AS 16 Borrowing Costs: formula sheet

Key formulas

Core rule of AS 16

Borrowing costs directly attributable to a qualifying asset → capitalise; all other borrowing costs → expense

Capitalise only while the asset is being acquired, constructed or produced. Rules on start, suspension and end are covered in a separate topic.

Items included in borrowing costs

Interest + commitment charges + amortisation of discount/premium + amortisation of ancillary costs + finance charges on finance leases + exchange difference to the extent treated as interest adjustment

Learn this list as five heads, as in AS 16. Interest and commitment charges count together as one head. Questions often ask which item does not belong.

Exchange difference limit

Exchange loss treated as borrowing cost = lower of (actual exchange loss) and (interest on equivalent rupee loan − interest on foreign currency loan)

Any exchange loss above this limit is not a borrowing cost and is accounted for under AS 11. If the foreign loan interest already equals or exceeds the rupee interest, no exchange loss is adjusted.

Qualifying asset test

Asset necessarily takes a substantial period of time to get ready for intended use or sale

Two parts: the asset is not ready on purchase, and the time needed is substantial. AS 16 does not define substantial or fix a number of months; judge on the facts and circumstances of each case.

Capitalise or expense test

Qualifying asset (substantial period) + directly attributable borrowing cost = capitalise; otherwise = expense

Capitalisation is required, not optional, when the conditions are met.

Commencement conditions (all three)

Expenditure incurred AND borrowing costs incurred AND activities to prepare the asset in progress

Capitalisation starts only when all three are met.

Cost of qualifying asset

Cost of asset = Expenditure on asset + Borrowing costs capitalised

Capitalised cost is then depreciated like the asset itself.

Income from temporary investment of specific borrowings

Eligible borrowing cost = Actual cost on specific borrowing − Income earned on temporary investment of that borrowing

Applies to funds borrowed specifically for the asset and parked temporarily.

Suspension and cessation

Suspend during extended periods of interrupted active development; cease when substantially all activities are complete

Brief interruptions, or delays that are a necessary part of the process, do not suspend capitalisation.

Specific borrowings: amount to capitalise

Actual interest on specific borrowings during the period − Income earned on temporary investment of unused specific funds

Capitalise only while capitalisation is active. Interest outside the capitalisation period is expensed.

Weighted average capitalisation rate

Total interest on general borrowings for the period ÷ Weighted average amount of general borrowings outstanding × 100

Weight each loan by months outstanding ÷ 12. If all loans are outstanding for the full year, the weighted average principal equals total principal, so the rate equals total interest ÷ total principal × 100.

General borrowings: amount to capitalise

Weighted average expenditure on the asset financed from general funds × Capitalisation rate

Expenditure financed by specific funds is excluded. Weight each outlay by the months it was on the asset.

Cap on capitalisation

Amount capitalised ≤ Borrowing cost actually incurred in the period

Apply the cap to general borrowings; the capitalised amount cannot exceed total interest on the general pool.

Expense to Statement of Profit and Loss

Total borrowing cost incurred − Amount capitalised

Check that capitalised plus expensed equals total incurred.

Conditions for commencement

Expenditure incurred + Borrowing costs incurred + Activities in progress = start capitalising

All three must be met. Missing any one means expense the interest.

Suspension rule

Extended interruption of active development → suspend and expense

No suspension for short or temporary delays, or when substantial technical or administrative work continues, or when the delay is a necessary part of the process.

Cessation rule

Substantially all activities complete → stop capitalising

Minor pending work does not delay cessation.

Part-completed asset

Each part usable on its own → cease for that part when it is ready. Part not usable until the whole is done → cease when the whole is ready

Test whether the completed part can be used while work continues on the rest.

Capitalised interest for a period

Borrowing cost × (months of active development ÷ months in period)

Use only for the months when capitalisation is allowed, where interest accrues evenly.

Disclosure

Accounting policy adopted + Amount of borrowing costs capitalised during the period

Both are required in the financial statements.

Quick revision

• A qualifying asset takes a substantial period to get ready for its intended use or sale.
• Borrowing costs include interest, certain finance charges and exchange differences arising from foreign currency borrowings, but only to the extent they are regarded as an adjustment to interest costs.
• Capitalise borrowing costs directly attributable to a qualifying asset. Expense the rest.
• Specific borrowings: capitalise actual cost less income from temporary investment of the unused funds.
• General borrowings: amount = expenditure on the asset financed by general borrowings (weighted average expenditure not covered by specific borrowings) × capitalisation rate.
• Capitalisation rate = weighted average of borrowing costs on general borrowings, not the specific ones.
• Capitalised general borrowing cost cannot exceed the actual borrowing cost for the period.
• Capitalisation commences when ALL three conditions are met: expenditure on the asset is incurred, borrowing costs are incurred, and activities to prepare the asset for its intended use or sale are in progress.
• Suspend capitalisation during extended periods when active development is interrupted.
• Temporary delays or delays that are a necessary part of the process do not require suspension.
• Capitalisation ceases when substantially all activities for intended use or sale are complete.
• If parts of an asset are complete and usable separately, stop capitalising for that part.

Common mistakes

• Treating the whole exchange loss on a foreign currency loan as a borrowing cost. Fix: Compute the interest differential first. Only exchange loss up to that amount is a borrowing cost. The rest goes under AS 11.
• Including dividend on preference shares or equity as a borrowing cost. Fix: AS 16 covers costs of borrowings only. Cost of owners' equity, including preference capital not classified as a liability, is outside its scope.
• Capitalising interest on an asset that is ready for use when purchased. Fix: Capitalise only if the asset is a qualifying asset needing a substantial period to get ready.
• Starting capitalisation on the date the loan is taken. Fix: Start only when expenditure, borrowing costs and preparation activities all exist.
• Deducting temporary investment income from general borrowing cost. Fix: The deduction applies to specific borrowings only. For general borrowings use the weighted average rate and no deduction.
• Using a simple average of interest rates instead of a weighted average. Fix: Divide total general interest by the weighted average general principal. Weight by months outstanding when loans are not outstanding for the full year.
• Starting capitalisation on the loan drawdown date. Fix: Start only when expenditure is incurred and development activity is in progress, as well as borrowing cost being incurred.
• Suspending capitalisation for every delay. Fix: Suspend only for extended interruptions. Short delays, necessary delays and periods of substantial technical or administrative work are not suspended.

Exam tips

• Learn the list of borrowing cost items as a fixed list. A typical MCQ asks which item is not included.
• For foreign currency loans, always show the comparison with the equivalent rupee loan interest. This is where step marks sit.
• State the excess exchange loss treatment explicitly as AS 11, not just as an expense.
• In theory questions, define a qualifying asset with both parts: substantial period and intended use or sale. Give two examples. Say that AS 16 does not define substantial period and that it depends on the facts and circumstances of each case.
• Remember there is no negative marking in MCQs, so attempt every one.
• Write the qualifying asset test first. Even a one-line reason earns marks.
• Mark the start date, suspension months and completion date on a small timeline before computing.
• In MCQs, check whether the asset is ready for use on purchase. That single fact often eliminates two options.