Introduction

Hello everyone! Im John Case

And Im Almy
And today were goin to talk
about Borrowing costs.
Now, PAS 23 is applied in
accounting for Borrowing Costs.
What are borrowing costs?
Well, Borrowing costs are interest and
other costs incurred by an entity in
connection with the borrowing fund.
To relieve you from having a
nosebleed, borrowing costs, are fees
added in relation to you borrowing
money from another entity.
Yes. Now these fees are:
Interest expense calculated using
effective interest method,
Finance Charges in respect of
finance leases and
Exchange differences arising from
foreign currency borrowings
Now, in order to further understand
more about borrowing costs, we must
also understand what qualifying assets
are.
Correct partner! A qualifying asset is
an asset that necessarily takes a
substantial period of time to get ready
for its intended use or sale
These are some things that can be
considered as such:
Inventories
Manufacturing Plants
Power Generation facilities
Intangible Assets and
Investment properties measured under
the cost model.
However, it excludes
Financial assets and inventories
manufactured over a short period.
Assets when acquired are not
qualifying assets
Routinely manufactured assets in
large, repetitive quantities.
How can you recognize a qualifying asset?
Well, you capitalize those that are directly
attributable to the acquisition,
construction or production of a qualifying
asset.
What happens to other borrowing costs?
They are recognized as expense when they
are incurred
For the commencement of
capitalization, there are conditions that
should be met. These are the following:
The entity should incur expenditure for
the asset and borrowing cost, and
undertakes activities that are necessary
to prepare the asset for its intended use
or sale.
capitalization is allowed during the
period activities necessary to prepare
the asset for its intended use or sale
such as:
Technical and administrative work
prior the start of physical construction,
and its actual physical construction.
If there is an excess of carrying amount
over recoverable amount, The carrying
amount is written down or off in
accordance with the requirements of other
standards during the excess of carrying
amount over recoverable amount.
And to suspend the capitalization, it should
be throughout the extended period of
suspension of active development of a
qualifying asset.
However, it will not be suspended if
the considered technical and
administrative work is being
performed and it is temporary delay
to process for getting the asset to
be ready for its intended use or
sale.
We then cease capitalization
when substantially all
activities necessary to
prepare the qualifying asset
for its intended use or sale
are complete.
An asset is ready for intended use or sale
when the physical construction of the
asset is complete even though routine
administrative work might still continue.
However, when the construction of a
qualifying asset is partly complete and
that part is capable to be used, its
capitalization shall cease.
To determine the borrowing costs
eligible for capitalization, what is the
difference between specific and
general borrowing?
The specific borrowing refers to fund
borrowed specifically for the purpose
of obtaining a qualifying asset. On the
other hand, the general borrowing
obtains for more than one purpose.
For example, On January 1, 2016, XYZ
Co. borrowed P5 million to finance
the construction of a new building.
Interest is payable on the loan of 8%.
Stage payments were due throughout
the construction period and therefore
excess funds were invested during
that period. By the end of the project
on December 31, 2016, investment
income of P150,000 has been earned.
The capitalizable borrowing cost is computed as follows:
Interest expense on
specific borrowing (5Mx8%) 400,000
Investment income earned
on specific borrowing
(150,000)
Borrowing cost eligible
for capitalization 250,000
This problem was an example of qualifying assets
financed through specific borrowing.
The 5 million pesos was borrowed for a specific
purpose and that is for the construction of a new
building
Is the new building a qualifying asset?
Yes! Because, it takes a long period of time to
construct and it is not constructed on a repetitive
basis.
Thats right! Lets try another case:
On January 1, 20x1, ABC Co. had the following borrowings made for general
purposes, a part of the proceeds was used to finance the construction of a
qualifying asset:
Principal
12% short-term note 10,000,000
14% bank loan (3-year) 18,000,000
16% note payable (5-year) 22,000,000
The construction of the qualifying assets was started immediately and
expenditures incurred on the qualifying asset were as follows:
Jan. 1 4,800,000
Mar. 31 2,200,000
July 30 3,500,000
Oct. 31 5,400,000
Dec. 31 300,000
First, we must look for the capitalization rate, this is the weighted average of the
borrowing costs applicable to the borrowings of the entity.

In order to compute for such is just as easy as 1, 2, and 3

Capitalization Rate = Total interest expense on general borrowings
Total general borrowings

The capitalization rate for the problem is computed as follows

Total interest expense on general borrowings
(10Mx12%)+(18Mx14%)+(22Mx16%) 7,240,000
Divide by: Total general borrowings (10M+18M+22M) 50,000,000
Capitalization rate 14.48%
Next, lets look for the average expenditure for each month and total them.

In order to compute for such. We need only to multiple the expenditure to the
months outstanding. Months outstanding are basically the months left in order to
complete a year.
Date Expenditures(a) Mos. Outstanding/12(b) Ave. Expenditure(c)=(axb)
Jan. 1 4,800,000 12/12 4,800,000
Mar. 31 2,200,000 9/12 1,650,000
July 30 3,500,000 5/12 1,458,333
Oct. 1 5,400,000 3/12 1,350,000
Dec.31 300,000 0/12 -------------
9,258,333
The rest of the table is be shown now. See? Very easy.
Finally, we multiply our average
expenditure by the capitalization rate
,which we have solved earlier in order to,
find the capitalization of the qualifying
asset.
The borrowing cost eligible for capitalization is computed as follows:
Average expenditure 9,258,333
Multiply by: Capitalization rate 14.48%
Borrowing cost that may be eligible for capitalization 1,340,607
That was an example of a qualifying
asset financed through general
borrowing, because it was clearly
stated on the problem that the
money was borrowed for general
purposes.
There may also be instances where
the qualifying asset is financed
through both specified and general
borrowings, in that case , in order to
find the borrowing cost eligible for
capitalization, the are two ways we
can try.
Lower of sum of borrowing cost on
specific borrowings, net of investment
income and borrowing costs on general
borrowings computed on average
expenditures excluding specific
borrowings and
Lower of actual borrowing costs
incurred during the period
For the latter part, There are two different
computations:
Average accumulated expenditure method
It is the Traditional Method where the Specific
Borrowing cost is the difference of the interest
expense on specific borrowing and the
investment income earned on specific borrowing.
General Borrowing is solved by average
expenditure less specific borrowing, then
multiplied by the capitalization rate.
There is a deduction of the specific
borrowing from the average expenditure
because expenditures are funded first
from specific borrowings, any excess is
funded from the general borrowings.
The amount eligible for capitalization is
the lower amount between the amount
derived from the formula and the
amount of the actual borrowing costs
Here is an example case: (flash the
problem for qualifying assets financed through
specific and general borrowing)
Notice some funds were
borrowed for a specific purpose
and others for general purposes.
To solve the problem, we must first
look for the capitalization rate, (flash
solution for capitalization rate) Which in this
case is 11%
Afterwards lets look for the average
expenditure (flash computation for average
expenditure) And we end up with A.E. of
9mil.
Furthermore we also compute for The borrowing cost eligible for
capitalization. As for the specific borrowing, you can notice that the
way we have computed is just the same as on the first case.
Specific Borrowing:
Interest expense on specific borrowing(7Mx10%) 700,000
Less: Investment income earned on specific borrowing (120,000)
Borrowing cost from specific borrowing 580,000

General Borrowing:
Average expenditures 9,000,000
Less: Specific borrowing (7,000,000)
Ave. expenditures financed by general borrowing 2,000,000
Multiply by: capitalization rate 11%
Borrowing cost from general borrowing 220,000
Total 800,000
The actual borrowing cost is
P3,300,000 (580k+2.75M).
The amount eligible for capitalization
is P800,000 the lower amount.
The second method is the avoidable interest method.
This is the contemporary method which places greater
emphasis on the avoidable cost concept on PAS 23.
There are three steps in this method
Allocate the expenditures
Average the expenditures
Compute the borrowing cost eligible for capitalization;
whichever is the lower amount between the computed and
the actual borrowing cost incurred during the period is
considered.
Avoidable meaning those that
would have been avoided if the
expenditure on the qualifying asset
had not been made.
For better understanding, lets use
the information from the
previous example to find the
capitalizable borrowing cost using
the avoidable interest method.
Solution:
Step 1: The expenditures are allocated to specific and general borrowings.
Step 2: The amounts allocated to general borrowings are averaged.
Date Expenditure Specific General Mos. Average
s Outstanding
1/1/x1 2,000,000 2,000,000 - N/A
3/31/x1 6,000,000 5,000,000a 1,000,000b N/A;9/12 750,000
9/30/x1 10,000,000 10,000,000 3/12 2,500,000
12/31/x1 2,000,000 2,000,000 0/12 -
TOTALS: 20,000,000 7,000,000a 13,000,000 3,250,000
a (7M specified borrowing-2M allocated on 1/1/x1)
b(6M expenditures on 3/31/x1-5M funded by specific borrowing)
The capitalization rate for the general borrowings is
computed as follows: (flash solution)
Total interest expense on general
borrowings(10Mx12.5%) + (15Mx10%) 2,750,000
Divide by: Total general borrowings (10M+15M) 25,000,000
Capitalization Rate 11%
Step 3: The borrowing cost eligible for
capitalization is computed as follows:
Specific Borrowing
Interest expense on specific borrowing (7Mx10%) 700,000
Less: Investment income earned from specific borrowing (120,000)
Borrowing cost from specific borrowing 580,000
General Borrowing
Average expenditures 3,250,000
Multiply by: Capitalization rate 11%
Borrowing cost from general borrowing 357,500
Total (3,330,000=.580M+2.75M) 937,5000
There are also cases wherein a part of the funds
borrowed specifically for the purpose of obtaining
a qualifying asset is used for other purposes.
Only interest pertaining to expenditures made on
the qualifying asset is eligible for capitalization.
Interest on other expenditure is expensed
immediately.
Specific borrowing is treated as general borrowing.
Formula:
Average expenditure net of investment
income Pxx
Multiply by: Interest rate on specific
borrowing %
Borrowing cost eligible for
capitalization Pxx
Lets try this with this case:
XYZ Co. started construction of a
new office building on January 1,
2016. Funds borrowed specifically
for the construction the building is
P2,000,000 accruing interest at 10%
annually.
However, a part of the borrowing is used
for other business requirements during the
year.
Investment, income earned on temporary
investments of proceeds from the
borrowing amounted to P12,000 which was
received in cash on September 1, 2016.
Expenditures on the building amounted
P1,800,000 which was incurred evenly
during the year.
The average expenditure are computed as follows:
Expenditures incurred evenly 1,800,000
Divide by: 2
Total 900,000
Investment income (12,000x4/12) ( 4,000)
Average expenditure 896,000

The borrowing cost eligible for capitalization is computed as follows:

Average Expenditures 896,000
Multiply by: Interest rate on specific borrowing 10%
Borrowing cost eligible for capitalization 89,600
XI.Limitation of Expenditures
Take note that the Expenditure on a qualifying
asset INCLUDE ONLY those expenditures that have
resulted in:
Payments of cash
Transfer of other assets
The assumption of interest-bearing liabilities
Expenditure are reduced by any progress
payments received and grants received in
connection with the asset.
Lets proceed with another kind of situation,
where capitalization is made during the
extended period of construction.
The average carrying amount during a
period, including borrowing costs previously
capitalized, is normally a reasonable
approximation of the expenditures to which
the capitalization rate is applied in that
period.
For you to further DATE EXPENDITURES
understand the YEAR 20X1
concept, here is an January 1, 20x1 1,000,000
example case. May 1, 20x1 450,000
ABC Co. started December 1, 20x1 720,000
construction of a YEAR 20X2
qualifying asset for XYZ,
January 1, 20x2 900,000
Inc. on January 1, 20x1.
The following were August 30, 20x2 300,000
expenditures incurred YEAR 20x3
on construction. July 1, 20x3 600,000
ABC Co. determined the capitalization rate to be
10%. The construction of the qualifying asset was
substantially completed on September 30, 20x3.

Lets now Compute for the capitalization

borrowing costs on 20x1, 20x2, 20x3 and for the
total cost of the constructed qualifying asset on
September 30, 20x3.
To find the capitalizable
borrowing costs for each year,
we need only to find the
average expenditures for each
year and multiply it by the
capitalization rate, which is in
this case, 10%
To find the total cost of the
building, we need only to add
all the average expenditure
and the borrowing costs for
each year.
 Now that we know how to account for
the borrowing costs, how do we present
them in the financial statements?
Qualifying assets are not segregated
from other assets in the financial
statements.
Presented as regular assets under their
normal classification as provided under
other standards
XIV.Disclosure
What the Entity shall Disclose
The amount of borrowing costs
capitalized during the period; and
The capitalization rate used to
determine the amount of
borrowing costs eligible for
capitalization.
And that is all for our topic about
borrowing costs!

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This is John Case and this is Almy,

giving you peace, love, and
accounting!