Borrowing Costs

The cost of borrowing is included in the cost of a self-constructed asset if it meets the criteria for the recognition of
interest as a component of the carrying amount as provided in IAS23, Borrowing Costs.

Borrowing costs are costs incurred related to borrowing transactions and include interest paid and accrued,
amortization of discounts, premiums and ancillary costs incurred in connection with the borrowing arrangements to
the extent that they are regarded as an adjustment to interest costs.

An entity shall begin capitalizing borrowing costs when the entity first meets all of the following conditions:
(1) It incurs expenditures for the asset;
(2) It incurs borrowing costs; and
(3) It undertakes activities that are necessary to prepare the asset for its intended use or sale.

There are two exceptions cited on the capitalization of borrowing costs:

(1) Borrowing costs incurred relating to qualifying assets that are measured at fair value, such as biological
assets and investment property measured at fair value; and
(2) Borrowing costs incurred relating to inventories that are produced in large quantities on a repetitive
basis.
It means, therefore, that relevant borrowing costs incurred on the construction of the qualifying assets, except as
noted above are capitalized. Borrowing costs not capitalized are treated as finance costs and are taken to profit or
loss during the period in which they are incurred.

The amount of borrowing costs capitalizable will depend upon whether the borrowing is:
(1) A specific borrowing; or
(2) A general borrowing.

Specific borrowing is one that is obtained by the enterprise to finance solely for the construction of the qualifying
asset. A general borrowing is one that is obtained by the enterprise to finance the general requirement for funds of
the enterprise. Proceeds of such borrowings are used partly to finance the asset construction and partly to finance
working capital and other fund requirements of the enterprise.

Illustration:

Pau Company made the following disbursements in relation to the construction of its building which started on
January 1 and was completed on December 31.
January 1 Php 10,000,000
March 31 5,000,000
June 1 6,000,000
August 1 3,000,000
December 31 1,000,000
----------------------------
Php 25,000,000
================
Case 1: On January 1, 2022, Pau Company obtained a loan for Php20,000,000 at an interest rate of 10%, specifically
to finance the construction of its building. Prior to their disbursements, the proceeds of the loan were temporarily
invested and earned interest income amounting to Php100,000.
Entries to record interest on loan.
Capitalized interest
Actual interest on specific borrowing (20,000,000 x10%) Php 2,000,000
Less: Interest earned 100,000
--------------------------------------------------------------------------------------------------------------------------
Total Interest added to the cost of building Php 1,900,000
=====================================================================

Building 2,000,000
Cash or Interest payable 2,000,000
Interest on specific borrowing

Cash or Interest receivable 100,000

Building 100,000
Interest on temporary investment

Building 25,000,000
Cash or Accounts payable 25,000,000

Total Cost of Self-Constructed Asset (Building): 25,000,000+2,000,000-100,000 = 26,900,000

1st Ruling on Capitalization of Interest: actual interest on specific borrowing less any interest income on temporary
investment of those borrowings.

Case 2: Pau Company had the following general borrowings during 2022, that were used to finance the construction
of the company’s new building:
Date obtained Term Interest Rate Amount
January 1, 2021 5 years 7.5% Php 10,000,000
January 1, 2022 2 years 12.0% 20,000,000

(a) Actual Interest Cost Incurred (Year 2022)

Jan 1, 2021: 10,000,000 x 7.5% = Php
750,000
Jan 1, 2022: 20,000,000 x 12% = 2,400,000
---------------------------
Php 3,150,000
===============
(b) Average Interest: Weighted average accumulated expenditure x Weighted average interest rate
Php18,500,000 x 10.5% = Php1,942,500

Weighted average interest rate = Total Actual Interest/Total amount of Loan

= Php3,150,000/Php30,000,000
= 10.5%
Weighted Average Accumulated Expenditure
Jan 1-Dec31 10,000,000x12/12 = Php 10,000,000
March 31-Dec 31 5,000,000 x9/12 = 3,750,000
June 1-Dec 31 6,000,000 x 7/12 = 3,500,000
Aug 1-Dec 31 3,000,000 x 5/12 = 1,250,000
Dec 31-Dec31 1,000,000 x 0/12 = 0
------------------------------------------------------------------------------------------------
Php 18,500,000
================
 Total Actual Interest Php 3,150,000
Capitalized cost of Interest 1,942,500
--------------------------
Finance Cost Php 1,207,500
==============

Building 1,942,500
Interest expense 1,207,500
Cash 3,150,000
Entry to record interest on Php30,000,000 loan

Building 25,000,000
Cash 25,000,000
Cost of labor, materials and overhead for building construction

2nd Ruling on capitalization of Interest: The lower between Actual Interest Cost and Weighted Average
Interest Cost during the period of construction.

Case 3: On January 1, 2022, Pau Company obtained a loan for Php12,000,000 at an interest rate of 10%, specifically
to finance the construction of its building. Interest earned from temporary investment of the proceeds of the loan prior
to their disbursement amounted to Php100,000. Other loans of pau Company, part of which were used for the
construction activities, follow:
Date obtained Term Interest Rate Amount
January 1, 2021 5 years 7.5% Php 10,000,000
January 1, 2022 2 years 12.0% 20,000,000

Solution:
Average Accumulated Expenditures Php 18,500,000
Finance by specific borrowings 12,000,000
---------------------------
Finance by general borrowings Php 6,500,000
================

Capitalized Interest:
On Specific borrowing
Actual interest cost (12,000,000 x 10%) Php 1,200,000
Less: Interest earned on temporary investment 100,000
--------------------------
Php 1,100,000
---------------------------
On General borrowings (lower between actual interest cost and weighted average interest cost)
Actual Interest Cost
Jan 1, 2021: 10,000,000 x 7.5% = Php 750,000
Jan 1, 2022: 20,000,000 x 12% = 2,400,000
---------------------------
Php 3,150,000
===============
Weighted Average Interest Costs
Php6,500,000 x 10.5% = Php 682,500
===============
 Capital Cost of Interest: Php1,100,000 + Php682,500 = Php1,782,500

Building (1,200,000+ 682,500) 1,882,500

Interest expense (3,150,000-682,500) 2,467,500
Cash (1,200,000 + 3,150,000) 4,350,000
To record payment of interest

Cash 100,000
Building 100,000
To record interest earned on specific borrowings

Building 25,000,000
Cash 25,000,000
To record cost of labor, material and overhead pertaining
To building constructions

Total Cost of New Building: Php25,000,000+1,782,500 = Php26,782,500

Additional Exercises:

On January 1, 2022, Mari Company started the construction of its new building. The company follows the policy of
capitalizing allowable interest costs. Construction costs were incurred as follows:
January 1 Php 400,000 September30 Php 1,000,000
March 31 1,000,000 December 31 400,000
August 1 1,200,000
The building completed on December 31, 2022.
Required: Compute Capitalized cost of interest and Cost of new building constructed
a. On January 1, 2022, the company obtained a loan for Php4,000,000 at a interest rate of 10%, specifically for the
construction of new building. Prior to their disbursement, the proceeds of the loan were temporarily invested and
earned interest amounting to Php85,000.
b. Mari Company had the following general borrowings during 2022 which were used to finance the construction of
the company’s new building.
10% bank loan Php 2,800,000
10% short-term note 1,600,000
12% long-term loan 1,000,000
c. On January 1, 2022, Mari Company borrowed Php1,600,000 at interest rate of 10% specifically for the construction
of its new building. Interest earned from the temporary investment of the proceeds of the loan prior to their
disbursement amounted to Php20,000. Mari Company also had the following other loans in 2022 which were
borrowed for general purposes. The proceeds of these loans were used in part for the construction of the building:
10%, 2-year note Php 1,200,000
12%, 5-year note 1,600,000
Exchange of Nonmonetary Asset

Measured at Fair Market Value unless

(1) The exchange transaction lacks commercial substance; or
(2) Both the fair value of asset given up and the fair value of the asset received are not reliably
measurable.
Deemed to have Commercial Substance
(1) The configuration (risk, timing and amount) of the cash flows of the asset received differs from the
configuration of the cash flows of the asset transferred; or
(2) The entity-specific value of the portion of the entity’s operations affected by the transaction changes as
a result of the exchange; and
(3) The difference in (1) and (2) is significant relative to the fair value of the assets exchanged.

Illustrations:
Assume that Company A and Company B exchange productive equipment with the following information:

Company A Company B
Cost Php 1,000,000 Php 1,200,000
Accumulated depreciation 400,000 550,000
Fair value 800,000 600,000
Case A. Assuming that the transaction cannot be considered as lacking commercial substance, therefore, the asset
received by each part is recorded at fair value.
Books of A, the entry is
Cash involved: 800,000-600,000 = 200,000; thus the value of new asset is at Fair Value
Equipment-New 600,000
Accumulated depreciation-Equipment old 400,000
Cash 200,000
Equipment-old 1,000,000
Gain on exchange 200,000

Value of Asset Received (600,000+200,000) Php 800,000

Carrying Value old equipment (1,000,000-400,000) 600,000
------------------------
Gain on exchange 200,000
==============

Books of B, the entry is

Equipment-new 800,000
Accumulated depreciation-Equipment old 550,000
Loss on exchange 50,000
Cash 200,000
Equipment-Old 1,200,000

Value of Asset Received (800,000-200,000) Php 600,000

Carrying of old equipment (1,200,000-550,000) 650,000
-----------------------
Loss on exchange Php 50,000
==============
Case B. Assuming that the transaction can be considered as lacking commercial substance, therefore, the asset
received by its part is recorded at book value of old equipment.
Books of A, the entry is (Equipment new is valued at Net book value of A’s old equipment)
Equipment-New 600,000
Accumulated depreciation-old equipment 400,000
Equipment-old equipment 1,000,000

Books B, the entry is ( Equipment new is valued at Net book Value of B’s old equipment)

Equipment-New 650,000
Accumulated depreciation-Equipment old 550,000
Equipment Old 1,200,000