IAS/NAS 23: Borrowing Costs
Outlines the accounting treatment for borrowing costs, including which costs to capitalize.
Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds.
This Standard is heavily practical & is used in almost every single entity at one point or another. Plain simple but very practical.
Borrowing costs may include:
- Interest expense calculated using the effective interest method as described in IFRS 9
- Interest in respect of lease liabilities recognized in accordance with IFRS 16 Leases.
- Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
Let’s Start with the first one.
Sabitri Industries on Jan 1, 2024, obtained a 9% 4 million loan from Rajesh Hamaal Commercial Bank with a service charge of 0.25%. Sabitri Industry doesn’t apply, full NFRS as a result GAAP to account for Interest costs.
Interest Cost for the year 2024 = 4 million * 9% = 0.36 million.
Here, 0.36 million is not the Interest expense calculated using the effective interest method as described in IFRS 9. Therefore, even if all conditions are met, the amount of 0.36 million cannot be capitalized to any asset.
Sabitri Industries applied NFRS 16 to account for Leases obtained on a land that is being developed for a large scale commercial building. The Lease Liability as at the end of the year 2025 is 1.54 million @ 9% .
Here, the interest cost of 0.14 million is the Interest in respect of lease liabilities recognized in accordance with IFRS 16 Leases. Therefore, if all other conditions are met, the amount of 0.14 million can be capitalized to an asset.
Lets talk about the third one Later.
An entity shall capitalize borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognize other borrowing costs as an expense in the period in which it incurs them.
Means, only qualifying assets actually qualify for any capitalization of 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.
It’s a three part Equation, one part fails – Not a qualifying Asset.
1. Substantial Period
The standard doesn’t provide any guidance on whether any period can be considered a substantial period. For E.g. A period of 3 months may be used to segregate substantial Period from a non-substantial Period. The period is an accounting estimate; therefore, it can vary between entities. A large Oil Producer may consider a period of 1 year and above substantial whereas a Commercial Palace could consider a period of 2 months as a substantial period of time.
2. Necessarily
One critical component of this definition is the term "necessarily." This distinguishes between the planned, essential construction period and any additional time caused by unexpected delays or inefficiencies. The focus is on the inherent time required, not the actual time that passes.
Downey’s Firearm company is producing a large tank “Jerico”, the estimated time for the assembly is around 9 days. On the 3rd day, the labor union called for a strike that lasted for around 4 months, during which the work on the Jerico was halted completely and was completed after around 3.5 Months. The Tank did take substantial period of time for its intended use - which was to sell to the military.
However, the standard does not focus on the actual time taken, but rather on the time that is necessarily required for the asset to be ready. For the Jerico tank, the necessary time was only 9 days. Since this is not a substantial period, the tank is not a qualifying asset.
3. It’s intended use or sale:
This is the most important section among the three sections and the most misunderstood. Let’s analyze with an example:
Sisan Baniya Hydropower has purchased from the Government of Nepal a license to carry on the hydroelectric generation works. The total cost incurred in the development phase {See IAS/NAS 38} was 35.2 Lakhs which was capitalized.
The Hydro was currently in the process of construction of the dam in Koshi River and it also has a loan of 45.3 million from Rajesh Hamaal Bank Ltd @ 9.03%.
Can we capitalize the interest on the intangible Asset?
On first glance, it may appear that the intangible asset is not a qualifying asset, as the registration of the license itself typically does not take a substantial period of time. However, a key point to consider is the intended use of the license - to generate electricity through the hydropower plant. Since the dam is not yet constructed, the license is not ready for its intended use or sale. Therefore, borrowing costs may be capitalized on the license.
Explanation:
The terms “Specific Borrowings” and “General Borrowings” shall not be given the text book definitions.
In the context of NAS 23, Specific Borrowings are borrowings whose funds are used exclusively for the acquisition, construction, or production of a qualifying asset. If the funds, even though initially obtained for a qualifying asset, are also used for other purposes like for financing net working capital, they do not qualify as specific borrowings.
General Borrowings are all other borrowings that do not meet the definition of specific borrowings.
1. Specific Borrowings:
[Ref Para 12] To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
On January 1,2024, Ortega’s Housing is has appointed Tom’s Construction to build and maintain a 14 luxury house colony on hillside of Pokhara. The contract term is for 25 Years, 5 Years for the construction and 20 Years of Maintenance. Ortega’s Housing has financed this construction solely through a Loan from Rajesh and Hamaal Bank of 12 million @ 8.45% with initial Service Charge of 0.45%. Until the time funds are utilized , the funds are kept in a saving account fetching interest income net of tax of 3.25% amounting 362,500.00
Loan Details
| Loan Amount | 12,000,000.00 |
| Interest Rate | 8.45% |
| Service Charge | 54,000.00 (0.45%) |
| Net Amount Received | 11,946,000.00 |
| Annual Equal Inst. | 3,041,208.44 |
Repayment Schedule as per Bank
| Year | Opening | Interest | Payment | Closing |
|---|---|---|---|---|
| 1 | 12,000,000.00 | 1,014,000.00 | 3,041,208.44 | 9,972,791.56 |
| 2 | 9,972,791.56 | 842,700.89 | 3,041,208.44 | 7,774,284.02 |
| 3 | 7,774,284.02 | 656,927.00 | 3,041,208.44 | 5,390,002.58 |
| 4 | 5,390,002.58 | 455,455.22 | 3,041,208.44 | 2,804,249.36 |
| 5 | 2,804,249.36 | 236,959.07 | 3,041,208.44 | - |
| Total | 3,206,042.18 | 15,206,042.18 | ||
But only the Interest calculated as per NFRS 9 can be capitalized So, Let's First Calculate EIR.
EIR Calculation
| Year | Cash Flows |
|---|---|
| 0 | (11,946,000.00) |
| 1 | 3,041,208.44 |
| 2 | 3,041,208.44 |
| 3 | 3,041,208.44 |
| 4 | 3,041,208.44 |
| 5 | 3,041,208.44 |
| EIR | 8.62% |
Repayment Schedule as per NFRS 9
| Year | Opening | Interest | Payment | Closing |
|---|---|---|---|---|
| 1 | 11,946,000.00 | 1,030,052.02 | (3,041,208.44) | 9,934,843.58 |
| 2 | 9,934,843.58 | 856,638.68 | (3,041,208.44) | 7,750,273.82 |
| 3 | 7,750,273.82 | 668,272.66 | (3,041,208.44) | 5,377,338.05 |
| 4 | 5,377,338.05 | 463,664.65 | (3,041,208.44) | 2,799,794.26 |
| 5 | 2,799,794.26 | 241,414.17 | (3,041,208.44) | (0.00) |
| Total | 3,260,042.18 | (15,206,042.18) | ||
Now the interest calculated as above can be capitalized as per NAS 23.
For Year 1,
| Interest Expense | 1,030,052.02 |
| Interest Income | (362,500.00) |
| Borrowing cost eligible for capitalization | 667,552.02 |
Interest Charges A/c Dr. 667,552.02
To Financial Liability at Amortized Cost A/c 667,552.02Construction WIP A/c Dr. 667,552.02
To Interest Charges A/c 667,552.02A single Entry may be passed for this purpose, these entries may be done for transparency Purposes.
2. General Borrowings:
To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization by applying a capitalization rate to the expenditures on that asset. The capitalization rate shall be the weighted average of the borrowing costs applicable to all borrowings of the entity that are outstanding during the period. However, an entity shall exclude from this calculation borrowing costs applicable to borrowings made specifically for the purpose of obtaining a qualifying asset until substantially all the activities necessary to prepare that asset for its intended use or sale are complete. The amount of borrowing costs that an entity capitalizes during a period shall not exceed the amount of borrowing costs it incurred during that period.
Explanation:
In the case of general borrowings, capitalization of borrowing costs is done as:
Expenditure on the Asset × Weighted Average Cost of Funds
This formula assumes that all expenditure on the qualifying asset are financed - directly or indirectly through the entity’s general borrowings.
Logic Behind the assumption:
Even if the entity uses its own funds (equity or internal cash) to construct the asset, those funds could otherwise have been used to repay outstanding borrowings. By not doing so, the entity continues to incur interest on those borrowings. This forgone reduction in interest is effectively the opportunity cost of using internal funds for the asset instead of debt repayment. Therefore, the interest rate on general borrowings is applied to the asset expenditure for capitalization purposes.
Let’s understand Weighted Average Borrowing Cost:
Mamoa’s tourism plc is building an underwater – “all around aquarium system”. The plc had the following borrowing as at 31st Dec 2024,
| Loan From | Sanctioned on | Year End | Period | Loan Amount | EIR | Interest | Wt. Avg Borrowing |
|---|---|---|---|---|---|---|---|
| Rajesh and Hamaal Bank | 1/1/2024 | 12/31/2024 | 365 | 45,000,000.00 | 9.04% | 4,068,000.00 | 45,000,000.00 |
| Upreti and Nikhil Bank | 3/1/2024 | 12/31/2024 | 305 | 34,000,000.00 | 8.54% | 2,426,295.89 | 28,410,958.90 |
| Sudhhartha Bank | 9/1/2024 | 12/31/2024 | 121 | 5,600,000.00 | 6.54% | 121,411.07 | 1,856,438.36 |
| Chartered Bank | 12/1/2024 | 12/31/2024 | 30 | 112,000,000.00 | 8.41% | 774,180.82 | 9,205,479.45 |
| Total | 196,600,000.00 | 7,389,887.78 | 84,472,876.71 | ||||
Weighted Average Borrowing Cost = Interest Expenses / Wt. Average borrowing
8.75%