Accounting Standard 16 – Accounting for Borrowing Costs (AS 16). This Standard should be applied in accounting for borrowing costs. This Standard does not deal with the actual or imputed cost of owners’ equity, including preference share capital not classified as a liability.
Exchange differences on foreign currency borrowings to the extent of the difference between the interest on local currency borrowings and the interest on foreign currency borrowings are considered to be borrowing costs under this Standard.
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Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds.
- Interest and commitment charges on borrowings
- Amortisation of discounts and premiums related to borrowings
- Amortisation of ancillary costs incurred in connection with arrangement of borrowings
- Finance charges in respect of assets acquired under finance lease
- Exchange differences arising from foreign currency borrowings to the extent they are regarded as adjustment to interest costs
Accounting Standard 16 – Accounting for Borrowing Costs
Scope of AS 16:
The Institute of Chartered Accountants of India (ICAI) has notified Accounting Standard on borrowing costs (AS 16). This standard has been made mandatory in respect of accounting period commencing from 1st April 2000.
This Standard should be applied in accounting for borrowing costs and this standard does not deal with the actual or imputed cost of owner’s equity, including preference share capital not classified as a liability.
Terms to be known:
Borrowing costs :
This includes commitment charges, discounts or premium relating to borrowings, ancillary costs incurred, finance charges under finance lease and exchange differences arising from foreign currency loans to the extent they are regarded as adjustment to interest costs. Practically all costs connected with borrowings have been included under the definition of interest. Thus one has to be careful in collecting all expenses relating to borrowings which otherwise would have been grouped under various heads such as bank charges, legal fees, lease charges, etc.
1) Now a days many banks and financial institutions charges up front fee or processing charge for work-ing capital. When debentures are raised, the firm may incur rating fees, registration charges, stamp duty, etc. For the limited purpose of this AS 16, these expenses have to be treated as interest on borrowings.
2. Exchange differences arising from foreign currency borrowings 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 costs to be accounted for under this Standard and the remaining exchange difference, if any, is accounted for under AS 11.
Qualifying asset :
Two conditions are important to make an asset as ‘qualifying asset’
- It necessarily takes substantial period of time to get the asset ready for its intended use.
- The time taken for that should be substantial.
What constitutes 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 facts and circumstances of the case. In estimating the period, time which an asset takes, technologically and commercially, to get it ready for its intended use or sale is considered.
Example : A company which is already in business can expand the capacity at the existing place or it may commence a new factory in a different place. When expansion is being done or balancing equipment are added in the same place, assets are generally ready for intended use within a year. Such assets will not qualify for capitalisation of interest even though there may be specific borrowings for those assets. A company may also put up an entirely new plant in a new location. Such new plant may come under qualifying asset only if it takes “‘substantial period'”
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. The amount of borrowing costs eligible capitalisation should be determined in accordance with this Other borrowing costs should be recognised as an expense in the in which they are incurred.
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. Such a difficulty occurs, for example, when the financing activity of an enterprise is co-ordinated centrally or when a range of debt instruments are used to borrow funds at varying rates of interest and such borrowings are not readily identifiable with a specific qualifying asset. As a result, the determination of the amount of borrowing costs thae are directly attributable to the acquisition, construction or production of t a qualifying asset is often difficult and the exercise of judgement is required.
A firm may borrow generally and use it for acquiring a qualifying asset. In such cases average cost of borrowing should be applied based on actual expenditure. The entity should find out weighted average cost of borrowing taking both time and quantum of borrowing for the period to arrive at the rate of borrowing. Suitable credit should be given for any subsidy or grant received. Here the entity should work out the actual cost based on such weighted average cost and actual usage of funds.
Commencement of capitalisation :
The following criteria should be satisfied for interest to be capitalised :
- a.Capital expenditure should be incurred.
- b.Borrowing costs are incurred.
There are many activities that are necessarily required to be done including technical and administrative work prior to commencement of work. If a land is acquired and kept without any development activity, such activity does not qualify for capitalisation. Hence one should be extra careful in ascertaining the period for which interest should be capitalised. Capitalisation of borrowing costs should be suspended during extended period in which active development is interrupted. Facts alone can prove this, based on circumstances.
Cessation of capitalisation :
Capitalisation of borrowing costs should be stopped when substantially all activities necessary to prepare the qualifying asset for its intended use are complete. Many companies capitalise interest up to the date of commercial production. Capitalisation of interest should stop when substantially all activities are complete and need not wait till commercial production is commenced.
Further the qualifying asset may be completed in parts. Capitalisation of interest should stop when that part can be put to use even though construction of other part may continue. In factory expansion, building may be completed and ready for use. The installation of machineries may be in progress. The capitalisation of interest on building will stop as soon as building is complete, even though construction of machinery may be under progress.
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