5.

112 ADVANCED ACCOUNTING

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v UNIT 4: ACCOUNTING STANDARD 16
BORROWING COSTS

LEARNING OUTCOMES
After studying this unit, you will be able to recognize–
 Meaning of Borrowing costs;
 Definition of Qualifying Asset;
 Accounting treatment for borrowings – Specific and general
borrowings;
 Time when does Commencement of Capitalisation takes place;
 Time when does Suspension and cessation of Capitalisation takes
place;
 Disclosure requirements for this standard.

4.1 INTRODUCTION
The objective of AS 16 is to prescribe the accounting treatment for borrowing
costs. It does not deal with the actual or imputed cost of owners’ equity, including
preference share capital not classified as a liability.

Clarification Chart:

Particulars Remarks – Is the fund covered

by AS 16?

Equity share capital No

Retained earnings No

Preference Share Capital classified as a Yes

liability
Preference Share Capital classified as equity No
 5.113
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4.2 DEFINITIONS v

Borrowing costs are interest and other costs incurred by an enterprise in

connection with the borrowing of funds.

Borrowing Cost

Finance
Amortisation
Interest & Amortisation charges for
of ancillary
Commitment of Discount/ assets Exchange
costs
charges on Premium on acquired on Differences*
relating to
Borrowings Borrowings Finance
Borrowings
Lease

*To the extent they are regarded as an adjustment to interest cost

A qualifying asset is an asset (Tangible or intangible) that necessarily takes a

substantial period of time to get ready for its intended use or sale.
Examples of qualifying assets are manufacturing plants, power generation
facilities, inventories that require a substantial period of time to bring them to a
saleable condition, and investment properties. Other investments and those
inventories that are routinely manufactured or otherwise produced in large
quantities on a repetitive basis over a short period of time, are not qualifying
assets. Assets that are ready for their intended use or sale when acquired also are
not qualifying assets.
Clarification Chart:

Particulars Is it a qualifying asset?

PPE (Property, plant and equipment) Yes

Intangible assets Yes

Investment Properties Yes
(Building meant for capital appreciation
and earning rental income)
 5.114 ADVANCED ACCOUNTING
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Inventory Yes – If they require a substantial
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period of time to bring them to a
saleable condition.
Investments (Financial assets) No
Accounting standard further clarifies the meaning of the expression ‘substantial
period of time’. According to it, substantial period of time primarily depends on
the facts and circumstances of each case. It further states that, ordinarily, a period
of twelve months is considered as substantial period of time unless a shorter or
longer period can be justified on the basis of the facts and circumstances of the
case. Therefore, a rebuttable presumption of a period of twelve months is
considered “substantial” period of time. In estimating the period, time which an
asset takes technologically and commercially to get it ready for its intended use
or sale should be considered.

4.3 EXCHANGE DIFFERENCES ON FOREIGN

CURRENCY BORROWINGS
Exchange differences arising from foreign currency borrowing and considered as
borrowing costs are those exchange differences which arise on the amount of
principal of the foreign currency borrowings to the extent of the difference
between interest on local currency borrowings and interest on foreign currency
borrowings. Thus, the amount of exchange difference not exceeding the
difference between interest on local currency borrowings and interest on foreign
currency borrowings is considered as borrowings cost to be accounted for under
this Standard and the remaining exchange difference, if any, is accounted for
under AS 11, ‘The Effect of Changes in Foreign Exchange Rates’. For this
purpose, the interest rate for the local currency borrowings is considered as that
rate at which the enterprise would have raised the borrowings locally had the
enterprise not decided to raise the foreign currency borrowings.
Clarification Chart:

Particulars Accounting Treatment

Exchange Credited to P&L

Gain
 5.115
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Exchange Lower of the following is treated as a part of borrowing costs: v
Loss v
1. Actual exchange loss;
2. Difference between interest on local currency borrowings
and interest on foreign currency borrowings.
Note: The excess exchange difference if any will be charged to
P&L A/c.
If the difference between the interest on local currency borrowings and the interest
on foreign currency borrowings is equal to or more than the exchange difference on
the amount of principal of the foreign currency borrowings, the entire amount of
exchange difference is covered under paragraph 4 (e) of AS 16.
If there is exchange gain in the next year, then it will reduce the borrowing cost in
that year to the extent exchange loss was earlier treated as borrowing cost for that
borrowing.
Example
XYZ Ltd. has taken a loan of USD 10,000 on April 1, 20X1, for a specific project at
an interest rate of 5% p.a., payable annually. On April 1, 20X1, the exchange rate
between the currencies was ` 45 per USD. The exchange rate, as at March 31, 20X2,
is ` 48 per USD. The corresponding amount could have been borrowed by XYZ Ltd.
in local currency at an interest rate of 11 per cent per annum as on April 1, 20X1.
The following computation would be made to determine the amount of borrowing
costs for the purposes of paragraph 4(e) of AS 16:
(i) Interest for the period = USD 10,000 x 5% x ` 48/USD = ` 24,000
(ii) Increase in the liability towards the principal amount = USD 10,000 x (48-45)
= ` 30,000
(iii) Interest that would have resulted if the loan was taken in Indian currency
= USD 10,000 x 45 x 11% = ` 49,500

(iv) Difference between interest on local currency borrowing and foreign currency
borrowing = ` 49,500 – ` 24,000 = ` 25,500
Therefore, out of ` 30,000 increase in the liability towards principal amount, only
` 25,500 will be considered as the borrowing cost. Thus, total borrowing cost would
be ` 49,500 being the aggregate of interest of ` 24,000 on foreign currency
borrowings (covered by paragraph 4(a) of AS 16) plus the exchange difference to
 5.116 ADVANCED ACCOUNTING
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the extent of difference between interest on local currency borrowing and interest
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on foreign currency borrowing of ` 25,500.

Thus, ` 49,500 would be considered as the borrowing cost to be accounted for as

per AS 16 and the remaining ` 4,500 would be considered as the exchange
difference to be accounted for as per Accounting Standard (AS) 11, The Effects of
Changes in Foreign Exchange Rates.
In the above example, if the interest rate on local currency borrowings is assumed
to be 13% instead of 11%, the entire exchange difference of ` 30,000 would be
considered as borrowing costs, since in that case the difference between the interest
on local currency borrowings and foreign currency borrowings [i.e., ` 34,500
(` 58,500 – ` 24,000)] is more than the exchange difference of ` 30,000. Therefore,
in such a case, the total borrowing cost would be ` 54,000 (` 24,000 + ` 30,000)
which would be accounted for under AS 16 and there would be no exchange
difference to be accounted for under AS 11 ‘The Effects of Changes in Foreign
Exchange Rates’.

4.4 BORROWING COSTS ELIGIBLE FOR

CAPITALISATION
Treatment of Borrowing Costs

Borrowing Costs

Directly related* for

* acquisition
* construction
* production of

Qualifying Assets Assets other than Qualifying assets

Capitalized Revenue Expenditure

*or that could have been avoided if the expenditure on qualifying assets had not been made.
 5.117
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The borrowing costs (including exchange loss treated as borrowing cost as per v
para 4(e)) that are directly attributable to the acquisition, construction or v
production of a qualifying asset are those borrowing costs that would have been
avoided if the expenditure on the qualifying asset had not been made. Other
borrowing costs are recognised as an expense in the period in which they are
incurred.

4.5 RECOGNITION CRITERIA

Borrowing costs are capitalised as part of the cost of a qualifying asset when:

(a) it is probable that they will result in future economic benefits to the
enterprise; and
(b) the costs can be measured reliably.

Borrowing costs

Specific borrowings General borrowings

Illustration 1
PRM Ltd. obtained a loan from a bank for ` 120 lakhs on 30-04-20X1. It was
utilised as follows:

Particulars Amount (` in lakhs)

Construction of a shed 50

Purchase of a machinery 40
Working Capital 20
Advance for purchase of truck 10

Construction of shed was completed in March 20X2. The machinery was installed on
the date of acquisition. Delivery of truck was not received. Total interest charged by
the bank for the year ending 31-03-20X2 was ` 18 lakhs. Show the treatment of
interest.
 5.118 ADVANCED ACCOUNTING
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Solutionv
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Qualifying Asset as per AS 16 = ` 50 lakhs (construction of a shed)

Borrowing cost to be capitalised = 18 x 50/120 = ` 7.5 lakhs

Interest to be debited to Profit or Loss account = ` (18 – 7.5) lakhs = ` 10.5 lakhs

4.6 SPECIFIC BORROWINGS

When an enterprise borrows funds specifically for the purpose of obtaining a
particular qualifying asset, the borrowing costs that directly relate to that
qualifying asset can be readily identified.
To the extent that funds are borrowed specifically for the purpose of obtaining a
qualifying asset, the amount of borrowing costs eligible for capitalisation on that
asset should be determined as the actual borrowing costs incurred on that
borrowing during the period less any income on the temporary investment of
those borrowings.

Amount eligible for capitalisation:

= Actual borrowing costs incurred (-) Any income on the temporary investment of
those borrowings

The financing arrangements for a qualifying asset may result in an enterprise

obtaining borrowed funds and incurring associated borrowing costs before some
or all of the funds are used for expenditure on the qualifying asset. In such
circumstances, the funds are often temporarily invested pending their expenditure
on the qualifying asset. In determining the amount of borrowing costs eligible for
capitalisation during a period, any income earned on the temporary investment of
those borrowings is deducted from the borrowing costs incurred.

4.7 GENERAL BORROWINGS

It may be difficult to identify a direct relationship between particular borrowings and
a qualifying asset and to determine the borrowings that could otherwise have been
avoided. To the extent that funds are borrowed generally and used for the purpose
of obtaining a qualifying asset, the amount of borrowing costs eligible for
 5.119
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capitalisation should be determined by applying a capitalisation rate to the v
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expenditure on that asset. The capitalisation rate should be the weighted average of
the borrowing costs applicable to the borrowings of the enterprise that are
outstanding during the period, other than borrowings made specifically for the
purpose of obtaining a qualifying asset. The amount of borrowing costs capitalised
during a period should not exceed the amount of borrowing costs incurred during
that period.

Step 1 - Compute the capitalisation rate:

Where,
Borrowing cost on general borrowings
Capitalization Rate = ×100
Weighted average of general borrowings
outstanding during the period

Step 2 - Amount eligible for capitalisation:

= Expenditure incurred on Qualifying asset x Capitalisation rate
Step 3 – Cross check:
The amount of borrowing costs capitalised during a period should not exceed the
amount of borrowing costs incurred during that period.

4.8 EXCESS OF THE CARRYING AMOUNT OF THE

QUALIFYING ASSET OVER RECOVERABLE
AMOUNT
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
Accounting Standards. In certain circumstances, the amount of the write-down or
write-off is written back in accordance with those other Accounting Standards.
Illustration 2
X Ltd. began construction of a new building on 1 st January, 20X1. It obtained ` 1
lakh special loan to finance the construction of the building on 1 st January, 20X1 at
an interest rate of 10%. The company’s other outstanding two non-specific loans
were:
 5.120 ADVANCED ACCOUNTING
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Amount Rate of Interest
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` 5,00,000 11%
` 9,00,000 13%

The expenditures that were made on the building project were as follows:

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January 20X1 2,00,000
April 20X1 2,50,000
July 20X1 4,50,000
December 20X1 1,20,000

Building was completed by 31 st December 20X1. Following the principles prescribed

in AS 16 ‘Borrowing Cost,’ calculate the amount of interest to be capitalised and
pass one Journal Entry for capitalising the cost and borrowing cost in respect of the
building.
Solution
(i) Computation of weighted average accumulated expenses

`
` 2,00,000 x 12 / 12 = 2,00,000
` 2,50,000 x 9 / 12 = 1,87,500
` 4,50,000 x 6 / 12 = 2,25,000
` 1,20,000 x 1 / 12 = 10,000
6,22,500

(ii) Calculation of weighted average interest rate other than for specific borrowings

Amount of loan (`) Rate of Amount of interest

interest (`)
5,00,000 11% = 55,000
9,00,000 13% = 1,17,000
14,00,000 1,72,000
Weighted average rate of interest = 12.285% (approx.)
 1,72,000 
 14,00,000  100 
 
 5.121
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(iii) Interest on weighted average accumulated expenses v
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Specific borrowings (` 1,00,000 x 10%) = 10,000
Non-specific borrowings (` 5,22,500 x 12.285%) = 64,189

Amount of interest to be capitalised = 74,189

(iv) Total expenses to be capitalized for building

`
Cost of building ` (2,00,000 + 2,50,000 + 4,50,000 + 10,20,000
1,20,000)
Add: Amount of interest to be capitalised 74,189

10,94,189

(v) Journal Entry

Date Particulars Dr. (`) Cr. (`)

31.12. Building account Dr. 10,94,189

20X1
To Bank account 10,94,189
(Being amount of cost of building
and borrowing cost thereon
capitalised)

4.9 COMMENCEMENT OF CAPITALISATION

The capitalisation of borrowing costs as part of the cost of a qualifying asset
should commence when all the following conditions are satisfied:
a. Expenditure for the acquisition, construction or production of a
qualifying asset is being incurred: Expenditure on a qualifying asset
includes only such expenditure that has resulted in payments of cash,


(` 6,22,500 – ` 1,00,000)
 5.122 ADVANCED ACCOUNTING
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transfers of other assets or the assumption of interest-bearing liabilities.
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Expenditure is reduced by any progress payments received and grants
received in connection with the asset. The average carrying amount of the
asset during a period, including borrowing costs previously capitalised, is
normally a reasonable approximation of the expenditure to which the
capitalisation rate is applied in that period.

b. Borrowing costs are being incurred.

c. Activities that are necessary to prepare the asset for its intended use or
sale are in progress: The activities necessary to prepare the asset for its
intended use or sale encompass more than the physical construction of the
asset. They include technical and administrative work prior to the
commencement of physical construction. However, such activities exclude
the holding of an asset when no production or development that changes
the asset’s condition is taking place. For example, borrowing costs incurred
while land is under development are capitalised during the period in which
activities related to the development are being undertaken. However,
borrowing costs incurred while land acquired for building purposes is held
without any associated development activity do not qualify for
capitalisation.

4.10 SUSPENSION OF CAPITALISATION

Capitalisation of borrowing costs should be suspended during extended periods
in which active development is interrupted.

Borrowing costs may be incurred during an extended period in which the

activities necessary to prepare an asset for its intended use or sale are
interrupted. Such costs are costs of holding partially completed assets and do not
qualify for capitalisation. However, capitalisation of borrowing costs is not
normally suspended during a period when substantial technical and
administrative work is being carried out.

Capitalisation of borrowing costs is also not suspended when a temporary delay is

a necessary part of the process of getting an asset ready for its intended use or
 5.123
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sale. For example: capitalisation continues during the extended period needed for
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inventories to mature or the extended period during which high water levels
delay construction of a bridge, if such high water levels are common during the
construction period in the geographic region involved.

4.11 CESSATION OF CAPITALISATION

Capitalisation of borrowing costs should cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale are
complete.

An asset is normally ready for its intended use or sale when its physical
construction or production is complete even though routine administrative work
might still continue. If minor modifications, such as the decoration of a property
to the user’s specification, are all that are outstanding, this indicates that
substantially all the activities are complete.

When the construction of a qualifying asset is completed in parts and a

completed part is capable of being used while construction continues for the
other parts, capitalisation of borrowing costs in relation to a part should cease
when substantially all the activities necessary to prepare that part for its intended
use or sale are complete. A business park comprising several buildings, each of
which can be used individually, is an example of a qualifying asset for which each
part is capable of being used while construction continues for the other parts. An
example of a qualifying asset that needs to be complete before any part can be
used is an industrial plant involving several processes which are carried out in
sequence at different parts of the plant within the same site, such as a steel mill.
 5.124 ADVANCED ACCOUNTING
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Capitalization of
Borrowing Cost

Commencement Suspension Cessation

Expenditure during when

Borrowing Activities to
for extended substantia
costs are prepare the
qualifying periods in lly all the
being qualifying
asset is which active activities
incurred asset is in
being development are
progress.
incurred. is interrupted. complete.

4.12 DISCLOSURE
The financial statements should disclose:
a. The accounting policy adopted for borrowing costs; and

b. The amount of borrowing costs capitalised during the period.

Illustration 3
The company has obtained Institutional Term Loan of ` 580 lakhs for
modernisation and renovation of its Plant & Machinery. Plant & Machinery
acquired under the modernisation scheme and installation completed on 31st
March, 20X2 amounted to ` 406 lakhs, ` 58 lakhs has been advanced to suppliers
for additional assets and the balance loan of ` 116 lakhs has been utilised for
working capital purpose. The Accountant is on a dilemma as to how to account for
the total interest of ` 52.20 lakhs incurred during 20X1-20X2 on the entire
Institutional Term Loan of ` 580 lakhs.
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Solution v
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As per para 6 of AS 16 ‘Borrowing Costs’, borrowing costs that are directly
attributable to the acquisition, construction or production of a qualifying asset
should be capitalised as part of the cost of that asset. Other borrowing costs
should be recognised as an expense in the period in which they are incurred.

A qualifying asset is an asset that necessary takes a substantial period of time* to

get ready for its intended use or sale.
The treatment for total interest amount of ` 52.20 lakhs can be given as:

Purpose Nature Interest to be Interest to be

capitalised charged to profit
and loss account
` in lakhs ` in lakhs
Modernisation Qualifying asset
406
and renovation * *52.20  = 36.54
580
of plant and
machinery
58
* *52.20  = 5.22
580
Advance to Qualifying asset
supplies for 116
52.20  = 10.44
additional assets 580
Working Capital Not a qualifying
asset
41.76 10.44
* A substantial period of time primarily depends on the facts and circumstances of
each case. However, ordinarily, a period of twelve months is considered as
substantial period of time unless a shorter or longer period can be justified on the
basis of the facts and circumstances of the case.
** It is assumed in the above solution that the modernisation and renovation of
plant and machinery will take substantial period of time (i.e. more than twelve
months). Regarding purchase of additional assets, the nature of additional assets
has also been considered as qualifying assets. Alternatively, the plant and
 5.126 ADVANCED ACCOUNTING
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machinery and additional assets may be assumed to be non-qualifying assets on
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the basis that the renovation and installation of additional assets will not take
substantial period of time. In that case, the entire amount of interest, ` 52.20 lakhs
will be recognised as expense in the profit and loss account for year ended 31 st
March, 20X2.
Illustration 4
Take Ltd. has borrowed ` 30 lakhs from State Bank of India during the financial
year 20X1-20X2. The borrowings are used to invest in shares of Give Ltd., a
subsidiary company of Take Ltd., which is implementing a new project, estimated to
cost ` 50 lakhs. As on 31 st March, 20X2, since the said project was not complete, the
directors of Take Ltd. resolved to capitalise the interest accruing on borrowings
amounting to ` 4 lakhs and add it to the cost of investments. Comment.
Solution
As per AS 13 (Revised) "Accounting for Investments", the cost of investment
includes acquisition charges such as brokerage, fees and duties. In the present
case, Take Ltd. has used borrowed funds for purchasing shares of its subsidiary
company Give Ltd. ` 4 lakhs interest payable by Take Ltd. to State Bank of India
cannot be called as acquisition charges, therefore, cannot be constituted as cost
of investment.
Further, as per para 3 of AS 16 "Borrowing Costs", a qualifying asset is an asset
that necessarily takes a substantial period of time to get ready for its intended
use or sale. Since, shares are ready for its intended use at the time of sale, it
cannot be considered as qualifying asset that can enable a company to add the
borrowing cost to investments. Therefore, the directors of Take Ltd. cannot
capitalise the borrowing cost as part of cost of investment. Rather, it has to be
charged to the Statement of Profit and Loss for the year ended 31 st March, 20X2.

Reference: The students are advised to refer the full text of AS 16 “Borrowing
Costs” (issued 2000).
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TEST YOUR KNOWLEDGE v
MCQ
1. As per AS 16, all the following are qualifying assets except

(a) Manufacturing plants and Power generation facilities

(b) Inventories that require substantial period of time

(c) Assets those are ready for sale.

(d) None of the above

2. Which of the following statement is correct:

(a) Entire exchange gain is reduced from the cost of the Qualifying asset.

(b) Entire exchange loss is added to the cost of a Qualifying asset.

(c) No adjustment is done for the exchange loss while computing cost of
Qualifying asset.

(d) None of the above

3. Capitalisation rate considers:

(a) Borrowing costs on general borrowings only.

(b) Borrowing costs on general and specific borrowings both.

(c) Borrowing costs on specific borrowings only

(d) None of the above

4. If the amount eligible for capitalisation in case of inventory as per AS 16 is `

12,000 and cost of inventory is ` 40,000 and its net realizable value is `
45,000; What amount can be capitalised as a part of inventory cost.

(a) ` 12,000.
(b) ` 5,000.
(c) ` 7,000.
(c) ` 10,000.
 5.128 ADVANCED ACCOUNTING
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5. v
X Ltd is commencing a new construction project, which is to be financed by
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borrowing. The key dates are as follows:

(i) 15th May, 20X1: Loan interest relating to the project starts to be
incurred

(ii) 2nd June, 20X1: Technical site planning commences

(iii) 19th June, 20X1: Expenditure on the project started to be incurred

(iv) 18th July, 20X1: Construction work commences

Identify the commencement date for capitalisation under AS 16.

(a) 15th May, 20X1.

(b) 19th June, 20X1.

(c) 18th July, 20X1.

(d) 2nd June, 20X1

Theory Questions
6. When capitalization of borrowing cost should cease as per Accounting Standard
16? Explain the provision.

7. H Ltd. incurs borrowing costs for the purpose of construction of a qualifying asset
for its own use. The construction gets completed on May 31, 20X1. However,
decoration work is under process which is expected to be completed by
November 20X1 after which H Ltd. will be able to start using the said asset for its
own use. H Ltd. wants to capitalize the eligible borrowing costs incurred up to
November 20X1.

8. ABC Ltd. is in the process of getting an entertainment park constructed. For this
purpose, it has taken loan from a bank. The said park consists of several rides
and facilities, each of which can be used individually. Three fourth part of the
park has been constructed and can be opened up for public, while construction
on the remaining part is continuing. Whether the capitalization of borrowing cost
should continue for the whole park until construction continues?
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Practical Questions v
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9. On 1st April, 20X1, Amazing Construction Ltd. obtained a loan of ` 32 crores
to be utilised as under:

(i) Construction of sealink across two cities:

(work was held up totally for a month during the : ` 25 crores

year due to high water levels)

(ii) Purchase of equipments and machineries : ` 3 crores

(iii) Working capital : ` 2 crores

(iv) Purchase of vehicles : ` 50,00,000

(v) Advance for tools/cranes etc. : ` 50,00,000

(vi) Purchase of technical know-how : ` 1 crores

(vii) Total interest charged by the bank for the year : ` 80,00,000
ending 31st March, 20X2

Show the treatment of interest by Amazing Construction Ltd.

10. Rainbow Limited borrowed an amount of ` 150 crores on 1.4.20X1 for
construction of boiler plant @ 11% p.a. The plant is expected to be completed
in 4 years. Since the weighted average cost of capital is 13% p.a., the
accountant of Rainbow Ltd. capitalized ` 19.50 crores for the accounting
period ending on 31.3.20X2. Due to surplus fund out of ` 150 crores, income
of ` 3.50 crores were earned and credited to profit and loss account.
Comment on the above treatment of accountant with reference to relevant
accounting standard.
11. Harish Construction Company is constructing a huge building project consisting
of four phases. It is expected that the full building will be constructed over several
years but Phase I and Phase II of the building will be started as soon as they are
completed.
Following is the detail of the work done on different phases of the building
during the current year:
 5.130 ADVANCED ACCOUNTING
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Phase I Phase II Phase III Phase IV

` ` ` `
Cash expenditure 10 30 25 30
Building purchased 24 34 30 38
Total expenditure 34 64 55 68

Total expenditure of all phases 221

Loan taken @ 15% at the 200

beginning of the year
During mid of the current year, Phase I and Phase II have become operational.
Find out the total amount to be capitalized and to be expensed during the year.

ANSWERS/SOLUTIONS
MCQs

1. (c) 2. (c) 3. (a) 4. (b) 5. (b)

Theory Questions
6. Capitalization of borrowing costs should cease when substantially all the
activities necessary to prepare the qualifying asset for its intended use or sale
are complete. An asset is normally ready for its intended use or sale when its
physical construction or production is complete even though routine
administrative work might still continue. If minor modifications such as the
decoration of a property to the user’s specification, are all that are outstanding,
this indicates that substantially all the activities are complete. When the
construction of a qualifying asset is completed in parts and a completed part is
capable of being used while construction continues for the other parts,
capitalisation of borrowing costs in relation to a part should cease when
substantially all the activities necessary to prepare that part for its intended use
or sale are complete.
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7. The capitalization of borrowing costs shall cease when substantially all the v
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activities necessary to prepare the qualifying assets for its intended use or sale
is completed.

In the given case, H Ltd. should capitalize borrowing costs only up to May 31,
20X1. The borrowing cost incurred thereafter cannot be capitalized as the asset
was ready for its intended use on May 31, 20X1. The fact that decoration work
was being carried out should not be considered as the asset was ready for its
intended use on May 31, 20X1.

8. ABC Ltd. is in process of constructing an entertainment park which consists of

several rides and facilities that can operate independently for their intended
use. Even though the park as whole is not complete, the individual facilities are
ready for their intended use.

The cessation of capitalization depends upon the nature of the qualifying

assets, particularly where the qualifying assets consists of various parts. There
are qualifying assets where each part is capable of being used while the
construction continues on other parts. There are qualifying assets where all
parts have to be completed before any earlier completed part can be put to
use.

Since in the given scenario, the individual facilities are capable of operating
independently and are ready for their intended use, therefore the borrowing
costs shall cease to be capitalized for the three-fourth part of the project.

Practical Questions
9. According to AS 16 ‘Borrowing costs’, qualifying asset is an asset that
necessarily takes substantial period of time to get ready for its intended use.

Borrowing costs that are directly attributable to the acquisition, construction

or production of a qualifying asset should be capitalised as part of the cost
of that asset. Other borrowing costs should be recognised as an expense in
the period in which they are incurred.
 5.132 ADVANCED ACCOUNTING
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The treatment of interest by Amazing Construction Ltd. can be shown as:
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Qualifying Interest to Interest to
Asset be be charged
capitalised to Profit &
` Loss A/c `
Construction Yes 62,50,000 [80,00,000x(25/32)]
of sea-link
Purchase of No 7,50,000 [80,00,000x(3/32)]
equipment and
machineries
Working No 5,00,000 [80,00,000x(2/32)]
capital
Purchase of No 1,25,000 [80,00,000x(0.5/32)]
vehicles
Advance for No 1,25,000 [80,00,000x(0.5/32)]
tools, cranes
etc.
Purchase of No 2,50,000 [80,00,000x(1/32)]
technical
know-how
Total 62,50,000 17,50,000
*It is assumed that work held up for a month due to high water level is normal
during the construction of sealink and capitalization of borrowing cost should
not be suspended for necessary temporary delay.
10. Para 10 of AS 16 'Borrowing Costs' states "To the extent that funds are
borrowed specifically for the purpose of obtaining a qualifying asset, the
amount of borrowing costs eligible for capitalization on that asset should be
determined as the actual borrowing costs incurred on that borrowing during
the period less any income on the temporary investment of those borrowings."

The capitalization rate should be the weighted average of the borrowing costs
applicable to the borrowings of the enterprise that are outstanding during the
period, other than borrowings made specifically for the purpose of obtaining a
qualifying asset.
 5.133
ASSETS BASED ACCOUNTING STANDARDS
v
v v
Thus, the treatment of accountant of Rainbow Ltd. is incorrect. v
v
Amount of borrowing costs capitalized should be calculated as follows:

Particulars ` in crores
Actual interest for 20X1-20X2 (11% of ` 150 crores) 16.50
Less: Income on temporary investment from specific (3.50)
borrowings
Borrowing costs to be capitalized during year 20X1-20X2 13.00

11. Computation of amount to be capitalized

No. Particulars `

1. Interest expense on loan ` 2,00,00,000 at 15% 30,00,000

2. Total cost of Phases I and II (` 34,00,000 +64,00,000) 98,00,000

3. Total cost of Phases III and IV (` 55,00,000 + 1,23,00,000

` 68,00,000)

4. Total cost of all 4 phases 2,21,00,000

5. Total loan 2,00,00,000

6. Interest on loan used for Phases I & II, based on 3,30,317

proportionate
(approx.)
30,00,000
Loan amount = × 98,00,000
2,21,00,000

7. Interest on loan used for Phases III & IV, based on 16,69,683

proportionate Loan amount =

30,00,000
×1,23,00,000 (approx.)
2,21,00,000

Accounting treatment
For Phase I and Phase II
Since Phase I and Phase II have become operational at the mid of the year, half
of the interest amount of ` 6,65,158.50 (i.e. ` 13,30,317/2) relating to Phase I
and Phase II should be capitalized (in the ratio of asset costs 34:64) and added
 5.134 ADVANCED ACCOUNTING
v
v
v
to respective assets in Phase I and Phase II and remaining half of the interest
v
amount of ` 6,65,158.50 (i.e. ` 13,30,317/2) relating to Phase I and Phase II
should be expensed during the year.
For Phase III and Phase IV
Interest of ` 16,69,683 relating to Phase III and Phase IV should be held in
Capital Work-in-Progress till assets construction work is completed, and
thereafter capitalized in the ratio of cost of assets. No part of this interest
amount should be charged/expensed off during the year since the work on
these phases has not been completed yet.