Financial Accounting · Borrowing Costs (AS 16)

AS 16 Capitalisation of Borrowing Costs Explained

Updated 10 October 2026 · Fact-checked

Under AS 16, borrowing 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. A qualifying asset is one that necessarily takes a substantial period, ordinarily twelve months, to get ready for use or sale.

Understand Recognition and Capitalisation of Borrowing Costs

Borrowing costs are interest and other costs a business incurs in connection with borrowing funds. Most of them are an expense of the year. AS 16 makes one exception: if the money was borrowed to build or buy an asset that takes a long time to get ready, the cost of borrowing is part of the cost of getting that asset ready.

The test has two parts. First, the asset must be a qualifying asset: one that necessarily takes a substantial period of time to get ready for its intended use or sale. Ordinarily twelve months is treated as substantial, unless facts justify a shorter or longer period. Second, the borrowing cost must be directly attributable: it would have been avoided if the expenditure on the asset had not been made.

When the conditions are met, the cost is capitalised when it is probable that it will give future economic benefits and it can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred.

The standard's list of what borrowing costs may include is: interest and commitment charges on borrowings; amortisation of discounts or premiums on borrowings; amortisation of ancillary costs of arranging borrowings; finance charges on assets acquired under finance leases or similar arrangements; and exchange differences on foreign currency borrowings, to the extent they are regarded as an adjustment to interest costs.

How much to capitalise depends on the funding. Specific borrowings are traced directly to the asset. General borrowings use a capitalisation rate applied to expenditure on the asset. Starting, pausing and stopping capitalisation is covered in a separate topic.

Key rules to remember

Specific borrowing: Capitalise = Actual borrowing cost incurred in the period − Income on temporary investment of the unspent funds; Applies when funds are borrowed specifically to obtain a qualifying asset (para 10). Investment income is deducted (para 11).
General borrowing: Capitalise = Capitalisation rate × Expenditure on the qualifying asset; Capitalisation rate is the weighted average of borrowing costs of outstanding borrowings, excluding specific borrowings for the asset (para 12).
Capitalisation rate: Rate = Σ (borrowing cost on general borrowings) ÷ Σ (weighted average general borrowings outstanding) × 100; Use only general borrowings outstanding in the period.
Ceiling: Amount capitalised in a period ≤ Borrowing costs incurred in that period; Never capitalise more than was actually incurred (para 12).
Expenditure base: Expenditure = Cash payments + Transfers of other assets + Interest-bearing liabilities assumed − Progress payments and grants received; Average carrying amount of the asset, including borrowing costs already capitalised, is normally a reasonable approximation (para 15).
Foreign currency borrowing (para 4(e)): Borrowing cost = Interest on FC loan + Lower of (Exchange loss on principal; Interest on local currency loan − Interest on FC loan); The remaining exchange difference, if any, goes to AS 11.

How to solve Recognition and Capitalisation of Borrowing Costs questions

Use this order for any AS 16 recognition question.

1Check whether the asset is a qualifying asset: does it necessarily take a substantial period (ordinarily twelve months) to get ready for use or sale? If not, expense all borrowing costs.
2Identify the borrowings: specific to the asset, or general.
3List what is a borrowing cost: interest, commitment charges, amortised discount, premium or ancillary costs, finance lease charges, and eligible exchange differences.
4For specific borrowings, take the actual cost for the period and deduct income earned on temporary investment of unspent funds.
5For general borrowings, compute the weighted average capitalisation rate and apply it to the expenditure on the asset.
6For foreign currency loans, compute the exchange difference and cap the borrowing-cost part at the interest differential.
7Check the ceiling: capitalised amount must not exceed borrowing costs incurred in the period.
8Pass the entry: capitalised part to the asset; the rest to Profit and Loss as finance cost.

Quickest way: Three-bucket split

When to use it: For numerical questions with several loans, investment income and a foreign currency loan, when time is short.

Bucket 1: specific loan cost minus investment income, straight to the asset.
Bucket 2: capitalisation rate × expenditure, for general loans.
Bucket 3: foreign currency, interest plus the lower of exchange loss and interest differential.
Add the buckets, compare with total cost incurred, and expense the balance.

Common mistakes in Recognition and Capitalisation of Borrowing Costs

Capitalising borrowing costs on every asset.
Students assume any loan-funded asset qualifies.
Fix: First test for a qualifying asset. A ready-to-use asset or one taking a short time to get ready gets no capitalisation.
Forgetting to deduct income from temporary investment of specific loan funds.
The deduction is mentioned in a small line of the question.
Fix: Always write: actual interest − investment income = amount capitalised for specific borrowings.
Including the specific loan in the weighted average capitalisation rate.
Students average all loans together.
Fix: Exclude borrowings made specifically for the qualifying asset from the rate.
Capitalising the full exchange loss on a foreign currency loan.
Students treat all exchange differences as interest.
Fix: Cap the borrowing-cost part at the difference between local currency interest and foreign currency interest. Balance goes under AS 11.
Capitalising more than interest actually incurred.
Rate multiplied by a large expenditure base gives a bigger number.
Fix: Compare with total borrowing costs incurred in the period and cap at that figure.

Worked examples

Example 1

Moonlight Ltd. borrowed ₹50,00,000 at 10% p.a. specifically to construct a factory that takes two years to complete. Of this, ₹10,00,000 was unspent for 3 months and was temporarily invested, earning ₹20,000. Compute the borrowing cost capitalised for the year.

Show the solution

The factory takes two years, so it is a qualifying asset.
Actual interest for the year = ₹50,00,000 × 10% = ₹5,00,000.
Deduct income on temporary investment = ₹20,000.
Amount capitalised = ₹5,00,000 − ₹20,000 = ₹4,80,000.

Answer: ₹4,80,000 is capitalised to the factory. The ₹20,000 investment income is netted off, not shown as income.

Example 2

XYZ Ltd. took a loan of USD 10,000 on 1 April 20X3 for a specific project at 5% p.a., payable annually. The rate was ₹45 per USD on 1 April 20X3 and ₹48 on 31 March 20X4. The same amount could have been borrowed locally at 11% p.a. Find the borrowing cost under AS 16 and the amount under AS 11.

Show the solution

Interest on FC loan = USD 10,000 × 5% × ₹48 = ₹24,000.
Exchange loss on principal = USD 10,000 × (48 − 45) = ₹30,000.
Interest on local currency loan = USD 10,000 × ₹45 × 11% = ₹49,500.
Interest differential = ₹49,500 − ₹24,000 = ₹25,500.
Exchange difference treated as borrowing cost is the lower of ₹30,000 and ₹25,500 = ₹25,500.
Total borrowing cost = ₹24,000 + ₹25,500 = ₹49,500.
Balance exchange difference = ₹30,000 − ₹25,500 = ₹4,500, accounted under AS 11.

Answer: Borrowing cost under AS 16 is ₹49,500. The remaining ₹4,500 exchange difference is dealt with under AS 11. If the local rate were 13%, the full ₹30,000 would be borrowing cost, making ₹54,000.

Exam tips

In MCQs, the usual traps are the qualifying asset test and the exchange difference cap. Check these first.
In written answers, state the asset qualifies and why, then show the specific and general calculations on separate lines. This earns step marks.
Always show the comparison with total interest incurred as the final check.
For foreign currency questions, list the four figures: FC interest, exchange loss, local interest, differential. Then pick the lower.

Practice questions from Borrowing Costs (AS 16)

Recognition and Capitalisation of 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.

Recognition and Capitalisation of Borrowing Costs: frequently asked questions

What is a qualifying asset under AS 16?

It is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Ordinarily, twelve months is considered substantial unless a shorter or longer period can be justified by the facts.

Which borrowing costs are expensed under AS 16?

Borrowing costs not directly attributable to a qualifying asset are recognised as an expense in the period in which they are incurred. This includes interest on loans for assets that are ready for use or take a short time to get ready.

How are exchange differences treated as borrowing costs?

Exchange differences on the principal of a foreign currency borrowing count as borrowing costs only up to the difference between interest on a local currency loan and interest on the foreign currency loan. Any remaining difference is accounted for under AS 11.

Is investment income deducted from capitalised interest?

Yes, for specific borrowings. Income earned on temporary investment of funds borrowed for the asset is deducted from the borrowing costs incurred to find the amount eligible for capitalisation.