs that are capitalised may give rise to deferred tax 19

20 Amount of borrowing costs to be capitalised Specific borrowings Actual borrowing costs incurred on funds borrowed specifically for the purpose of acquiring or constructing a qualifying asset Any investment income earned on the temporary investment of the funds borrowed, pending their expenditure on the qualifying asset The amount of borrowing costs eligible for capitalisation [HKAS 23.12, 13] 20

21 Example: Qualifying asset funded by specific borrowings Background An entity borrowed $1M specifically to finance the cost of constructing a new office. The loan was drawn on 1 Feb 2012 and the entity paid interest at 12% on the loan until 1 Nov 2012 when the interest rate increased to 13%. Construction on the building does not begin until 1 Sept 2012 and continues until after the year ended 31 Dec The entity incurred directly attributable costs of $100,000 in Sept 2012 and $250,000 in each month from Oct 2012 to Dec Each month the borrowings, less any amount that is to be expended for the building works in that month are re-invested and earn interest at a rate of 5% per annum. 21

22 Example: Qualifying asset funded by specific borrowings (cont'd) Interest capitalised: The interest paid and received during the period of construction: Balance outstanding Interest Interest payable for Sept 2012 at 12% 10,000 Interest payable for Oct 2012 at 12% 10,000 Interest payable for Nov 2012 at 13% 10,833 Interest payable for Dec 2012 at 13% 10,834 Total interest payable during period of construction to Dec ,667 Interest receivable on re-invested funds of $900,000 in Sept ,750 Interest receivable on re-invested funds of $650,000 in Oct ,708 Interest receivable on re-invested funds of $400,000 in Nov ,667 Interest receivable on re-invested funds of $150,000 in Dec Total interest receivable to end Dec ,750 Net interest cost capitalised 32,917 22

23 Amount of borrowing costs to be capitalised General borrowing costs Expenditure on the qualifying assets Capitalisation rate [HKAS 23.14] Amount of borrowing costs eligible for capitalisation should be reduced by any pre-sale deposits, progress payments or grants received in connection with the qualifying asset The average carrying amount of the asset during a period, including borrowing costs previously capitalised, is normally a reasonable approximation of the expenditures to which the capitalisation rate is applied in that period Total general borrowing cost for the period (i.e. other than specific borrowings relating to qualifying assets) Weighted average total general borrowings (i.e. other than those specific borrowings) 23

24 Example: Qualifying asset funded from a general borrowing pool Background An entity centrally co-ordinates its financing activities through a treasury function, with borrowings being raised to finance general requirements, including the acquisition and development of qualifying assets During the year ended 31 December 2012, the entity commenced a property development project and incurred the following expenditure: HK$' 000 June 1 5,000 October 1 10,000 November 1 10,000 24

25 Example: Qualifying asset funded from a general borrowing pool (cont'd) Background (cont'd) The entity had total borrowings outstanding during the period, and incurred interest on those borrowings, as follows: Balance outstanding Interest Long term loans HK$'000 HK$'000 Short-term loans* 10 years at 10% 35,000 3,500 5 years at 8% 10, ,000 1,600 Bank overdraft* 5, ,000 6,400 * The amounts disclosed for short-term loans and the bank overdraft represent the average amounts outstanding during the period and the interest incurred at variable 25 rates

26 Example: Qualifying asset funded from a general borrowing pool (cont'd) Question How much should Entity A capitalise its borrowing cost? Answer Capitalisation rate: Total borrowing costs for the period 6,400 Weighted average total borrowings = 62,000 = 10.32% Interest capitalised is therefore calculated as follows: HK$'000 HK$5M x 7/12 x 10.32% 301 HK$10M x 3/12 x 10.32% 258 HK$10M x 2/12 x 10.32% 172 Interest capitalised for the period

27 Limits on borrowing costs capitalised The capitalisation of general borrowing costs calculated using the capitalisation rate is subject to the condition that the amount of borrowing costs capitalised should not exceed the actual borrowing costs incurred during that same period [HKAS 23.14] 27

28 Limits on borrowing costs capitalised During 2012, CEF Ltd incurred general borrowings on 1 January for a general loan of $50,000 at 4% per annum. It also issued a debenture of $200,000 on 1 April 2012 at 5% per annum. CEF Ltd. Is constructing numerous qualifying assets and had capitalised $9,000 borrowing costs on other qualifying assets, excluding the qualifying asset A, for the year ended 31 December Expenses incurred as from 1 May 2012 on this qualifying asset A was $45,000. What are capitalised borrowing rate? How much costs should be capitalised? 28

29 Limits on borrowing costs capitalised During 2012, CEF Ltd incurred general borrowings on 1 January for a general loan of $50,000 at 4% per annum. It also issued a debenture of $200,000 on 1 April 2012 at 5% per annum. CEF Ltd. Is constructing numerous qualifying assets and had capitalised $9,000 borrowing costs on other qualifying assets, excluding the qualifying asset A, for the year ended 31 December Expenses incurred as from 1 May 2012 on this qualifying asset A was $45,000. Capitalisation rate: 4.75% - Interest expense: $9,500 - weighted average loan amount: [(50,000) + (200,000 x 9/12)] = $200,000 Interest on qualifying asset: ($45,000 x 4.75%) x 8/12 = $1,425 Borrowing costs to the amount of $500 would be capitalised on the qualifying asset A The balance of $925 would not be capitalised, since total borrowing costs capitalised would then exceed total borrowing cost incurred 29

30 Calculation in the consolidated financial statements No specific guidance in HKFRSs related to the calculation in consolidated financial statements. Judgment is required. Where the treasury function is managed within the group - may include all borrowings of a parent and its subsidiaries when calculating the weighted average borrowing costs Where each subsidiary is responsible for managing its own treasury, may be appropriate for each subsidiary to calculate the weighted average applicable to its own borrowings Only external borrowings should be considered in calculating a weighted average group borrowing rate 30

31 Background Example: Borrowing cost capitalised A group consists of the parent and two subsidiaries. Sub 1 is engaged in the construction of a power plant that is wholly financed by fellow subsidiary 2, which obtains the necessary funds through bank borrowings. No intra group interest is charged by Subsidiary 2 to subsidiary 1 Question Can interest be capitalised? Answer No interest should be capitalised in either of the individual financial statements of subsidiary 1 and subsidiary 2 under these circumstances. Subsidiary 1 has incurred no borrowing costs, and subsidiary 2 has no qualifying asset Interest will be capitalised in the consolidated financial statements of the parent, provided that the amount capitalised fairly reflect the interest cost to the group of borrowings from third parties which could have been avoided if the expenditure on the qualifying asset had not been made 31

32 Example: Exchange differences to be included in borrowing costs An entity which prepares its financial statements in Thai Baht (the entity's functional currency) enters into a borrowing arrangement, with the following terms and conditions: Drawdown amount (in the foreign currency) US $100M Drawdown date 1 January 2012 Exchange rate at drawdown Interest rate on foreign borrowings (fixed) Interest rate on similar borrowing in Thailand as at the drawdown date (fixed) Average exchange rate for 2012 Closing exchange rate for 2012 Baht 25: US$1 6% per annum 12% per annum Baht 36: US$1 Baht 47: US$1 32

33 Example: Exchange differences to be included in borrowing costs (cont'd) The following interest payments were made in 2012: Interest payments (6% X US$100M) Translated at average rate US$6M Baht 216 million The borrowing costs that would have been incurred in the 2012 reporting period if the funds had been borrowed in Baht: Baht equivalent of US$100M at 1 January 20X1 Annual interest expense based on Thai interest rates (12%) Baht 2,500 million Baht 300 million Baht 84 million is the limit on the amount to be classified as borrowing costs. 33

34 Example: Exchange differences to be included in borrowing costs (cont'd) The foreign exchange loss incurred on the retranslation of the principal amount of the US$100 million borrowings during 2012 is calculated as follows: Baht equivalent at opening rate of Baht 25: US$1 Baht equivalent at closing rate of Baht 47: US$1 Foreign exchange loss Baht 2,500 million Baht million Baht 2,200 million The amount of borrowing costs included in the cost of assets under construction for 2012 = Baht 300 million (the Baht equivalent of the US$ interest paid of Baht 216 million plus Baht 84 million of the exchange loss arising on the principal amount). This is equal to the interest expense that would have been incurred if the funds had been borrowed in Thailand based on commercial interest rate at that time The remaining exchange loss on the principal (Baht 2,116 million) is recognised in profit or loss in the year 34

35 Agenda Core principle of HKAS 23 Borrowing costs Qualifying assets Costs eligible for capitalisation Period of capitalisation of directly attributable costs and borrowing costs 35

36 Period of capitalisation [HKAS 23.17,19] Commencement date Capitalisation Period Cessation date The commencement date for capitalisation is the date when the following three conditions are first met: expenditures for the asset are being incurred borrowing costs are being incurred; and activities that are necessary to prepare the asset for its intended use or sale are being undertaken Capitalisation should cease when substantially all of the activities necessary to prepare the qualifying asset for its intended use or sale are complete Such activities include initial technical and administrative work, such as activities associated with obtaining permits, prior to the commencement of the physical construction of the asset [HKAS 23.19] The mere holding of an asset without any associated development activities does not entitle an entity to capitalise related borrowing costs [HKAS 23.19] e.g. holding land banks 36

37 Suspension of capitalisation Suspension Capitalisation continue Capitalisaion of interest is suspended during extended periods in which active development is interrupted e.g. waiting for parts to arrive, cash flow difficulties, desire to hold back development due to economic downturn Capitalisation may continue during a temporary delay caused by an external event, e.g. rain or flooding, technical or legal obstacles that are typical part of the process No guidance on what length of time is considered "extended delay" 37

38 Qualifying assets construction in stages A qualifying asset is constructed in stages, and each stage or part can be used or sold individually while construction of the remaining development continues Capitalisation of the borrowing costs related to that part should cease when substantially all of the activities necessary to prepare that part for its intended use or sale are completed [HKAS 23.24] e.g. a development comprising several buildings or units, each of which can be used or sold individually Borrowing costs should be capitalised until all of the activities necessary to prepare the entire asset for its intended use or sale are substantially complete E.g. a manufacturing facility involving a sequence of processes, where production cannot begin until all the processes are in place Capitalisation ceases when the activities necessary to prepare the asset for its intended use or sale are substantially complete 38

39 Recognition of an impairment loss or write-down When the carrying amount or the expected ultimate cost of the qualifying asset exceeds its recoverable amount or net realisable value, the carrying amount is written down or written off in accordance with the requirements of other HKFRSs. [HKAS 23.16] Capitalised the interest cost as part of the gross carrying amount of the asset, and then recognise an impairment loss for any excess over the estimated recoverable amount or net realisable value in accordance with the requirements of HKAS 36 "Impairment of Assets" or HKAS 2 "Inventories", as appropriate 39

40 Agenda Core principle of HKAS 23 Borrowing costs Qualifying assets Costs eligible for capitalisation Period of capitalisation of directly attributable costs and borrowing costs Disclosures 40

41 Disclosures Entities are required to disclose: [HKAS 23.26] the amount of borrowing costs capitalised during the period; and the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation 41