Borrowing costs related to the funding of revenue earning
fixed assets are a recurring cost of operation and should be
charged against the revenue earned. But what about
funding the construction of future revenue earning fixed
assets? A legitimate argument is that borrowing costs
should be capitalised during the construction phase of a
fixed asset. Unless clear rules exist borrowing costs could
disappear from the P&L account, instead appearing as a
constituent of a fixed assets “worth”!
Capitalising revenue related costs was one of the techniques
used by Worldcom to lower costs and thus enhance earnings.
Ideas – concepts
Borrowing costs are an inevitable cost of funding business
activities. They should most prudently be considered a cost
to be charged as incurred against revenue.
However, fixed assets often require considerable funds to
finance their construction or purchase. Borrowing costs
incurred during the construction phase could legitimately be
considered a necessary cost to bring the asset into a revenue
earning condition, that is, they are a cost of the fixed
asset as much as materials or labour are. A good way of
justifying this view is to consider that if a business
purchased a completed property say, the construction company
that built the property would have factored into its selling
price the borrowing costs of funding their work in progress
during the property’s construction.
Borrowing costs should be recognised as an expense in the
period in which they are incurred except to the extent that
they are directly attributable to acquisition, construction
or production of a qualifying asset.
The accounting policy adopted for borrowing costs should
be disclosed. Also the amount of borrowing costs capitalised
during the period and the interest rate used to determine the
amount of capitalised borrowing costs.
Problems areas and questions to ask about the accounts
What borrowing costs qualify to be capitalised?
Those that specifically relate to the construction of a
fixed asset. An appropriate weighted average cost of relevant
general borrowings may be capitalised.
Consistency of approach
If a policy of capitalising interest is adopted then it
must be applied to all qualifying assets - the policy cannot
be used selectively. Businesses can either capitalise
interest on all qualifying assets or not apply it to any.
When should capitalisation commence and cease?
When expenditure and borrowing costs are being incurred on
activities necessary to prepare the asset for its intended
use. When all the preparatory activities are substantially
complete then capitalisation should cease.
What happens if a capital project is suspended?
Capitalisation should be suspended during extended periods
during which active development is interrupted.
What happens if a project is completed in stages?
If each stage or part is capable of being used while
construction continues on other parts then capitalisation of
borrowing costs should cease for the part that is in revenue
What happens if capitalisation of borrowing costs leads to
over valuation of an asset?
Where the cost of assets contain an element of capitalised
borrowing costs check that the asset is not over valued.
There is no significant difference between the
requirements of UK FRS 15 - Tangible Fixed Assets and this
Objective and definitions from the standard
The objective of this standard is to prescribe the
accounting treatment for borrowing costs. This standard
generally requires the immediate expensing of borrowing
costs. However, the standard permits, as an allowed
alternative treatment, the capitalisation of borrowing costs
that are directly attributable to the acquisition,
construction or production of a qualifying asset.
Borrowing costs are interest and other costs incurred by
an enterprise in connection with the borrowing of funds
A qualifying asset is an asset that necessarily takes a
substantial period of time to get ready for its intended use
The Complete Guide to IFRS including IAS and
interpretation - Ralph Tiffin explains the IFRS in clear
terms pointing to the areas of possible concern. ISBN
1 85418 279X publisher Thorogood - firstname.lastname@example.org