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Recognition
Extract from FRS102: Section 25.2 – 25.2C
25.2 An entity may adopt a policy of capitalising borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. Where an entity adopts a policy of capitalisation of borrowing costs, it shall be applied consistently to a class of qualifying assets. Where an entity does not adopt a policy of capitalising borrowing costs, all borrowing costs shall be recognised as an expense in profit or loss in the period in which they are incurred.
25.2A The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made.
25.2B 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 capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
25.2C To the extent that funds applied to obtain a qualifying asset form part of the entity’s general borrowings, the amount of borrowing costs eligible for capitalisation are determined by applying a capitalisation rate to the expenditure on that asset. For this purpose the expenditure on the asset is the average carrying amount of the asset during the period, including borrowing costs previously capitalised. The capitalisation rate used in an accounting period shall be the weighted average of rates applicable to the entity’s general borrowings that are outstanding during the period. This excludes borrowings by the entity that are specifically for the purpose of obtaining other qualifying assets. The amount of borrowing costs that an entity capitalises during a period shall not exceed the amount of borrowing costs it incurred during that period.
OmniPro comment
Definition of qualifying asset A qualifying asset as defined by Appendix I of FRS 102 is ‘an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Depending on the circumstances any of the following may be qualifying assets:
- Inventories;
- Manufacturing plants;
- Power generation facilities
- Intangible assets; and
- Investment properties
Financial asset and inventories that are produced over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired are not qualifying assets’ under Appendix I FRS 102.
Accounting policy choice
Section 25 allows a policy choice to either expense qualifying borrowing costs or capitalise the borrowing costs in the asset. Even when a policy of capitalisation is chosen, only qualifying borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset can be capitalised. Where a policy of expensing qualifying borrowing cost, these costs should be expensed as incurred.
Substantial period of time
Section 25 does not define what is meant by a substantial period of time however where an asset is constructed over a one year period, this would generally meet this requirement. Management will need to exercise judgement on a case by case basis and should detail in its accounting policy what it considers a substantial period of time.
Class of qualifying assets
When a policy of capitalisation is chosen, this must be applied consistently to a class of qualifying asset. A class of qualifying asset is defined in Appendix 1 FRS 102 as ‘a grouping of assets of a similar nature and use in an entity’s operations.’ Therefore it may be possible to have a capitalisaton policy only in relation to plant or buildings under construction but not machinery under construction or inventories that are qualifying assets.
Borrowing costs less any investment income generated
Section 25.2B makes it clear that specific and general borrowing costs can be capitalised where they are a directly attributable cost. However where funds are invested as the full draw down is not required from the start, any investment income earned should be capitalised and deducted from the amount to be capitalised. However where investment losses are made these are not allowed to be capitalised.
Example 1: Borrowing costs net of investment income Company A obtained a loan of CU100,000 on a fixed rate of 10% to construct a factory. On commencement of the build, the full CU100,000 was drawn down and the unapplied funds were invested at a rate of 5%. The total interest charge on the loan was CU10,000 for the year. Details of the interest earned was:
| CU80,000 for 6 months | CU2,000 (CU80,000*5%/12*6) |
| CU10,000 for 6 months | CU250 (CU10,000*5%/12*6) |
The total amount to be capitalised is CU7,750 (CU10,000-CU2,250)
General borrowings Section 25.3 above makes it clear how these costs should be considered. Any general borrowing should not be reduced by interest income earned from the investment of general borrowings nor should such income be included in the capitalisation rate to be used. The amount of the general borrowing costs which are directly attributable costs on the construction of the asset is not always easy to determine and requires judgement. The accounting policy note should detail how this is determined. When determining the capitalisation rate, entities can include or exclude any specific borrowings relating to non-qualifying assets. In order to determine the capitalisation rate the following formula should be used: Total interest expense for the period / weighted average total borrowings
Example 2: Calculation of capitalisation rate Company A engages a construction company to construct a factory which will cost CU100,000. Company A has taken out borrowings some of which would have been avoided had the construction not occurred. Details of the loans used for general purposes during the period is:
| CU10,000 for full year at an interest rate of 5%= | CU500 |
| CU60,000 for full year at an interest rate of 10%= | CU6,000 |
| CU15,000 for 6 months of the year at 2.5%= | CU187.50 |
Expenditure incurred on construction in the year was:
| 1 April | CU20,000 |
| 1 September | CU50,000 |
The capitalisation rate would be: CU6,000+CU500+CU187.50 = 8.63% CU10,000+CU60,000+(CU15,000/12mths*6mths) The interest to be capitalised would be:
| (CU20,000 * 8.63%) / 12mths * 9 mths | CU1,294.50 |
| (CU50,000 * 8.63%) / 12mths * 3 mths | CU1,078.75 |
| Total | CU2,373.25 |
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