Advanced Accounting · AS 16 Borrowing Costs

AS 16 Scope, Definitions and Borrowing Costs

Updated 5 October 2026 · Fact-checked

AS 16 prescribes how to account for borrowing costs. Borrowing costs are interest and other costs a company incurs on borrowing funds. Costs directly attributable to acquiring, constructing or producing a qualifying asset are capitalised as part of its cost. All other borrowing costs are expensed in the period incurred.

Understand AS 16 Scope, Definitions and Borrowing Costs

Companies borrow money to buy or build assets. The cost of that borrowing is a real cost of getting the asset ready. AS 16 Borrowing Costs says when that cost goes into the asset's cost (capitalised) and when it goes to the Statement of Profit and Loss (expensed).

The objective of AS 16 is to prescribe the accounting treatment for borrowing costs. The core rule: borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are capitalised as part of the cost of that asset. Other borrowing costs are recognised as an expense in the period in which they are incurred.

Borrowing costs under AS 16 are interest and other costs incurred by an enterprise in connection with the borrowing of funds. They include:

Interest and commitment charges on bank borrowings and other short-term and long-term borrowings.
Amortisation of discounts or premiums relating to borrowings.
Amortisation of ancillary costs incurred in connection with arranging the borrowings.
Finance charges in respect of assets acquired under finance leases or under other similar arrangements.
Exchange differences arising from foreign currency borrowings, to the extent they are regarded as an adjustment to interest costs.

The last item is a common trap. Only the part of the exchange difference that works as an adjustment to interest is a borrowing cost. Think of it this way: the interest you would have paid on a similar rupee loan is the benchmark. The extra cost of the foreign currency loan, due to exchange loss, is treated as borrowing cost only up to the difference between the interest on the foreign currency loan and the interest on an equivalent rupee loan. Any exchange loss beyond that is not a borrowing cost and is treated under AS 11.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. For example, manufacturing plants, power generation facilities and inventories that require a substantial period to bring to a saleable condition can be qualifying assets. Other assets qualify only if they take a substantial period to get ready. An asset that is ready for use or sale when bought, or inventory made quickly and repeatedly, is not a qualifying asset.

AS 16 does not define a substantial period and does not fix a number of months. It depends on the facts and circumstances of each case. Some people use twelve months as a rough rule of thumb, but that figure is not in AS 16, so do not quote it as the Standard's rule.

AS 16 deals with the treatment of borrowing costs only. It does not deal with the actual or imputed cost of owners' equity, including preference share capital not classified as a liability.

Key rules to remember

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.

How to solve AS 16 Scope, Definitions and Borrowing Costs questions

Use this method for any question on scope, definitions, or classification of costs under AS 16.

1Read the question and list every cost mentioned: interest, commitment charges, discount, ancillary costs, lease charges, exchange differences, and anything else.
2Decide for each cost whether it falls inside the AS 16 definition of borrowing costs. Costs of owners' equity, such as dividend on equity or preference capital not classified as a liability, are outside it.
3For foreign currency borrowings, compute the interest on the foreign loan at its own rate, then the interest on an equivalent rupee loan. The gap is the maximum exchange loss that can be treated as interest.
4Check whether the asset is a qualifying asset: does it need a substantial period to get ready for intended use or sale?
5If it is a qualifying asset and the cost is directly attributable to it, mark the cost for capitalisation. Otherwise mark it as an expense.
6State the final split clearly: amount capitalised, amount charged to the Statement of Profit and Loss, and amount handled under AS 11.
7Write one line of reasoning citing AS 16, so you earn step marks even if a figure differs.

Quickest way: Fast classification and MCQ method

When to use it: Use this for MCQs and short theory parts where you must decide quickly whether a cost is a borrowing cost or whether an asset is qualifying.

For MCQs, ask two questions: is it a cost of borrowing debt (not equity)? Is the asset one that takes a long time to get ready?
Eliminate options that mention dividend on equity shares or any cost of owners' equity as a borrowing cost.
For exchange differences, remember the cap: only up to the interest differential between rupee and foreign loans.
For written answers, use a three-line format: definition from AS 16, application to the facts, conclusion with amounts. Show the exchange difference working as a small separate table in lines.
Always write the final treatment words: capitalised or charged to Profit and Loss.

Common mistakes in AS 16 Scope, Definitions and Borrowing Costs

Treating the whole exchange loss on a foreign currency loan as a borrowing cost.
The list of borrowing costs mentions exchange differences, and students forget the qualifier.
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.
Dividend feels like a cost of raising funds.
Fix: AS 16 covers costs of borrowings only. Cost of owners' equity, including preference capital not classified as a liability, is outside its scope.
Calling any asset a qualifying asset.
Students link capitalisation to every fixed asset purchase.
Fix: Ask whether the asset necessarily takes a substantial period to get ready. A ready-to-use machine bought off the shelf is not a qualifying asset.
Leaving out finance charges on finance leases, or commitment charges, from the list.
Students remember only interest.
Fix: Memorise all items: interest, commitment charges, discount or premium amortisation, ancillary cost amortisation, finance lease charges and exchange difference adjustment.
Capitalising all borrowing costs of a company that owns a qualifying asset.
Students ignore the words directly attributable.
Fix: Capitalise only costs that would have been avoided if the qualifying asset had not been acquired, constructed or produced. Other borrowing costs are expensed.

Worked examples

Example 1

Classify each as a borrowing cost under AS 16 or not: (a) interest on a term loan, (b) commitment charges on an undrawn bank limit, (c) dividend on equity shares, (d) finance charges on a finance lease, (e) processing fees paid to arrange a loan.

Show the solution

Interest on a term loan is the basic example of a borrowing cost.
Commitment charges on borrowings are listed in AS 16, so they are borrowing costs.
Dividend on equity shares is a cost of owners' equity. AS 16 does not cover it.
Finance charges on assets under finance leases are included in borrowing costs.
Processing fees to arrange the loan are ancillary costs in connection with arranging borrowings. The borrowing cost for a period is only the amortised portion of the fee for that period, not the whole fee paid.

Answer: (a), (b) and (d) are borrowing costs. (e) is a borrowing cost only to the extent of the amortised portion of the processing fee for the period. (c) is not a borrowing cost.

Example 2

A company borrowed US $ 1,00,000 at 5% p.a. on 1 April to build a plant (a qualifying asset). The exchange rate was ₹ 60 per US $ on 1 April and ₹ 65 per US $ on 31 March. The average rate for the year was ₹ 62.50 per US $. A similar rupee loan would have carried interest at 11% p.a. Compute the borrowing cost to be capitalised for the year. Ignore other costs and assume capitalisation for the full year. Convert the foreign interest at the average rate for the year (interest assumed to accrue evenly through the year), and use the closing rate for the exchange loss on principal.

Show the solution

Principal in rupees on 1 April = 1,00,000 × 60 = ₹ 60,00,000.
Interest on the foreign loan at 5% = US $ 5,000. At the average rate of ₹ 62.50: 5,000 × 62.50 = ₹ 3,12,500.
Interest on an equivalent rupee loan at 11% on ₹ 60,00,000 = ₹ 6,60,000.
Exchange loss on principal = 1,00,000 × (65 − 60) = ₹ 5,00,000.
Interest differential (limit) = 6,60,000 − 3,12,500 = ₹ 3,47,500.
Exchange loss treated as borrowing cost = lower of 5,00,000 and 3,47,500 = ₹ 3,47,500.
Total borrowing cost = 3,12,500 + 3,47,500 = ₹ 6,60,000.
The remaining exchange loss = 5,00,000 − 3,47,500 = ₹ 1,52,500 is not a borrowing cost. It is accounted for under AS 11 and is charged to the Statement of Profit and Loss.

Answer: Borrowing cost to be capitalised is ₹ 6,60,000 (interest ₹ 3,12,500 plus exchange loss of ₹ 3,47,500). The balance exchange loss of ₹ 1,52,500 is charged to the Statement of Profit and Loss under AS 11.

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.

Practice questions from AS 16 Borrowing Costs

AS 16 Scope, Definitions and Borrowing Costs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

AS 16 Scope, Definitions and Borrowing Costs: frequently asked questions

What is a qualifying asset in AS 16?

It is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples are a manufacturing plant or a power plant under construction. An asset ready for use on purchase is not a qualifying asset.

Is the exchange difference on a foreign currency loan always a borrowing cost?

No. Only the part that is regarded as an adjustment to interest is a borrowing cost. It is limited by the difference between interest on an equivalent rupee loan and interest on the foreign currency loan. The rest is dealt with under AS 11.

Does AS 16 cover the cost of equity capital?

No. AS 16 does not deal with the actual or imputed cost of owners' equity, including preference share capital not classified as a liability. It covers only costs of borrowings.

What happens to borrowing costs that are not capitalised?

They are recognised as an expense in the period in which they are incurred, which means they are charged to the Statement of Profit and Loss.