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.
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%.
