Chapter 7 – Property, Plant and Equipment Page 101
14. Under IAS16 Property, plant and equipment, which TWO of the following
costs relating to non-current assets should be capitalised?
A
Replacement of a buildings roof every 15 years
B
Maintenance of an asset on a three-monthly basis
C Installation and assembly costs
D
Replacement of small spare parts annually
15. The Charcoal Company is purchasing a second-hand polishing machine from
a competitor who has gone bankrupt. It will incur the following costs:
CU
Agreed price to be paid to vendor 8,000
Dismantling the machine at its current location 400
Transportation to Charcoals factory 350
Machine refurbishment costs prior to re-installation 175
Re-installation 125
Under IAS16 Property, plant and equipment, the total included in non-current assets in respect of the machine should be
A CU8,875
B CU9,050
C CU8,125
D CU8,000
16. The Plaice Company acquired a new filing machine, the list price of which
was CU49,000. The supplier allowed a trade discount of CU1,700 off the list price.
On delivery, the cost of installing the machine in its desired location was CU450.
According to IAS16 Property, plant and equipment, at what cost should the filing machine be measured in the financial statements of Plaice?
A CU47,750
B CU49,000
C CU49,450
D CU47,300
Chapter 7 – Property, Plant and Equipment Page 102
17. The Tanager Company purchased a boring machine on 1 January 20X1 for
CU81,000. The useful life of the machine is estimated at 3 years with a residual value at
the end of this period of CU6,000. During its useful life, the expected units of production from the machine are:
20X1 12,000 units
20X2 7,000 units
20X3 5,000 units
What should be the depreciation expense for the year ended 31 December 20X2, using the most appropriate depreciation method permitted by IAS16
Property, plant and equipment?
A CU27,000
B CU21,875
C CU23,625
D CU25,000
18. The Lamprey Defence Company acquired an aeroplane in 20X5. At the time
of acquisition, the cost of the jet frame was CU4.6million and the additional cost of the engine was CU600,000.
In 20X8, the engine was replaced with a new one costing CU1,100,000. At the time of replacement, the accumulated depreciation to date on the jet
frame was CU1,750,000 and on the engine was CU400,000.
Using the principles outlined in IAS16 Property, plant and equipment, what amount should be derecognised at the date of replacement?
A CU200,000
B
Nil
C CU600,000
D CU1,100,000
Chapter 7 – Property, Plant and Equipment Page 103
19. The Matteo Company acquired a drilling machine on 1 October 20X5 at a
cost of CU25,000 and depreciated it at 25 per annum on a straight line basis.
On 1 October 20X7, CU5,000 was spent on an upgrade to the machine in order to improve its efficiency and increase the inflow of economic benefits
over the machines remaining life.
According to IAS16 Property, plant and equipment, what depreciation expense should be recognised in profit or loss for the year ended 30
September 20X8?
A CU8,750
B CU6,250
C CU7,500
D CU11,250
20. The Maraldi Company purchased a non-current asset with a useful life of 12
years on 1 January 20X7 for CU6,500,000. At its year end of 31 December 20X7, the amount the company would receive
from the disposal of the asset if it was already of the age and in the condition expected at the end of its useful life was estimated at CU700,000. Inclusive of
inflation the actual amount expected to be received on disposal was estimated at CU900,000.
What should be the depreciation charge under IAS16 Property, plant and equipment, for the year ended 31 December 20X7?
A CU483,333
B CU466,667
C Nil
D CU541,667
Chapter 8 – Borrowing Costs Page 105
Chapter 8 BORROWING COSTS
1 Business Context
Inventories that require a number of manufacturing processes or the construction of non- current assets such as investment properties or a cruise liner can take a significant time to
complete. In addition, they typically require substantial capital expenditure and are therefore often financed through borrowings on which the entity incurs finance costs.
The issue is whether borrowing costs specifically incurred on the construction of such assets form part of the cost of such assets. The treatment can have a significant effect on the results
and capital employed for an entity.
2 Chapter Objectives
This chapter deals with the treatment of costs of financing the construction, production or acquisition of a qualifying asset.
On completion of this chapter you should be able to: demonstrate a knowledge of the objectives and scope of IAS 23 Borrowing costs;
demonstrate an understanding of the principles relating to the treatment of borrowing costs; and
apply IAS 23 knowledge through basic calculations.
3 Objectives, Scope and Definitions of IAS 23
The objective of IAS 23 is to set out the accounting treatment for borrowing costs. The principal issue is whether finance costs on borrowings incurred during the construction of
an asset are, in effect, part of the cost of the asset. The recognition of borrowing costs as part of the cost of the related asset is known as ‘capitalising’ such costs.
A revised version of IAS 23 was issued in 2007, although its adoption is only mandatory for accounting periods beginning on or after 1 January 2009.
The previous version of IAS 23 allowed two treatments for the recognition of certain borrowing costs. The benchmark treatment was to expense borrowing costs in profit or loss in the
period in which they were incurred. Under the allowed alternative treatment borrowing costs could be capitalised as part of a qualifying asset in specific circumstances. The finance costs
on the relevant borrowings became part of the overall asset and were therefore recognised in profit or loss as the asset was depreciated over its useful life, rather than as incurred.
The 2007 version of IAS 23 requires entities to capitalise all relevant borrowing costs. The alternative treatment, to immediately recognise borrowing costs in profit or loss, was removed
to improve comparability and to align the accounting treatment with US Generally Accepted Accounting Policies GAAP.
Two scope exclusions were inserted into the 2007 version of IAS 23. The first is in relation to qualifying assets that are measured at fair value, such as biological assets; because the
assets are measured at fair value, their carrying amount will not be affected by borrowing costs. The second is in relation to inventories that are produced in large quantities on a
Chapter 8 – Borrowing Costs Page 106
repetitive basis; because of the difficulties of monitoring directly attributable borrowing costs, entities are permitted to immediately expense in profit or loss any related borrowing costs.
The rest of this chapter is based on the 2007 revised version of IAS 23.
4 Capitalisation of borrowing costs
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 should be capitalised as part of that
asset. Other borrowing costs are recognised as an expense in profit or loss. [IAS 23.1, 23.8]
A qualifying asset is defined as one that necessarily takes a substantial period of time to get ready for its intended use or sale. The definition is wide and therefore may cover assets
accounted for under IAS 11 Construction contracts and IAS 2 Inventories as well as property, plant and equipment under IAS 16 Property, plant and equipment. [IAS 23.5, 23.7]
4.1 Which costs should be capitalised?
Borrowing or finance costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds. [IAS 23.5]
This definition encompasses interest on all types of borrowings, including finance leases and ancillary costs incurred in connection with the arrangement of borrowings. [IAS 23.6]
Only borrowing costs directly attributable to the acquisition of the asset should be capitalised. Capitalisation of borrowing costs takes place when it is probable that they will generate future
economic benefits for the entity. The principle is that the amount to be capitalised under IAS 23 is the borrowing costs which would have been avoided if the expenditure on the qualifying
asset had not been made. [IAS 23.8]
Illustration 1
An entity has a bank overdraft of CU500,000 and a loan of CU1 million which was taken out to finance the expansion of the entity several years ago. The entity has just commissioned the
construction of a new factory to expand the business. The factory will cost CU2 million to build and this will be financed by a new loan.
The finance costs on the new loan only CU2 million should be capitalised as part of the cost of the new factory. The entity should also capitalise the ancillary costs incurred in connection
with setting up the new borrowing facility.
Where funds are specifically borrowed to finance the construction of an asset, the specific borrowing costs incurred can be readily identified. However, the asset may also be financed
from borrowings made for general use within the entity or group. The amount of borrowings that should be capitalised is calculated by applying to the expenditure on the asset a
capitalisation rate calculated by reference to a weighted average of the costs of all the general use borrowings. The weighted average calculation will exclude any borrowings used
to finance a specific purchase or building. [IAS 23.12, 23.14]
Chapter 8 – Borrowing Costs Page 107
Illustration 2
An entity already has a number of general loan arrangements: Loan 1 of CU800,000, interest paid at 9;
Loan 2 of CU2 million, interest paid at 8; and Loan 3 of CU400,000, interest paid at 7.5.
The entity has commissioned a new printing press to be constructed on its behalf. The total cost will be CU800,000 and the entity will be able to fund the purchase from its existing
borrowings since it has arranged for stage payments to be made.
The construction takes six months. The weighted average is calculated as follows
800,000 x 0.09 + 2,000,000 x 0.08 + 400,000 x 0.075 = 8 800,000 + 2,000,000 + 400,000
Borrowing costs to be capitalised: Cost of asset 800,000 x 8 x 612 = CU32,000
Where the funds specifically borrowed to finance the asset are not wholly utilised immediately but are instead invested until they are required, the finance cost to be capitalised should be
reduced by any investment income received on the excess funds invested. [IAS 23.12]
Illustration 3
An entity borrowed CU5 million to fund the construction of a new building. Interest is payable on the loan at 8. Stage payments were due throughout the construction period and
therefore excess funds were reinvested during that period. By the end of the project investment income of CU150,000 had been earned and the construction took twelve months
to complete.
Interest capitalised as part of the cost of the asset is the actual interest cost less income earned on the temporary investment of the surplus funds.
Interest cost: CU5,000,000 x 8 = CU400,000 Total borrowing costs capitalised: CU400,000 - CU150,000 = CU250,000
The amount of borrowing costs that should be capitalised is limited by the requirement that the carrying amount of the asset including borrowing costs should not exceed the asset’s
recoverable amount.
4.2 When should capitalisation of borrowing costs commence?
Borrowing costs of the asset should be capitalised when the following three conditions have been met: [IAS 23.17]
expenditure on the acquisition, construction, or production of the asset is being incurred;
borrowing costs are being incurred; and
Chapter 8 – Borrowing Costs Page 108
activities are taking place that are necessary to prepare the asset for its intended use or sale.
Activities necessary to prepare the asset for use include more than just the actual construction and may include, for example, drawing up plans and obtaining permits for a
building where the land has been purchased. However, merely holding assets for use or development without any associated development activity does not qualify for capitalisation.
4.3 Suspension of capitalisation
There may be periods when the development of an asset is temporarily suspended. During such inactive periods the capitalisation of borrowing costs should be discontinued and instead
finance costs incurred during this period should be immediately recognised in profit or loss. [IAS 23.20]
It is possible that a temporary delay is part of the production or construction process, and during such periods borrowing costs should continue to be capitalised. Examples include
where the maturity of an asset is an essential part of the production process or where there is expected non-activity due to geological features such as periods of very high tides.
Illustration 4
The following events take place: An entity buys some land on 1 December.
Planning permission is obtained on 31 January. Payment for the land is deferred until 1 February.
The entity takes out a loan to cover the cost of the land and the construction of the building on 1 February.
Due to adverse weather conditions there is a delay in starting the building work for six weeks and work does not commence until 15 March.
In the above scenario the key dates are: Expenditure on the acquisition is incurred on 1 February when construction
commences. Borrowing costs start to be incurred from 1 February.
Although work was being undertaken on planning permission etc. during December and January, no borrowing costs were incurred during this period.
During the six-week inactive period borrowing costs should not be capitalised. Capitalisation of borrowing costs should commence from 15 March.
4.4 Ceasing capitalisation
Capitalisation should cease when substantially all the activities necessary to get the asset ready for its intended use or sale are complete. It is the availability for use which is important,
not when the asset is actually brought into use. An asset is normally ready for its intended use or sale when its physical construction is complete. [IAS 23.22]
Some assets are completed in parts. Where each part is capable of being used separately while other parts continue to be constructed, for example the construction of separate
buildings within a new business park, the cessation of capitalising borrowing costs should be assessed on the substantial completion of each part. [IAS 23.24]
Chapter 8 – Borrowing Costs Page 109
5 Disclosure
The entity should disclose the amount of borrowing costs capitalised during the period and the capitalisation rate used to determine the amount of borrowing costs eligible for
capitalisation. [IAS 23.26]
6 Chapter Review
This chapter has been concerned with the key issues relating to how borrowing costs incurred are accounted for and disclosed in the purchase or construction of qualifying assets.
The chapter has covered: the objectives, scope, definitions and disclosure requirements of IAS 232007;
the required treatment of borrowing costs; and when the capitalisation of borrowing costs should commence, when it should cease,
and when it should be suspended.
Chapter 8 – Borrowing Costs Page 110
7 Self Test Questions
Chapter 8
1. According to IAS23 Borrowing costs, which TWO of the following assets could
be treated as qualifying assets for the purpose of capitalising interest costs?
A
Investment property
B Investments in financial instruments
C Inventory of finished goods produced over a short period of time
D
Power generation facilities
2. According to IAS23 Borrowing costs, which ONE of the following statements
about the capitalisation of borrowing costs as part of the cost of a qualifying asset is true?
A If funds come from general borrowings, the amount to be capitalised is
based on the weighted average cost of borrowing
B Capitalisation always continues until the asset is brought into use
C
Capitalisation always commences as soon as expenditure of the asset is incurred
D Capitalisation always commences as soon as interest on relevant
borrowings is being incurred
3. According to IAS23 Borrowing costs, which of the following treatments are
required for borrowing costs incurred that are directly attributable to the construction of a qualifying asset?
Treatment 1 Recognise as an expense in the period incurred.
Treatment 2 Capitalise as part of the cost of the asset.
A
Treatment 1 only
B Either Treatment 1 or Treatment 2
C
Neither Treatment 1 nor Treatment 2
D Treatment 2 only
Chapter 8 – Borrowing Costs Page 111
4. The Scandium Company is commencing a new construction project, which is
to be financed by borrowing. The key dates are as follows: 15 May 20X8
Loan interest relating to the project starts to be incurred
3 June 20X8 Technical site planning commences
12 June 20X8 Expenditures on the project start to be incurred
18 July 20X8 Construction work commences
According to IAS23 Borrowing costs, from what date can Scandium commence the capitalisation of borrowing costs?
A 15 May 20X8
B
3 June 20X8
C
12 June 20X8
D 18 July 20X8
5. On 1 April 20X7 The Arrakis Company took out a loan to finance the
construction of a building. Work on the building commenced on 1 July 20X7 and was completed on 31 March 20X8. The building was brought into use on
1 July 20X8.
According to IAS23 Borrowing costs, what is the period over which borrowing costs relating to the project should be capitalised?
A 1 April 20X7 – 31 March 20X8
B
1 April 20X7 – 30 June 20X8
C 1 July 20X7 – 31 March 20X8
D
1 July 20X7 – 30 June 20X8
6. On 1 January 20X7 The Hamerkop Company borrowed CU6 million at an
annual interest rate of 10 to finance the costs of building an electricity generating plant. Construction commenced on 1 January 20X7 and cost CU6
million.
Not all the cash borrowed was used immediately, so interest income of CU80,000 was generated by temporarily investing some of the borrowed
funds prior to use. The project was completed on 30 November 20X7.
What is the carrying amount of the plant at 30 November 20X7?
A CU6,000,000
B CU6,470,000
C CU6,520,000
D CU6,550,000
Chapter 8 – Borrowing Costs Page 112
7. On 1 January 20X7 The Cygan Company took out a loan of CU26 million in
order to finance the renovation of a building. The renovation work started on the same date. The loan carried interest at 10.
Work on the building was substantially complete on 31 October 20X7. The loan was repaid on 31 December 20X7 and CU180,000 investment income
was earned in the period to 31 October on those parts of the loan not yet used for the renovation.
According to IAS23 Borrowing costs, what is the total amount of borrowing costs to be included in the cost of the building?
A CU2,600,000
B CU2,420,000
C CU2,166,667
D CU1,986,667
8. The Whitianga Company commenced the construction of a new packaging
plant on 1 February 20X7. The cost of CU1,800,000 was funded from existing borrowings. The construction was completed on 30 September 20X7.
Whitiangas borrowings during 20X7 comprised: Loan from Largo Bank: CU800,000 at 6 per annum;
Loan from Andante Bank: CU1 million at 6.6 per annum; and Loan from Allegro Bank: CU3 million at 7 per annum.
In accordance with IAS23 Borrowing costs, the amount of borrowing costs to be capitalised in relation to the packaging plant is
A
Nil
B CU121,500
C CU81,000
D CU91,125
Chapter 9 – Government Grants Page 113
Chapter 9 GOVERNMENT GRANTS
1 Business Context
It is common practice amongst governments around the world to offer some form of selective financial assistance to certain entities. There are various motives for governments
to provide such aid, including:
geographical – to stimulate employment in poorer regions; industrial – to support key industries such as defence, IT and energy;
inward investment – to promote investment from overseas; and new start-ups – to help infant entities gain a foothold in a market.
To ensure that the objective of providing the assistance is met by the recipient entity in its application of such amounts there are often a variety of criteria and conditions attached to
their receipt. Conditions, for example, may require a minimum investment to be provided or a minimum level of employment to be sustained over a specified period by the entity.
In a financial reporting context it is important to disclose adequate information in relation to government assistance, to ensure that an entity’s performance is accurately interpreted.
The identification of government assistance allows a fair comparison to be made with other entities in a similar industry that have not received such assistance.
2 Chapter Objectives
This chapter deals with the accounting treatment of government grants and in particular the issue of when revenue from such grants should be recognised. It also considers the
distinction between asset-related and income-related grants.
On completion of this chapter you should be able to: understand the scope of IAS 20 Accounting for government grants and disclosure
of government assistance; interpret the important terminology and definitions which relate to the treatment
of government grants in financial statements; understand the key principles relating to the recognition and measurement of
government grants; demonstrate knowledge of the principal disclosure requirements of IAS 20; and
apply knowledge and understanding of IAS 20 in particular circumstances through basic calculations.
