Financial Accounting · Borrowing Costs (AS 16)

Introduction and Scope of AS 16 Borrowing Costs

Updated 10 October 2026 · Fact-checked

AS 16 Borrowing Costs prescribes the accounting treatment of interest and related costs on borrowed funds. Borrowing costs that are directly attributable to acquiring, constructing or producing a qualifying asset are capitalised as part of its cost. All other borrowing costs are recognised as an expense in the period they are incurred.

Understand Introduction and Scope of AS 16 Borrowing Costs

A business often borrows money to build or buy something big, such as a factory or a plant. The interest paid on that loan is a cost. The question is whether it goes to the Profit and Loss Statement now or into the cost of the asset.

AS 16 answers this. Its objective is to prescribe the accounting treatment for borrowing costs. The core principle: borrowing costs 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 treated as an expense.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples are a power plant under construction, a large building, or inventory that needs a long maturing period. A machine bought off the shelf and ready to use is not a qualifying asset. What counts as a substantial period depends on the facts. Many practitioners treat about twelve months as a guide, but it is not a fixed rule.

Borrowing costs are interest and other costs a business incurs in connection with borrowing 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 similar arrangements; and exchange differences arising from foreign currency borrowings, to the extent they are regarded as an adjustment to interest costs.

AS 16 does not deal with the actual or imputed cost of owners' equity, including preference share capital not classified as a liability. So a dividend on equity shares is never a borrowing cost under this standard.

Key rules to remember

Capitalisation rule: Borrowing costs directly attributable to a qualifying asset → capitalised; all other borrowing costs → expense; Capitalise only while the conditions of AS 16 are met; otherwise charge to Profit and Loss.
Qualifying asset test: Asset that necessarily takes a substantial period of time to get ready for intended use or sale; Both the time and the necessity matter. Ready-to-use assets do not qualify.
Borrowing costs include: Interest + commitment charges + amortisation of discount/premium + amortisation of ancillary costs + finance lease charges + exchange differences treated as interest adjustment; List these five or six heads in definition answers.
Excluded from scope: Actual or imputed cost of owners' equity (including preference capital not classified as a liability) is outside AS 16; Equity dividends and notional return on own funds are not borrowing costs.

How to solve Introduction and Scope of AS 16 Borrowing Costs questions

Use this method for any definition, scope or classification question on AS 16.

1Identify the item given: interest, discount, ancillary cost, lease charge, exchange difference or dividend.
2Check whether it is a borrowing cost under the AS 16 definition. Equity cost is outside scope.
3Identify the asset financed and ask whether it necessarily takes a substantial period to get ready for use or sale.
4If it is a qualifying asset, check that the cost is directly attributable to it. If yes, capitalise.
5If the asset is not a qualifying asset, or the cost is not attributable, charge the cost to the Profit and Loss Statement.
6State the conclusion with the reason in one line, naming the AS 16 term used.

Quickest way: Two-question filter

When to use it: For MCQs and short classification questions where time is tight.

Question 1: Is it a cost of borrowed money? If it is equity cost, stop: not a borrowing cost.
Question 2: Is the asset one that takes a substantial time to get ready? If yes, capitalise; if no, expense.
Watch for keywords: 'ready to use on purchase' means expense; 'construction over several years' means capitalise.

Common mistakes in Introduction and Scope of AS 16 Borrowing Costs

Treating dividend on equity shares or notional interest on own capital as a borrowing cost.
Students think any cost of funds counts.
Fix: Remember AS 16 covers only borrowed funds. Cost of owners' equity is outside its scope.
Capitalising interest on every asset bought with a loan.
Students ignore the qualifying asset test.
Fix: Capitalise only if the asset necessarily takes a substantial period to get ready for use or sale.
Leaving out finance lease charges, discount amortisation or exchange differences from the list of borrowing costs.
Students remember only interest.
Fix: Learn the full list of heads in the definition and write all of them in theory answers.
Calling an asset qualifying just because it is expensive.
Size is confused with time taken.
Fix: The test is time to get ready, not cost. A costly ready machine is not qualifying.
Thinking only fixed assets can be qualifying assets.
Examples in books are mostly buildings and plant.
Fix: Inventories that need a substantial period to bring to saleable condition can also qualify.

Worked examples

Example 1

Sunrise Textiles Ltd incurred the following during the year: (a) interest on a term loan of ₹4,00,000 used to build a new factory that will take two years to complete; (b) dividend of ₹1,00,000 on equity shares; (c) interest of ₹50,000 on a loan used to buy a ready-to-use computer. State which items are borrowing costs under AS 16 and which are capitalisable.

Show the solution

Item (a): interest on a loan is a borrowing cost. A factory taking two years is a qualifying asset. The interest is directly attributable, so it is capitalised: ₹4,00,000.
Item (b): dividend on equity shares is a cost of owners' equity. It is outside AS 16 and is not a borrowing cost.
Item (c): interest is a borrowing cost. A ready-to-use computer is not a qualifying asset. So it is charged as an expense: ₹50,000.
Total borrowing costs under AS 16 = ₹4,00,000 + ₹50,000 = ₹4,50,000, of which ₹4,00,000 is capitalised.

Answer: Borrowing costs are ₹4,50,000. Capitalise ₹4,00,000 to the factory; expense ₹50,000; the ₹1,00,000 dividend is not a borrowing cost.

Example 2

Explain what a qualifying asset is under AS 16 and decide whether each is one: (i) a hydroelectric plant taking three years to build, (ii) office furniture bought and put to use immediately, (iii) wine stock that must mature for several years before sale.

Show the solution

Definition: a qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale.
(i) Plant taking three years to build: qualifying asset.
(ii) Furniture ready for use on purchase: not a qualifying asset, as no substantial period is needed.
(iii) Wine stock needing years to mature before sale: an inventory that takes a substantial period to get ready for sale, so it is a qualifying asset.

Answer: (i) and (iii) are qualifying assets; (ii) is not. Borrowing costs on (i) and (iii) that are directly attributable are capitalised, and costs on (ii) are expensed.

Exam tips

In theory answers, begin with the definition of borrowing costs and list every head included. Step marks follow the list.
For MCQs, look for equity dividend or ready-to-use assets, which are the usual traps.
Give a reason in every classification answer, such as 'substantial period' or 'directly attributable'.
Always give one example of a qualifying asset and one of a non-qualifying asset to show you understand the test.

Practice questions from Borrowing Costs (AS 16)

Introduction and Scope of AS 16 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.

Introduction and Scope of AS 16 Borrowing Costs: frequently asked questions

What are borrowing costs as per AS 16?

They are interest and other costs incurred in connection with borrowing funds. They include interest, commitment charges, amortisation of discount, premium and ancillary costs, finance lease charges and certain exchange differences treated as an interest adjustment.

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. Borrowing costs directly attributable to it are capitalised.

Does AS 16 cover dividend on preference shares?

AS 16 does not deal with the cost of owners' equity, including preference share capital not classified as a liability. So such dividend is not treated as a borrowing cost under it.

Is there a fixed period that makes a period substantial?

The standard does not fix a number of months. It depends on the facts of the case. Twelve months is often used only as a practical guide.