Financial Accounting · Borrowing Costs (AS 16)

How to Calculate Capitalisation Rate under AS 16

Updated 10 October 2026 · Fact-checked

Under AS 16, borrowing costs on a qualifying asset are capitalised. For specific borrowings, capitalise actual cost less income earned on temporary investment of unused funds. For general borrowings, capitalise the weighted average rate of all general borrowings multiplied by the expenditure on the asset, limited to actual cost incurred.

Understand Calculation of Capitalisation Rate and Borrowing Costs

AS 16 says borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of its cost. A qualifying asset is one that takes a substantial period of time to get ready for its intended use or sale. Other borrowing costs are expensed in the period.

Two situations arise. In the first, you borrowed money specifically to build the asset. This is a specific borrowing. You capitalise the actual interest on it for the period of capitalisation. If you park unused borrowed money in a temporary investment, the income earned on it is deducted from the interest you capitalise.

In the second, you used the funds from your general pool of loans, debentures and so on. This is a general borrowing. You cannot trace the interest to the asset, so you apply a capitalisation rate to the expenditure on the asset. The rate is the weighted average of the borrowing costs on all general borrowings outstanding during the period.

There is one safety limit. The borrowing cost capitalised in a period cannot exceed the actual borrowing cost incurred in that period. Also, the capitalisation rate applies only to the part of expenditure on the asset not financed by specific borrowings.

The period of capitalisation also matters. Capitalisation starts when expenditure is incurred, borrowing costs are incurred and activities to prepare the asset are in progress. It is suspended during extended interruptions and stops when the asset is substantially ready. Most numerical questions give you dates, so always count months carefully.

Key rules to remember

Specific borrowings: Capitalisable cost = Actual interest on the specific loan for the capitalisation period − Income from temporary investment of unused funds; Use only the months when capitalisation is on. Any investment income earned in that period is deducted.
Capitalisation rate: Capitalisation rate = (Σ Interest on general borrowings ÷ Σ Weighted average amount of general borrowings) × 100; Use the borrowing cost for the period and weighted average amounts outstanding in that period. If all general loans are outstanding throughout, a simple weighted average of the interest amounts and loan amounts gives the same result.
General borrowings: Capitalisable cost = Weighted average expenditure on the asset funded by general borrowings × Capitalisation rate; Weight each expenditure by the time it was outstanding in the period. Exclude the part funded by specific borrowings.
Ceiling: Amount capitalised ≤ Actual borrowing cost incurred in the period; Apply this limit to general borrowings. If the calculated amount is more than actual interest, capitalise only the actual interest.
Total cost of asset: Cost of asset = Expenditure on asset + Capitalised borrowing costs; Borrowing costs not capitalised are charged to the Statement of Profit and Loss.

How to solve Calculation of Capitalisation Rate and Borrowing Costs questions

Use the same sequence for any AS 16 numerical. It keeps the specific and general parts separate and prevents double counting.

1Confirm the asset is a qualifying asset and fix the capitalisation period from commencement to substantial completion, excluding any extended suspension.
2Separate specific borrowings (taken for the asset) from general borrowings (the pool).
3For each specific borrowing, compute interest for the capitalisation period and deduct income earned from temporary investment of unused funds.
4List the expenditure on the asset with dates, and deduct the portion financed by specific borrowings to find expenditure funded by general borrowings.
5Compute the weighted average rate on general borrowings: total interest ÷ weighted average amount of loans, as a percentage.
6Weight the general-funded expenditure by months outstanding, then multiply by the capitalisation rate. Check it does not exceed actual general borrowing cost.
7Add specific and general amounts to get total capitalised borrowing cost; charge the balance of interest to Profit and Loss.
8Show the cost of the asset (expenditure plus capitalised borrowing cost) and state any journal entry if asked.

Quickest way: Rate times weighted expenditure shortcut

When to use it: Use when the question gives clear dates and asks only for the amount to be capitalised, not full disclosures.

Write the specific loan interest and subtract investment income in one line.
Compute the rate once: total general interest ÷ total general loans, assuming loans run the whole period.
Draw a small table of expenditure, months outstanding and amount × months ÷ 12.
Multiply the weighted total by the rate, compare with actual general interest, and add the two results.

Common mistakes in Calculation of Capitalisation Rate and Borrowing Costs

Capitalising the full specific loan interest without deducting temporary investment income
Students remember the interest but forget the unused funds earned something.
Fix: Always check the question for surplus funds or fixed deposits. Deduct that income from the specific interest.
Applying the capitalisation rate to the total expenditure instead of only the portion not funded by specific loans
Students treat all expenditure the same way and double count.
Fix: First subtract specific borrowing used from expenditure. Apply the rate only to the balance.
Ignoring time weighting for expenditure incurred part way through the year
Students multiply the full amount by the annual rate.
Fix: Multiply each expenditure by months outstanding ÷ 12 before applying the rate.
Including interest for the suspension or post-completion period
Students use the whole financial year by default.
Fix: Mark the start and end of capitalisation on a timeline. Interest outside the period goes to Profit and Loss.
Forgetting the ceiling of actual interest on general borrowings
The calculated figure looks final.
Fix: Compare the calculated amount with actual general interest incurred and capitalise the lower.
Taking a simple average of interest rates instead of a weighted average
It is quicker and looks reasonable.
Fix: Divide total interest by total loan amount. Do not average the percentages.

Worked examples

Example 1

Meera Textiles Ltd is constructing a plant. It took a specific loan of ₹50,00,000 at 10% p.a. on 1 April 2026. Capitalisation continued for the whole year ended 31 March 2027. Unused funds of ₹10,00,000 were invested in a fixed deposit for 3 months and earned ₹25,000. Compute the borrowing cost to be capitalised.

Show the solution

Interest on specific loan for the year = ₹50,00,000 × 10% = ₹5,00,000.
Income from temporary investment of unused funds = ₹25,000.
Capitalisable borrowing cost = ₹5,00,000 − ₹25,000 = ₹4,75,000.

Answer: ₹4,75,000 is capitalised as part of the cost of the plant.

Example 2

Kaveri Infra Ltd is building a warehouse during the year ended 31 March 2027. General borrowings throughout the year: 12% debentures ₹40,00,000 and a 9% term loan ₹20,00,000. A specific loan of ₹30,00,000 at 11% was taken on 1 April 2026 for the warehouse and fully used on that date. Expenditure on the warehouse: ₹30,00,000 on 1 April 2026 (from specific loan), ₹12,00,000 on 1 October 2026 and ₹6,00,000 on 1 January 2027, both from general funds. Capitalisation continued to 31 March 2027. Compute the borrowing cost to be capitalised.

Show the solution

Specific loan interest = ₹30,00,000 × 11% = ₹3,30,000. No temporary investment income is given.
General interest = ₹40,00,000 × 12% = ₹4,80,000 plus ₹20,00,000 × 9% = ₹1,80,000, total ₹6,60,000.
Total general loans = ₹60,00,000, so capitalisation rate = ₹6,60,000 ÷ ₹60,00,000 × 100 = 11%.
Weighted expenditure from general funds: ₹12,00,000 × 6 ÷ 12 = ₹6,00,000, and ₹6,00,000 × 3 ÷ 12 = ₹1,50,000. Total = ₹7,50,000.
General borrowing cost to capitalise = ₹7,50,000 × 11% = ₹82,500. This is below actual general interest of ₹6,60,000, so the ceiling is met.
Total capitalised = ₹3,30,000 + ₹82,500 = ₹4,12,500.
Interest charged to Profit and Loss = (₹3,30,000 + ₹6,60,000) − ₹4,12,500 = ₹5,77,500.

Answer: Borrowing cost capitalised = ₹4,12,500 (specific ₹3,30,000 plus general ₹82,500). Cost of warehouse = ₹48,00,000 expenditure + ₹4,12,500 = ₹52,12,500.

Exam tips

Underline dates in the question first. Months outstanding drive most of the marks.
Show the capitalisation rate working separately, even when it is a round figure, so you earn step marks.
Write the ceiling check as a one-line statement. Examiners look for it in general borrowing questions.
If the question gives investment income, it almost always relates to specific borrowings. Deduct it there only.
End with the total capitalised amount and the interest charged to Profit and Loss, as the MCQs often ask for either.

Practice questions from Borrowing Costs (AS 16)

Calculation of Capitalisation Rate 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.

Calculation of Capitalisation Rate and Borrowing Costs: frequently asked questions

How do I calculate the capitalisation rate under AS 16?

Divide total borrowing cost on general borrowings for the period by the weighted average amount of those borrowings, then multiply by 100. Use only general borrowings outstanding during the period. Specific borrowings are excluded.

What is the difference between specific and general borrowings in AS 16?

Specific borrowings are taken directly to acquire or build a qualifying asset, so actual interest is capitalised. General borrowings are the pool of funds used for several purposes, so you capitalise using a weighted average rate applied to expenditure on the asset.

Is investment income deducted from general borrowings?

No. AS 16 asks you to deduct income from temporary investment of specific borrowings pending their use. For general borrowings you apply the capitalisation rate, subject to the limit of actual interest incurred.

Can the capitalised amount exceed the interest actually paid?

No. The borrowing cost capitalised in a period cannot exceed the borrowing cost incurred in that period. If your calculation is higher, capitalise only the actual amount.