Accounting Standard (AS) 16: Borrowing Cost
Borrowing costs are interests and other costs incurred by an enterprise in connection with the borrowing of funds. A qualifying asset is an asset that necessarily takes substantial period of time to get ready for its intended use of sale.
Examples of qualifying assets:
- Any tangible fixed assets, which are in construction process or acquired tangible fixed assets, which are not ready for use or resale. Such as plants and machinery.
- Any intangible assets, which are in development phase or acquired but not ready for use or resale, such as patent.
- Investment property.
- Inventories that require a substantial period(i.e. generally more than one accounting period) to bring them to a saleable condition.
The Statement is applied in accounting for borrowing costs which include:
1. Interest and commitment charges on bank borrowing and other short term borrowings
2. Amortization of discounts/premium relating to borrowings
3. Amortization of ancillary cost incurred in connection with arrangement of borrowings
4. Finance charges for assets acquired under finance lease or other similar arrangement
5. Exchange difference in foreign currency borrowing to the extent it relates to interest element
Borrowing cost incurred on assets, which takes substantial period, is treated as cost of that asset in respect of (1) above.
As per the Guidance Note on Audit of Miscellaneous Expenditure issued by ICAI, deferment for amortization cost upto the time the asset is put to use, in respect of (2) and (3), should be capitalized (see below for AS-16 provision).
Finance charges as in (4) can be capitalized upto the time the asset is put to use (AS- 19 deals with elaborate provision)
Conditions for capitalization of borrowing costs:
- Directly attributable costs for acquisition, construction or production of qualifying asset, are eligible for capitalization.
- Qualifying assets will render future economic benefit to the enterprise and the cost can be measured reliably.
Amount of borrowing costs eligible for capitalization (specific borrowing):
Amount of borrowing eligible for capitalization = Actual borrowing cost incurred during the period less income generated on the temporary investment of amount borrowed.
All other borrowing costs are charged to P/L Account:
AS-16 establishes a key test for capitalization which states that “borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those costs that would have been avoided if the expenditure on the qualifying asset had not been made”.
Accounting treatment of borrowing cost as per AS-16
(a) Borrowing costs should either be capitalized or charged to P/L Account depending on the situation but deferment is not permitted.
(b) Borrowing costs are capitalized as part of cost of qualifying asset when it is probable that they will result in future economic benefits and cost can be measured reliably – other borrowing costs are charged to P/L Account in the accounting period in which they are incurred.
(c) Capitalization, on one hand reflects closely the total investment in the asset and on the other hand to charge the cost to future period against accrual of revenue.
(d) Notional interest cost are not allowed to be capitalized.
(e) A qualifying asset is an asset that necessarily takes a substantial period of time (usually a period of 12 months unless otherwise justified on the basis of facts and circumstances) to get ready for its intended use or sale.
(f) Capitalization should be suspended during extended period in which active development is interrupted.
(g) Capitalization should cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
(h) Capitalization also ceases ‘when part is completed, which is capable of being used independent of the whole.
Disclosure under AS- 16
(a) Accounting Policy adopted
(b) Amount of borrowing cost capitalized during the accounting period