Capitalising borrowing costs on a built asset
When interest on loans used to build an asset belongs in its cost under IAS 23, and how the amount is worked out for specific and general borrowings.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A client spends most of a year building a new warehouse, paid for partly with a dedicated bank loan and partly out of its overdraft. Interest goes to finance costs every month, as it always has. At year end the warehouse sits in property, plant and equipment at the cost of bricks, steel and contractors, while the income statement carries a heavy interest charge.
Under IAS 23 that picture may be wrong on both sides. Part of the interest belongs in the cost of the warehouse.
Interest that would have been avoided
ACCA explains that IAS 23 Borrowing Costs requires borrowing costs that would have been avoided if a constructed asset had not been built to be included in its cost. The idea sits comfortably with IAS 16, under which the cost of property, plant and equipment includes costs directly attributable to bringing the asset to the location and condition needed for it to operate as management intends. Financing the construction is part of getting the asset built.
"Would have been avoided" is the test to hold on to. Had the client not built the warehouse, it would not have drawn the construction loan and would have used less of its overdraft. That interest is a cost of the warehouse. Before going further, read the scope of IAS 23 itself to confirm that the asset is one the standard covers.
Specific loans and general borrowings
ACCA explains that the amount is worked out differently depending on how the construction was financed: actual finance costs for specific borrowings, and a weighted average rate for general borrowings.
Specific borrowings
Where the client took out a loan specifically to build the asset, the borrowing costs to capitalise are the actual finance costs on that loan during construction. The loan agreement and the bank statements give the figures directly.
General borrowings
Where the building was paid for out of the client's general pool of debt, such as an overdraft, a revolving facility or a general term loan, the client works out a weighted average rate across those borrowings and applies it to the amounts spent on the asset.
A worked example in words: the client has two general facilities, an overdraft and a term loan, at different rates. The weighted average rate is the total borrowing cost on those facilities for the period divided by the average amount outstanding on them. The client then applies that rate to its spending on the warehouse, weighted for how long each payment was outstanding during the construction period. The result is the interest moved from finance costs to the asset.
Many clients have both kinds of funding. Use the actual cost for the part paid from the dedicated loan, and the weighted average rate for the rest.
When capitalisation starts and stops
IAS 23 sets out when capitalisation begins, and the preparer should read those conditions against the client's construction timeline: when spending started, when borrowing started and when work began.
On the end point, ACCA explains that capitalisation of costs stops when an asset is ready for use, even if it is brought into use later. A warehouse that is finished but stands empty while the client looks for a tenant stops gathering interest in its cost on completion. ACCA also notes that abnormal costs, such as wasted material, cannot be capitalised. Where work stopped for a long stretch during construction, check what IAS 23 says about such periods before adding that interest to cost.
Put the key dates on file: the start of spending and work, any stoppages, and the date the asset was ready for use.
Moving interest with an adjusting entry
Most small clients post all their interest to finance costs during the year, so the correction comes at year end. In Achekam's Financials Studio, staff can post a year-end adjusting entry that debits the asset under construction, or the completed asset, and credits finance costs, with the working attached. A wrong adjusting entry is reversed with a record of who reversed it and why, never deleted.
Two knock-on effects to remember:
- Depreciation. The capitalised interest becomes part of the asset's cost and is depreciated with it once the asset is in use. The Studio does not calculate depreciation; it presents the trial balance figure and flags a charge that does not agree with the movement in accumulated depreciation. If the client's register leaves out the capitalised interest, the charge will need adjusting as well.
- Tax. The tax treatment of capitalised interest may differ from the accounting treatment, which can create a temporary difference for deferred tax.
Policy and note wording to complete
The Studio's standard policy wording is based on IFRS for SMEs and labelled for review before issue. Check that the borrowing costs policy matches both the framework the client reports under and what it actually did; staff can write their own policy where it does not. Notes take their figures from the mapped trial balance, and details the trial balance cannot hold, such as the amount capitalised in the year and the rate used, are left as "[to be completed]" for the preparer to fill in from the working.
The property, plant and equipment note should show the capitalised borrowing costs within the asset's cost, and the policy should explain the basis. The note itself is discussed in the property, plant and equipment note, and the wider question of which costs belong in an asset is covered in which asset costs to capitalise and which to expense.
ACCA's technical article on measuring and depreciating property, plant and equipment explains the initial measurement of property, plant and equipment under IAS 16, including borrowing costs on constructed assets.
What to ask the client for
- The loan agreements for every facility in place during construction.
- Bank statements showing interest charged on each facility.
- A schedule of construction payments with dates.
- The date the asset was ready for use, with evidence such as an occupation certificate or the contractor's completion notice.
- Any period when work stopped, and why.
With those five items, the calculation is mechanical. Without them, it is guesswork, and guesswork has no place in an asset's cost.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
