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 owners’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.
Example:
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, th amount of exchange difference not
exceeding the difference betwee e n interest on local currency borrowings and
interest on foreign currenc y borrowings is considered as borrowings costs to
be accounted for unde 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’
They are
1.It necessarily takes substantial period of time to get the asset ready for its
intended use.
2.The time taken for that should be substantial.
Substantial period:
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'”
Capitalization:
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, whe 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 qualifyin g asset.
As a result, the determination of the amount of borrowing costs tha 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 useare
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.