Question

Borrowing Costs

Hello,

I am a student of Diploma in IFRS. I am preparing for December 2021 DIPIFRS exams from India.

I am having a doubt regarding a suggested answer provided on the website of ACCA [DIP IFRS December 2020 attempt Question 2 ].  

Question 2 Part second in December 2020 Exams that reads “ On 1 November 20x4 Gamma placed order for machinery which was to be used in new business venture…….”

In this question Gamma borrowed $ 90 million on 1 November 20X4. It says that the new business venture in which the machinery is being used is one which qualifies for preferential loans. These loans are of 12 months duration and carry a fixed annual interest rate of 4%.

Solution provided in Suggested Answers on the website of ACCA : “Under the principles of IAS 23 – Borrowing Costs, borrowing costs which are directly attributable to the acquisition of an asset should be included as part of the carrying amount of that asset.” Thus a borrowing cost of 1.8 million has been capitalized to the cost of machinery in the suggested answer.

However, my submission is:

IAS23- Borrowing costs says that , “Borrowing costs that are directly attributable to the acquisition, construction, or production of a Qualifying Asset, form part of the cost of that asset and, therefore should be capitalized. Other borrowing costs are recognized as an expense [IAS 23.8]

Further IAS 23 defines , A qualifying asset that takes a substantial period of time to get ready for its intended use or sale.  

Although IAS 23 does not clarify what is substantial period of time, however as per many other literatures it is understood to be at least 12-month period.

As per my understanding the Borrowing costs given in the question should be expensed to Profit and loss instead of capitalizing them to the carrying value of machinery, Due to below reasons:

1. Firstly, as per the question, Gamma had acquired a machinery on 30 November 20X4 which was ready for use on 31 May 20X5, (i.e in 6 month period). As per my understanding this machinery cannot be considered a Qualifying asset. And hence the borrowing costs cannot be capitalized.
2. The question reads as “ The new business venture in which the machinery is being used is one which qualifies for preferential loans. These loans are of 12 months duration and carry a fixed annual interest rate of 4%. The are available only on 1 November each. Therefore, on 1 November 20X4 Gama borrowed $90 million and repaid this amount, including accrued interest on 31 October 20X5.”  

It is not clear from the question that the amount was borrowed specifically for the acquisition of the machinery, whether the supplier was paid from the borrowed amount or whether the borrowed funds were utilized for some other business purpose. It says that such loan was obtained as it was available on low rates and was available only on 1 November. Hence the amount was borrowed. But the nexus of this borrowing with the machinery is not clear.  

Please post your views on above.

Answer 1

Hi, it looks like you're right. I have read the question, looked up the IAS 23 - and would agree these costs need to be expensed. The significant amount of the investment does not suffice it to consider the asset as the qualifying asset in my opinion too.