1. BORROWING COSTS MFRS 123

2. Learning Objectives Define borrowing costs.
Explain the accounting issues for borrowing costs.
Apply the accounting treatment for borrowing costs.
Prepare financial statement extracts for borrowing costs.

3. Definition of borrowing costs
Interest and other costs that are incurred when funds are borrowed.
MFRS 123 SCOPE:
Borrowing costs incurred on funds borrowed to construct or develop an asset. (Qualifying assets)
Include:
Interest on bank overdrafts, short-term & long-term borrowings
Amortisation of discounts/premiums relating to borrowings
Amortisation of ancillary costs incurred in the arrangement of borrowings
Finance charges in respect of finance leases (MFRS 117)
Exchange differences arising from foreign currency borrowings, to the extent they are regarded as an adjustment to interest costs.

4. Issue Capitalise? the borrowing cost as part of the
cost of assets (qualifying assets), because:
They are part of construction costs just like material, labour & overheads – without borrowed funds, construction costs cannot proceed
Cost of the ready-made asset includes the borrowing costs & will be taken into account when pricing the asset.
Write off? the borrowing cost in income statement when incurred because:
Borrowing costs are period costs
Borrowing costs may not be specifically for the construction but for the overall operation of the enterprise

5. Qualifying assets
An asset that necessarily takes a substantial period of time to get ready for its intended use or sale. This include:
the construction of building,
long term construction contract
R&D; and
the production of inventories that take a considerable period of time to bring to saleable condition and others.
Not qualifying assets are:
inventories routinely produced on a repetitive manner over a short period of time
Assets ready for intended use
If entity borrows for other reasons – these costs will be expensed off as period costs.

6. Capitalisation of borrowing costs
Conditions:
It is probable that they will result in future economic benefit to the enterprise; and
The cost can be measured reliably
Funds borrowed are specifically for the purpose of obtaining a qualifying asset

7. Borrowing costs eligible for capitalisation
= Borrowing costs on the funds borrowed less any income from temporary investment of the borrowing
E.g. An entity borrowed RM39m for the construction of a building that is estimated to cost RM45m.
However, only RM10m was used and the balance of RM29m was invested temporarily.
Investment income of RM400,000 was earned on the temporary investments.
Interest accrued on the borrowing of RM39m was RM2m.
Borrowing costs could be capitalised if borrowing was to construct a qualifying asset.
Borrowing costs to be capitalised = RM2m – RM400,000 = RM1.6m.
To be capitalised as part of construction cost of building.

8. Central borrowings Borrowing is sometimes done centrally
Or entity might take up different loan packages with varying interest rates
If the fund was borrowed generally, without specification of amount for the project:
Measure borrowing cost by applying a WEIGHTED AVERAGE INTEREST RATE

9. Central borrowings
On 1 Jan x5, Jay Bhd raised finance amounting to RM400,000. The borrowing was to finance both a construction of a plant and for operations.
On 31 Dec x5, the outstanding borrowings were RM400,000 with no capital repayment in x5.
The borrowings were mainly used for the construction of the plant at the cost of RM300,000.
Jay Bhd wants to capitalise borrowing costs on qualifying assets.
Borrowings details:
31.12.x5 (RM)
12% loan stock
100,000
10% term loan
220,000
8% redeemable preference shares
80,000

10. Central borrowings
Compute the capitalisation rate & the amount of interest that qualifies for capitalisation for the year ended x5.
Of the borrowings of RM400,000, only the borrowing costs pertaining to RM300,000 is eligible for capitalisation.
The borrowings are from different sources & differ in interest rates.
The weighted average rate will be used to determine the amount of interest that can be capitalised.

11. Central borrowings Capitalisation rate: Principal at 31.12.x5 Weighted
average (a)
Interest
rate (b)
(a)
X (b) (%)
12% loan stock
100,000
25%
12%
3.0
10% term loan
220,000
55%
10%
5.5
8% redeemable
preference shares
80,000
20% 8%
1.6
400,000
100%
10.1%

12. Central borrowings Principal at 31.12.x5 Interest rate RM
Total interest:
Interest that can be capitalised: RM300,000 x 10.1% = RM30,300
Interest that can be charged as expense = RM40,400 – RM30,300 = RM10,100
Principal at
31.12.x5
Interest
rate RM
12% loan stock
100,000
12%
12,000
10% term loan
220,000
10%
22,000
8% redeemable
preference shares
80,000 8%
6,400
400,000
40,400

13. Limitation to Capitalisation
If the carrying amount of an asset on the total cost of the asset (including borrowing cost) > its recoverable amount or net realisable value (NRV)
Asset has to be written down/written off accordingly.
Inventory  written down to NRV
PPE  written down to recoverable amount

14. Commencement of Capitalisation
When:
Expenditure for the asset is being incurred
Borrowing costs are being incurred; and
Activities that are necessary to prepare the assets for its intended use or sale are in progress
If the fund is raised before the construction starts, borrowings cost to be capitalised is from the date when the construction starts.

15. Suspension of Capitalisation
Capitalisation stops when active development is interrupted.
Borrowing costs incurred during the interruption period will not be capitalised.
Not considered interruption of construction:
If the physical activities were not carried out, but technical works still carried on
Necessary temporary delays
Extended period for inventory to mature
Delays in construction

16. Cessation of Capitalisation
When all the construction activity is completed
When substantially all activities necessary to prepare the assets for its intended use or sale are complete
Usually when physical construction is complete, eventhough some admin work/decoration of asset is not done
When the construction of a qualifying asset is completed in parts and each part is ready for use while construction continues on the other parts, capitalisation should cease when substantially all the activities necessary to prepare that pat for its intended use/sale are complete.

17. Worked Example
Everywhere Bhd started constructing a building on 1.1.x1. The building was completed on x3. The useful life of the building was estimated to be 50 years. Construction costs (excluding interest) incurred on the building was RM1.5m.
Everywhere Bhd secured a loan of RM1m from Rich Finance Bhd in x1 to finance the construction costs. Interest on the loan was charged at 10% p.a. Repayment period of the loan was 5 years.
Since Everywhere Bhd did not need the full amount of the loan in the first year of the construction, it deposited RM600,000 in a fixed deposit which yielded an interest of 8% p.a. The deposit matured on x1.

18. Worked Example Calculate the cost of the building.
Construction cost of building RM1,500,000
Interest capitalised:
RM1m x 10% x 3 years = RM300,000
Less: Interest income from fixed deposit
600,000 x 8% = (48,000) RM1,752,000

19. Interest costs have been capitalised during construction
Worked Example
Show the statements of comprehensive income (extract) for the years ended X1 to X4.
Interest costs are charged as expenses after year 3:
RM1m x 10% X1 RM X2 X3 X4
Expenses:
Interest expense -
100,000
Depreciation
35,040
Cost of building RM1,752,000/50 years
Interest costs have been capitalised during construction

20. Disclosures in Financial Statements
Should include:
Amount of borrowing capitalised for the period
Capitalisation rate used to determine amount of borrowing costs eligible for capitalisation.

21. Class exercise