Emerging Issues Capitalisation Of Borrowing Costs:

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Matthew Stevenson
6 years ago
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1 CR summarise changes in companies' reporting practice and collate changes identified previously in our CR Monitors. These reports address the most immediate issues facing companies reporting under IFRS, identify trends and highlight areas of evolving or divergent practices. The sample of companies covered reflects a mix of country, auditor and industrial classification. An Extract focusing on each company s disclosure accompanies the report. This report examines the extent to which companies follow disclosure requirements when capitalising interest costs. Our conclusion is that we are puzzled as to why some companies are unable to comply with what are minimal disclosure requirements. Introduction This report focuses on companies that have capitalised borrowing costs and assesses the extent to which they follow minimal requirements to disclose the amount of borrowing costs capitalised and the capitalisation rate used. Our sample consists of 14 European companies drawn from the S&P Europe 250 index that report under International Financial Reporting Standards. Their reporting periods range from December 2009 to December 2010 and all have been reviewed previously in a CR Monitor. Summary Our analysis of financial statements during 2010 has shown that companies began to capitalise borrowing costs that they had previously expensed. This was driven by revised IAS 23 Borrowing costs that required capitalisation of borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset. As the disclosure requirements of IAS 23 are entirely straightforward, we believe it would have been reasonable to expect all companies to comply. This expectation was not fulfilled. Whilst two out of our sample stated there had been no significant impact, only six published what we considered to be full disclosure. Reporting framework Previously, the benchmark treatment of IAS 23 was for borrowing costs to be recognised as an expense in the period in which there were incurred. An allowed alternative treatment was for capitalisation where they were attributable to qualifying assets. Revisions were made to IAS 23 as part of the convergence project conducted jointly by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board. The IASB considered that application of only one treatment would enhance comparability and, in a move that achieved convergence in principle with US GAAP, decided to eliminate the previous benchmark treatment. For accounting periods beginning on or after 1 January 2009, IAS 23 requires that all borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset be capitalised as part of the cost of that asset. Its disclosure requirements are minimal in that a company is required only to disclose the amount of borrowing costs capitalised during the period and the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation. 1

2 Companies under review Early in the year, we noted that Danish biotechnology company Novozymes had adopted revised IAS 23 and disclosed both the amount of interest capitalised and the rate used. Swiss pharmaceutical company Novartis previously indicated that it did not expect revised IAS 23 to have a significant impact. It discloses $1 million costs have been capitalised but does not specify a capitalisation rate. Finnish engineering company Wärtsilä states that there has been no significant impact. Swedish paper manufacturer Holmen discloses amounts capitalised and that they have been classified as work in progress and advance payments and the rate used. In contrast, whilst Swedbank states that it has applied IAS 23, it omits any disclosure of amounts capitalised and the rate applied. French retailer Casino, Guichard-Perrachon identifies that, although it continues to expense interest on projects that commenced before 1 January 2009, it has adopted revised IAS 23 prospectively. It discloses interest capitalised of 3 million and an average rate of 7.43%. Although Austrian steel manufacturer voestalpine discloses that the costs capitalised during the year are immaterial, it does disclose the average rate. Telecoms company BT and utility company Severn Trent, both of the UK, follow IAS 23 in full by disclosing the amounts capitalised and the rates. In contrast, neither broadcaster British Sky Broadcasting nor building materials supplier Wolseley make any disclosure. Meanwhile, UK technology company Smiths indicates there has been no material impact while food producer Associated British Foods discloses the amount capitalised but not the rate. Most recently, Danish Wind Turbine manufacturer Vestas Wind Systems discloses that it has capitalised 1 million borrowing costs at a rate of 3.9%. Conclusion The requirement of IAS 23 that companies disclose the amount of borrowing costs capitalised during the period and the capitalisation rate used is not onerous. Nevertheless, we are puzzled as to why not all companies covered by our review have been able to follow this and it is not at all clear why they fail to make these minimal disclosures. 2

3 NOVOZYMES A/S Period End: 31 December 2009 Industry classification (ICB): 4573 Biotechnology Line of business: Production of enzymes for industrial applications Auditors: PricewaterhouseCoopers, Bagsvaerd Novozymes has also adopted revised IAS 23 which eliminates the option to expense borrowing costs eligible for capitalisation. Its previous policy was to expense these costs. The company indicates that it commenced capitalisation in 2009, costs capitalised during the year amount to DKK7 million (para 26(a)) and that the capitalisation rate used is 3.4%. 3

NOVARTIS AG Period End: 31 December 2009 Industry classification (ICB): 4577 Pharmaceuticals Line of business: Pharmaceuticals and consumer health Auditors: PricewaterhouseCoopers, Basel Novartis

4 NOVARTIS AG Period End: 31 December 2009 Industry classification (ICB): 4577 Pharmaceuticals Line of business: Pharmaceuticals and consumer health Auditors: PricewaterhouseCoopers, Basel Novartis discloses that, from 1 January 2009, it has commenced capitalising borrowing costs associated with the construction of property, plant and equipment, although such costs relating to projects commencing before that date have been expensed. Prospective application follows revised IAS 23, though retrospective application is also permitted. Last year, the company stated that it did not expect adoption of revised IAS 23 to have a significant impact on its financial statements. The company discloses that $1 million such costs are capitalised in the current year, but not the capitalisation rate. 4

5 WÄRTSILÄ CORPORATION Period End: 31 December 2009 Industry classification (ICB): 2757 Industrial Machinery Line of business: Marine and energy power propulsion systems Auditors: KPMG, Helsinki Wärtsilä adopts revised IAS 23 and commences capitalising borrowing costs directly attributable to the acquisition, construction or production, and completion of assets where this requires a considerable length of time. However, it states that the change has no significant impact. We recently noted Novozymes and Novartis adopt revised IAS 23, which is effective for periods beginning on or after 1 January 2009, with similar small scale effects in increased capitalisation. Basis of preparation

HOLMEN AB Period End: 31 December 2009 Industry classification (ICB): 1737 Paper Line of business: Production of paper, paperboard and timber Auditors: KPMG, Stockholm Holmen has adopted amended IAS

6 HOLMEN AB Period End: 31 December 2009 Industry classification (ICB): 1737 Paper Line of business: Production of paper, paperboard and timber Auditors: KPMG, Stockholm Holmen has adopted amended IAS 23 and commenced capitalisation prospectively from 1 January It discloses in the note on property, plant and equipment that SEK1 million costs have been capitalised in the year, classified as work in progress and advance payments to suppliers and that an interest rate of 3% has been used to determine the amount. Note 11 Property, plant and equipment 6

7 SWEDBANK AB Period End: 31 December 2009 Industry classification (ICB): 8355 Banks Line of business: Bank Auditors: Deloitte, Stockholm Swedbank states that the European Union approved in 2009 revised IAS 23, applicable from 1 January 2009 and it has applied the Standard this year. This requires capitalisation of borrowing costs on qualifying assets. However, there is no disclosure of the amount capitalised or of the capitalisation rate, falling short of the required disclosures. CASINO, GUICHARD-PERRACHON SA Period End: 31 December 2009 Industry classification (ICB): 5337 Food Retailers & Wholesalers Line of business: Food and drug retailers Auditors: Ernst & Young, Lyon and Didier Kling, Paris Casino, Guichard-Perrachon (Casino) adopts revised IAS 23 prospectively from the start of the current year. The company states that it now capitalises borrowing costs as part of the cost of an assets where they are directly attributable to the acquisition, construction or production of a qualifying asset. However, it adds that interest capitalised in the current year was only 3 million and that an average interest rate of 7.43% was applied. Casino states that it continues to expense interest on projects with commencement dates prior to 1 January We have recently seen Novozymes and Wärtsilä adopt revised IAS 23 from the start of

8 VOESTALPINE AG Period End: 31 March 2010 Industry classification (ICB): 1757 Iron & Steel Line of business: Production, working and distribution of steel products Auditors: Grant Thornton, Vienna voestalpine discloses that application of revised IAS 23 constitutes a change in its policy for borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset. It states that these costs are now capitalised whereas previously they were expensed and that 1 April 2009, the start of its current annual period, was the commencement date for capitalisation. In contrast, we have seen some companies adopt revised IAS 23 and designate a commencement date earlier than the beginning of their annual periods in which the adoption was made. These include Diageo which applied revised IAS 23 in the annual period ending 30 June 2009 but designated July 2007 as the commencement date. voestalpine discloses that immaterial borrowing costs have been capitalised during the year and that the average capitalisation rate is 4.4%. 9. Property, plant and equipment 8

BT GROUP PLC Period End: 31 March 2010 Industry classification (ICB): 6535 Fixed Line Telecommunications Line of business: Supply of telecommunication services and equipment, FTSE 100 Auditors:

9 BT GROUP PLC Period End: 31 March 2010 Industry classification (ICB): 6535 Fixed Line Telecommunications Line of business: Supply of telecommunication services and equipment, FTSE 100 Auditors: PricewaterhouseCoopers, London Last year, BT expensed borrowing costs in the income statement as incurred. This year the company commences capitalisation of borrowing costs relating to qualifying assets which take more than 12 months to complete, from 1 April This follows the adoption of revised IAS 23. The company discloses that it has capitalised 3 million borrowing costs in the current year and that the assets concerned were property, plant and equipment under construction and software development costs. It shows the amount as a deduction in its analysis of net finance expense and discloses that the weighted average capitalisation rate on general borrowings was 7.9%. 9

SEVERN TRENT PLC Period End: 31 March 2010 Industry classification (ICB): 7577 Water Line of business: Supply of water, treatment and disposal of sewage, FTSE 100 Auditors: Deloitte, London Severn

10 SEVERN TRENT PLC Period End: 31 March 2010 Industry classification (ICB): 7577 Water Line of business: Supply of water, treatment and disposal of sewage, FTSE 100 Auditors: Deloitte, London Severn Trent has adopted revised IAS 23 and changes from expensing borrowing costs on qualifying assets to capitalising such costs. It designates 1 April 2009 as the commencement date for capitalisation and discloses that 2.6 million borrowing costs on its property, plant and equipment have been capitalised, using a 5.65% rate. 10

11 BRITISH SKY BROADCASTING GROUP PLC Period End: 30 June 2010 Industry classification (ICB): 5553 Broadcasting & Entertainment Line of business: Operation of pay television services, FTSE 100 Auditors: Deloitte, London Last year, British Sky Broadcasting expensed borrowing costs. This year, the company adopts revised IAS 23 and explains that it capitalises borrowing costs directly attributable to the acquisition of qualifying assets. It explains that, to the extent that the financing of a qualifying asset is part of its general borrowings, it calculates interest to be capitalised based on its weighted average cost of borrowing, excluding any specific borrowings. However, no figures are disclosed. SMITHS GROUP PLC Period End: 31 July 2010 Industry classification (ICB): 2727 Diversified Industrials Line of business: Manufacture of security and medical equipment and seals, FTSE 100 Auditors: PricewaterhouseCoopers, London Smiths has adopted revised IAS 23 Borrowing costs in the year. Whilst it notes that this had not yet had a material impact, the company discloses that development projects expected to take a substantial period of time and which commenced on or after the start of the current year will include attributable borrowing costs. The company currently has 87 million development costs on its balance sheet. Accounting policies Basis of preparation

12 WOLSELEY PLC Period End: 31 July 2010 Industry classification (ICB): 2797 Industrial Suppliers Line of business: Distribution of plumbing and other building materials, FTSE 100 Auditors: PricewaterhouseCoopers, London This year, Wolseley states that borrowing costs directly attributable to long-term construction or production of an asset are capitalised. Last year, it stated that borrowing costs attributable to assets under construction were charged to the income statement as incurred. This coincides with revision to IAS 23, though the company does not refer to this. 12

13 ASSOCIATED BRITISH FOODS PLC Period End: 18 September 2010 Industry classification (ICB): 3577 Food Products Line of business: Processing of food and retailing of textiles, FTSE 100 Auditors: KPMG, London Associated British Foods discloses that it has changed accounting policy prospectively to capitalise interest on qualifying assets from the current year. This follows revision to IAS 23 which requires interest to be capitalised as part of the cost where conditions are met. The company discloses in the note on property, plant and equipment that 1 million interest is capitalised, but not the interest rate applied. We recently noted Severn Trent in 2010 commence capitalising interest from the current year, disclosing also the interest rate applied; whilst Diageo in 2009 designated a 2007 commencement date. 13

14 VESTAS WIND SYSTEMS A/S Period End: 31 December 2010 Industry classification (ICB): 0583 Renewable Energy Equipment Line of business: Development, manufacture and sale of wind power turbines Auditors: PricewaterhouseCoopers, Copenhagen The company discloses that it has capitalised 1 million borrowing costs relating to property, plant and equipment and development projects at a rate of 3.9%. This follows IAS

CR Common Practices Leases

CR Common Practices Leases Introduction IAS 17 was originally issued in 1997 and has been revised since then. One recent amendment was incorporated by Improvements to IFRSs issued by the IASB in April 2009 and this relates to the