AS 16, effective in April 2000, is mandatory in all enterprises, related only to External Borrowings, and steers clear of any costs associated with raising Equity of Convertible Preference Shares.
The ICAI states that Borrowing Costs defined are the interest as well as other costs incurred from the borrowing of funds. For borrowing costs as per accounting standard 16, the following concepts should be taken into account:
- Borrowing cost should incorporate the interest on both short-term or long-term debts.
- Any discounts or premiums incurred from the borrowing cost should be amortised. Ex. A loan processing cost paid to financial institutions
- Enterprises should be amortised if they have incurred financial or ancillary costs in relation to its borrowings. Ex. Amount paid to professionals to create project reports
- Finance costs associated with an enterprise that acquired any asset under a finance lease should be amortised. Ex. The wages the lessor receives from the leasing cost
- The exchange rate fluctuation of any enterprise that borrowed in a foreign currency should be amortised (if they are regarded as an adjustment of interest costs). Ex. A $1 difference in the yearly increase in a loan counts as a Borrowing Cost
Assets that take a lot of time to prepare for sale or use are known as qualifying assets.
According to accounting standard 16, This time period depends on the circumstances of the assets. A 12-month period is typically enough time to substantiate qualification, but a shorter period may suffice.
The promise of good economic benefits will surge borrowing costs in accounts with qualifying assets.
Capitalizing on the Borrowing Cost
To capitalize on borrowing cost, the conditions below must be met:
- Any borrowing cost is eligible for capitalization that is directly attributable to the qualifying asset’s acquisition, construction or production.
- If an asset is qualified, it will give an advantage to the enterprise and boost reliability
Forms of borrowing
According to AS 16, borrowings come in two main types: specific and general.
In specific borrowing, the amount needing to be capitalized is the actual borrowing cost minus the income has been made on a temporary investment of borrowed money.
General borrowing takes a few steps. First, the capitalization rate (extracted from the average of the borrowing cost) should be measured. The capitalization rate is equal to the cost to be capitalized (or the amount spent out of general borrowing on the qualifying asset).
If a delay halts the developments in the process of capitalization, then according to the accounting standard a suspension of capitalization occurs. But if the delay is a crucial part of the process of getting an asset ready for sale, a suspension of capitalization is necessary.
When the process of preparing a qualifying asset is complete, the capitalization of borrowing cost ceases.
The Financial Statements for AS 16 should disclose the following:
- The accounting policy adopted for borrowing costs.
- How much in borrowing costs was capitalized throughout the year.
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