SLPSAS-4 BORROWING COSTS Workshop on Sri Lanka Public Sector Accounting Standards (SLPSAS) P.Ariyasena Chief Accountant Ministry of Foreign Employment Promotion and Welfare

Introduction to SLPSAS- 4 Scope of Standard Objectives of Standard Accounting Treatments Capitalization of Borrowing Costs Disclosures of Accounting Policy Questions & Answers Conclusion

Introduction SLPSAS – 4 is drawn primarily from IPSAS -5 Borrowing costs are interest and other expenses incurred by an entity in connection with borrowing of funds. Borrowing Costs may include Interest on Bank Overdraft Short Term Borrowings Long Term Borrowings (Foreign/Local) Cont..

Introduction Also Borrowing Costs may include … Cost of amortization of discounts relating to borrowings Ancillary costs incurred in connection with arrangement of borrowings E.g.: Stationary Cost, Legal fees, Loans Negotiation cost. Finance Charges of finance lease Exchange differences arising from foreign currency borrowings Cont.

Introduction This standard is applicable for public sector entities that prepare and present their financial statements under accrual basis of accounting Cont.

This Standard should be applied in accounting for Borrowing Costs Also standard applies to all public sector entities other than Government Business Enterprises Standards does not deal with cost of Equity/Net assets

Objectives of the Standard Standards prescribes the accounting treatment for Borrowing Cost. Two accounting treatments have been set out in the standard Bench Mark Treatment Recognition Allowed Alternative Treatment Recognition

Accounting Treatments Benchmark Treatment: Borrowing costs should be recognized as an expense in the period in which they are incurred. Also Borrowing cost are recognized as an expense regardless of how the borrowing are used. Under this treatment costs should be charged to Income & Expenditure account. Cont

Accounting Treatments Allowed Alternative Treatment Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalized as part of the cost of that asset. Alternative treatment should be applied consistently to all borrowing costs.

Accounting Treatments Benchmark Treatment Allowed Alternative Treatment Borrowing costs charge to Statement of Financial Performance Capitalize as part of Cost of Qualifying Asset (Statement of Financial Position)

Qualifying Assets If an assets require a substantial period of time bring them to a condition ready for its intended use or sale can be defined as a qualifying assets E.g. Office Buildings, Hospitals, Roads Inventories Assets that are ready for their intended use or sale when acquired are not qualifying assets

Capitalization of Borrowing Costs Capitalizing amount of the Borrowing Costs should be determined actual borrowing cost incurred on qualifying assets less any investment income on the temporary investment of the borrowings. Cont..

Capitalization of Borrowing Costs If the controlling entity borrows funds and funds transferred to Controlled entity,in this connection on deciding the capitalization amount is difficult and the exercise of judgment is required Cont..

Capitalization of Borrowing Costs If funds borrowed specifically use that interest rate If funds are borrowed generally and used for the purpose of obtaining a qualifying assets, the amount of borrowing costs capitalization amount should be determined by appalling the rate of interest weighted Average Rate of the borrowing costs. Cont..

Commencement of Capitalization The capitalization of borrowing costs as part of a qualifying asset should commence when: (a) Outlays for the assets are being incurred: (b) Borrowing costs are being incurred (c) Activities that are necessary to prepare the asset for its intended use are in progress.

Suspension of Capitalization Capitalization of Borrowing Costs should be suspended during the extended period which active development is interrupted However Borrowing Costs is not normally suspended during a period when technical and administrative work is being carried out. Cont..

Suspension of Capitalization Further it is not suspended when a temporary delay is a necessary as part of the process of getting an assets ready for its intended use. E.g.: High water levels delay construction of a bridge, (Common thing)

Cessation of Capitalization Capitalization of borrowing costs should cease when substantially all the activities necessary to prepare the qualifying assets for its intended use are completed. Cont..

Cessation of Capitalization When construction of a qualifying assets is completed in parts and each part is capable of being used for its intended purpose, for that part capitalization should be ceased E.g.: office development comprises several buildings. A completed building can be used individually

Disclosure Followings should be disclosed in the Financial Statements. (a) Accounting policy adopted for Borrowing Costs (b) Amount of borrowing costs capitalized during the period (c) The capitalization rate used to determined the amount of borrowing costs.

E.g. Accounting Policy Borrowing Costs are recognized as an expense in the period in which they are incurred, except the extent where borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset, which takes a substantial period of time to get ready for its intended use or sale, are capitalized a part of the specific asset.

This disclosure may be made in Financial Statements Statement of Financial Performance E.g. Amount of Annual Borrowing cots Charged Statement of Financial Position E.g. Amount of Borrowing Cost capitalized during the year Accounting policy adopted for Borrowing Costs

Questions & Answers Q.1 In what instances does the borrowing cost become eligible for capitalization? A.1 Under allowed alternative treatment borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset should be capitalized as part of the cost of that asset. cont….

Questions & Answers Q.2 What is Qualifying asset? A.2 An asset that takes a substantial period of time to get ready for its intended use or sale. E.g.: Manufacturing plats which takes a substantial period of time to assemble and put to use. cont….

Questions & Answers Q.3 Can the borrowing costs relating to land be capitalized? A.3 Borrowing costs associated with the purchase of the land cannot be capitalized as the land once purchased is deemed ready for its intended use. However if the land purchase needs to be further development before put into its intended use, the borrowing costs directly attributable to such development and incurred during the period of development could be capitalized. cont….

Questions & Answers Q.4 When should the capitalization of borrowing cost commence and cease? A.4 Capitalization commence from the time the activities necessary to prepare the asset for its intended use or sale commences or the expenditure for the asset are incurred. When all the activities necessary for preparation of the asset for its intended use or sale are completed the capitalization of borrowing cost cease. cont….

Questions & Answers Q.5 How do we determine the borrowing cost and the rate to be used for capitalization? A.5 If the funds are borrowed specifically for the purpose of acquiring a qualified asset the borrowing cost incurred thereon should be capitalized as a part of the cost of related asset. If fund are borrowed generally,capitalization rate should be the Weighted Average Rate. cont….

Exercise 01 A public entity borrowed Rs.15 millions to finance the production of two buildings i.e. A & B Cost of the assets A -Rs 5 Million B- Rs.10 Million Both are expected to take a year to build Interest rate is 10%.The loan facility drawn on

Answer for Exercise 01 Buildings A B Cost of the Assets (Millions) 5 10 Add Interest by 10% for Total cost of Buildings (Mn) (If there is any interest income earned on temporary investment should be deducted from the interest cost)

Conclusion This standard is almost similar with SLAS -20 Also Standard is applicable only to material items Under bench mark treatment Borrowing costs are recognized as an expense in the period Allowed Alternative Treatment is applicable in respect of Qualifying Assets Effective date