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MFRS 123 BORROWING COSTS

DEFINITION
Borrowing costs are interest and other costs that an entity incurs in connection with the
borrowing of funds.
Borrowing costs may include:
(a) Interest expense calculated using the effective interest method as described in MFRS
139 Financial Instruments: Recognition and Measurement,
(b) Finances charges in respect of finance leases recognised in accordance with MFRS
117 Leases; and
(c) Exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs.
RECOGNITION
An entity shall capitalize borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset as part of that asset. An entity shall recognise
other borrowing costs as an expense in the period in which it incurs them.
Borrowing costs that are directly attributable to the acquisition, construction or production of
a qualifying asset are included in the cost of the asset. Such borrowing costs are capitalized as
part of the cost of the asset when it is probable that they will result in future economic
benefits to the entity and the costs can be measured reliably.

MFRS 123 BORROWING COSTS

MEASUREMENT
When an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the
entity should consider three items, which are qualifying assets, capitalization period and
amount to capitalize.
Qualifying Assets
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready
for its intended use or resale.
Depending on the circumstances, any of the following may be qualifying assets:
(a) Inventories
(b) Manufacturing plants
(c) Power generation facilities
(d) Intangible assets
(e) Investment properties
Financial assets, and inventories that are manufactured, or otherwise produced, over a short
period of time, normally less than one year or less than one financial period, are not
qualifying assets.
Assets that are ready for their intended use or sale when acquired are not qualifying assets.
Capitalization Period
The capitalization period is the period of time during which a company must capitalize
interest. It begins with the presence of the following conditions:
(a) Expenditures for the asset are being incurred.
(b) Activities those are necessary to get the asset ready for its intended use or sale in progress.
(c) Interest cost is being incurred.
Interest capitalization continues as long as these conditions are present. The capitalization
period ends when the asset is substantially complete and ready for its intended use.

MFRS 123 BORROWING COSTS

Amount to Capitalize
The amount of interest to capitalize is limited to the lower of actual interest cost incurred
during the period or avoidable interest.
Avoidable interest is the amount of interest cost during the period that an entity could
theoretically avoid if it had not made expenditures for the asset.
To apply the avoidable interest concept, an entity determines the potential amount of interest
that it may capitalize during an accounting period by multiplying the appropriate interest
rate(s) by the weighted-average accumulated expenditures for qualifying assets during the
period.
Weighted-Average Accumulated Expenditures (WAAE):
In computing the WAAE, an entity weights the construction expenditures by the amount of
time (fraction of year or accounting period) that it can incur interest cost on the expenditure.
Expenditures Capitalization Period=WAAE
Interest Rates:
Entities follow these principles in selecting the appropriate interest rates to be applied to the
WAAE:
(a) For the portion of WAAE that is less than or equal to any amounts borrowed specifically
to finance construction of the assets, use the interest rate incurred on the specific
borrowings.
(b) For the portion of WAAE that is greater than any debt incurred specifically to finance
construction of the assets, use a weighted average of interest rates incurred on all other
outstanding debt during the period.
Capitalization rate=

Total interest
Total principal

MFRS 123 BORROWING COSTS

Special Issues Related to Interest Capitalization:


(a) Expenditures for land
When an entity purchases land as a site for a structure (such as a plant site), interest costs
capitalized during the period of construction are part of the cost of the plant, not the land.
(b) Interest revenue
Interest revenue should be offset against interest cost when determining the amount of
interest to capitalize.

DISCLOSURE
An entity shall disclose:
(a) the amount of borrowing costs capitalized during the capitalization period and
(b) the capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

MFRS 123 BORROWING COSTS


PRESENTATION

On November 1, 2010, Shalla Company contracted Pfeifer Construction Co. to construct a


building for RM 1,400,000 on land costing RM 100,000 (purchased from the contractor and
included in the first payment). Shalla made the following payments to the construction
company during 2011.
Date

Amount (RM)

Jan 1

210,000

March 1

300,000

May 1

540,000

Dec 31

450,000
1,500,000

Total

Construction was completed the building was ready for occupancy on December 31, 2011.
Shalla Company had the following debt outstanding at December 31, 2011.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and construction of the building, dated
December 31, 2010, with principal on December 31 RM 750,000.
Other Debt
2. 10%, 5-year note payable, dated December 31, 2007, with principal on December 31
RM 550,000.
3. 12%, 10-year bond issued December 31, 2006, with principal on December 31 RM
600,000.
Interest revenue earned in 2011 on funds related to specific borrowing RM 10,000.

MFRS 123 BORROWING COSTS


Compute WAAE for 2011:
Expenditures

Current-Year

WAAE

Date
January 1
March 1
May 1
December 1

Amount Capitalization Period


RM 210,000
12/12
300,000
10/12

540,000
8/12
450,000
0
RM 1,500,000

RM 210,000
250,000
360,000
0
RM 820,000

Compute the avoidable interest:


WAAE
RM 750,000
70,000*
RM 820,000

Interest
Rate
15%
11.04%**

Avoidable Interest
RM 112,500
7,728
RM 120,228

* The amount by which the WAAE exceeds the specific loan.


** Weighted-average interest rate computation:
Principal
RM 550,000
600,000
RM 1,150,000

10%, 5-year note


12%, 10-year bond

Weightedaverage interest rate=

Interest
RM 55,000
72,000
RM 127,000

Total interest
RM 127,000
=
=11.04
Total principal RM 1,150,000

MFRS 123 BORROWING COSTS


Compute the actual interest cost, which represents the maximum amount of interest that it
may capitalize during 2011:
Construction note

RM 750,000 15

= RM 112,500

5-year note

RM 550,000 10

= RM 55,000

10-year bond

RM 600,000 12

= RM 72,000

Actual interest cost

RM 239,500

The interest cost that Shalla capitalizes is the lesser of RM 120,228 (avoidable interest) and
RM 239,500(actual interest) deduct with the interest revenue earned RM 10,000. Hence, the
interest cost that Shalla capitalizes is RM 110,228.
Shalla records the following journal entries during 2011:
Journal
Date
January 1

Descriptions
Land

Debit (RM)
100,000

Building

110,000
Cash

March 1

Building

210,000
300,000

Cash
May 1

Building

300,000
540,000

Cash
December 31

Credit (RM)

Building

540,000
450,000

Cash

450,000

Building

110,228

Interest Expense

129,272
Cash

239,500

MFRS 123 BORROWING COSTS


At December 31, 2011, Shalla discloses the amount of interest capitalized either as part of the
statement of profit or loss and other comprehensive income (income statement) or in the
notes to the financial statements.
Statement of Profit or Loss and Other Comprehensive Income

Other Income and Expense


Interest expense
Less: Capitalized interest

RM 239,500
110,228

129,272
XXXX

Income before tax


Income tax

XXX

Net income

XXXX

Notes to the Financial Statements


Note 1: Accounting Policies. Capitalized interest. During 2011, total interest cost was RM 239,500, of which
RM 110,228 was capitalized and RM 129,272 was charged to expense. The capitalization rate used was
11.04%.