AS 16 Borrowing cost CA P.S.

Beniwal (9990301165)

AS 16 Borrowing cost

Part I

1. Paras Ltd. had the following borrowings during a year in respect of capital expansion.
Plant Cost of Asset(Rs.) Remarks
P 100 lakhs No specific borrowings
Q 125 lakhs Bank loan of Rs. 65 lakhs at 10%
R 175 lakhs 9% Debentures of Rs. 125 lakhs were issued.
In addition to the specific borrowings stated above, the Company had obtained term loans from two banks (1) Rs. 100
lakhs at 10% from Corporation Bank and (2) Rs. 110 lakhs at 11.50% from State Bank of India, to meet its capital
expansion requirements. Determine the amount of borrowing costs to be capitalized in each of the above Plants, as per
AS - 16. Answer: Rs. 40.40 lakhs.

2. X Ltd. began construction of a new building on 1st January, 2007. It obtained Rs.1 lakh special loan to finance the
construction of the building on 1st January, 2007 at an interest rate of 10%. The company’s other outstanding two non-
specific loans were:
Amount Rate of Interest
Rs.5,00,000 11%
Rs.9,00,000 13%
The expenditure that were made on the building project were as follows:
Rs.
January 2007 2,00,000
April 2007 2,50,000
July 2007 4,50,000
December 2007 1,20,000
Building was completed by 31st December, 2007. Following the principles prescribed in AS-16 ‘Borrowing Cost,’
calculate the amount of interest to be capitalized and pass one Journal Entry for capitalizing the cost and borrowing cost
in respect of the building. (10 Marks) (May, 2008)
Answer: Amount of Interest to be capitalized Rs. 74,189

3. The borrowings profile of Santra pharmaceuticals Ltd set up for the manufactacure of antibiotics at Navi Mumbai as
under:

Date Nature of Amount Purpose of borrowings Incidental

borrowing Borrowed (Rs) expenses
1st January,2014 15%demand loan 60lakhs Acquisition of fixed assets 8.33%
1st July,2014 14.5%Term loan 40lakhs Acquisition of plant and machinery 5%
1st October,2014 14%bonds 50lakhs Acquisition of fixed assets 8%
The incidental expenses consist of commission and service and are paid after rounding of the nearest lakh.
Fixed assets considered as qualifying assets are as under:
(Rs)
Sterile Manufacuring shed 10,00,000
Plant and machinery (total) 90,00,000
Other fixed assets 10,00,000
The project is completed on 1st January,2015 and is ready for commercial production. Show The capitalization of the
borrowing costs.

4. On 20.4.2003 JLC Ltd. obtained a loan from the Bank for Rs. 50 lakhs to be utilised as under:
Rs.

Construction of a shed 20 lakhs

Purchase of machinery 15 lakhs
Working capital 10 lakhs
Advance for purchase of truck 5 lakhs
In March, 2004 construction of shed was completed and machinery installed. Delivery of truck was not received. Total
interest charged by the bank for the year ending 31.3.2004 was Rs. 9 lakhs. Show the treatment of interest under AS 16.

5. On 01/04/09, Amazing Construction Ltd. Obtained a loan of Rs. 32crores to be utilized as under:

(i) Construction of sealink across two cities:

(work was held up totally for a month during the year due to high water levels) : Rs. 25 crores
(ii) Purchase of equipments and machineries : Rs. 3 crores
(iii) Working Capital : Rs. 2 crores
(iv) Purchase of Vehicles : Rs. 50,00,000
 AS 16 Borrowing cost CA P.S. Beniwal (9990301165)

(v) Advance for tools/cranes etc. : Rs. 50,00,000

(vi) Purchase of technical know-how : Rs. 1 crore
(vii) Total interest charged by bank for the year ending 31/3/10 : Rs. 80,00,000
Show the treatment of interest by Amazing Construction Ltd.
Answer: Rs. 62,50,000 to be capitalized.

6. A company obtained term loan during the year ended 31st March, 2004 in an extent of Rs. 650 lakhs for modernisation
and development of its factory. Buildings worth Rs. 120 lakhs were completed and Plant and Machinery worth Rs. 350
lakhs were installed by 31st March, 2004. A sum of Rs. 70 lakhs has been advanced for assets, the installation of which is
expected in the following year. Rs. 110 lakhs has been utilised for Working Capital requirements. Interest paid on the
loan of Rs. 650 lakhs during the year 2003–2004 amounted to Rs. 58.50 lakhs. How should the interest amount be treated
in the Accounts of the Company?
Answer: Capitalised (i) Building Rs. 10.8 lakhs; (ii) P&M Rs. 31.5 lakhs (iii) Cost of WIP Rs. 6.3 lakhs and (iv)
charged into P&L account Rs. 9.9 lakhs.

7. In May, 2004 Speed Ltd. took a bank loan to be used specifically for the construction of a new factory building. The
construction was completed in January, 2005 and the building was put to its use immediately thereafter. Interest on the
actual amount used for construction of the building till its completion was Rs. 18 lakhs, whereas the total interest payable
to the bank on the loan for the period till 31st March, 2005 amounted to Rs. 25 lakhs. Can Rs. 25 lakhs be treated as part
of the cost of factory building and thus be capitalized on the plea that the loan was specifically taken for the construction
of factory building?
Ans. Amount to be capitalised only Rs. 18 lakhs.

8. Take Ltd. has borrowed Rs. 30 lakhs from State Bank of India during the financial year 2013-14. The borrowings are
used to invest in shares of Give Ltd., a subsidiary company of Take Ltd., which is implementing a new project, estimated
to cost Rs. 50 lakhs. As on 31st March, 2014, since the said project was not complete, the directors of Take Ltd. resolved
to capitalize the interest accruing on borrowings amounting tò 4 lakhs and add it to the cost of investments. Comment.
Solution: As per para 9 of AS 13 "Accounting for Investments", the cost of investment includes acquisition charges such
as brokerage, fees and duties. In the present case, Take Ltd. has used borrowed funds for purchasing shares of its
subsidiary company Give Ltd. Rs. 4 lakhs interest payable by Take Ltd. to State Bank of India cannot be called as
acquisition charges, therefore, cannot be constituted as cost of investment.
Further, as per para 3 of AS 16 "Borrowing Costs", a qualifying asset is an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale. Since, shares are ready for its intended use at the time of sale, it cannot be
considered as qualifying asset that can enable a company to add the borrowing cost to investments. Therefore, the
directors of Take Ltd. cannot capitalise the borrowing cost as part of cost of investment. Rather, it has to be charged to
the Statement of Profit and Loss for the year ended 31st March, 2014.

9. The notes to accounts of X Ltd. for the year 1999-2000 include the following:
“Interest on bridge loan from banks and Financial Institutions and on Debentures specifically obtained for
the Company’s Fertiliser Project amounting to Rs. 1,80,80,000 has been capitalized during the year, which
includes approximately Rs. 1,70,33,465 capitalised in respect of the utilization of loan and debenture
money for the said purpose.” Is the treatment correct? Briefly comment. (6 marks)(May, 2000)
Answer: The treatment done by the company is not in accordance with AS 16 ‘Borrowing Costs’.
As per para 10 of AS 16, to the extent that funds are borrowed specifically for the purpose of obtaining a
qualifying asset, the amount of borrowing costs eligible for capitalisation on that asset should be determined
as the actual borrowing costs incurred on that borrowing during the period. Hence, the capitalisation of borrowing
costs should be restricted to the actual amount of interest expenditure i.e. Rs. 1,70,33,465. Thus, there is an
excess capitalisation of Rs. 10,46,535. This has resulted in overstatement of profits by Rs. 10,46,535 and amount
of fixed assets has also gone up by this amount.

10. Harish Construction Company is constructing a huge building project consisting of four phases. It is expected that the full
building will be constructed over several years but Phase l and phase II of the building will be stared as soon as they are
completed. Following is the detail of the work done on different phases of the building during the current year:

(Rs. In Lakhs)
Phase I Phase II Phase III Phase IV
Rs. Rs. Rs. Rs.
Cash expenditure 10 30 25 30
Building purchased 24 34 30 38
Total expenditure 34 64 55 68
Total expenditure of all Phases 221
Loan taken @15%at the
beginning of the year 200
During the current year Phase I and phase II have become operational. Find out the total amount to capitalize and to be
expensed during the year. (May 16)
 AS 16 Borrowing cost CA P.S. Beniwal (9990301165)

11. XYZ Ltd., has undertaken a project for expansion of capacity as per the following details:
Plan Actual
Rs. Rs.
April, 2002 2,00,000 2,00,000
May, 2002 2,00,000 3,00,000
June, 2002 10,00,000 –
July, 2002 1,00,000 –
August, 2002 2,00,000 1,00,000
September, 2002 5,00,000 7,00,000
The company pays to its bankers at the rate of 12% p.a., interest being debited on a monthly basis. During the half year
company had Rs. 10 lakhs overdraft upto 31st July, surplus cash in August and again overdraft of over Rs. 10 lakhs from
1.9.2002. The company had a strike during June and hence could not continue the work during June. Work was again
commenced on 1st July and all the works were completed on 30th September. Assume that expenditure were incurred
on 1st day of each month.
Calculate:
(i) Interest to be capitalised.
(ii) Give reasons wherever necessary.
Assume:
(a) Overdraft will be less, if there is no capital expenditure.
(b) The Board of Directors based on facts and circumstances of the case has decided that any capital expenditure
taking more than 3 months as substantial period of time. (8 marks) (May, 2003)

With AS – 10

12. J Ltd. purchased machinery from K Ltd. on 30.09.2007. The price was Rs. 370.44 lakhs after charging 8% Sales-tax and
giving a trade discount of 2% on the quoted price. Transport charges were 0.25% on the quoted price and installation
charges come to 1% on the quoted price.
A loan of Rs. 300 lakhs was taken from the bank on which interest at 15% per annum was to be paid.
Expenditure incurred on the trial run was Materials Rs. 35,000, Wages Rs. 25,000 and Overheads Rs. 15,000.
Machinery was ready for use on 1.12.2007. However, it was actually put to use only on 1.5.2008. Find out the cost of the
machine and suggest the accounting treatment for the expenses incurred in the interval between the dates 1.12.2007 to the
entire loan amount remained unpaid on 1.5.2008.

With AS – 11

13. AB Limited acquired at the start of the financial year a fixed assets from USA at a price of US$ 1, 25,000 and made a
down payment of US$ 25,000. The exchange rate was 61.50 per dollar at the date of transaction. The balance amount
was payable in 4 equal half yearly instalments with interest @ 8% per annum. The exchange rate on due dates of
instalment has been Rs. 61.60; Rs. 61.80; Rs.61.90: and Rs. 62.10. The asset was under construction during the period of
six months from its acquisition. Ascertain the amount to be capitalised and the gain or loss to be recognised in each of the
year. (May 15)

14. XYZ Ltd. has taken a loan of USD 10,000 on April 1, 2X13, for a specific project at an interest rate of 5% p.a., payable
annually. On April 1, 2X13, the exchange rate between the currencies was Rs. 45 per USD. The exchange rate, as at
March 31, 2X14, is Rs. 48 per USD. The corresponding amount could have been borrowed by XYZ Ltd. in local currency
at an interest rate of 11 per cent per annum as on April 1, 2X13.

Solution:-
The following computation would be made to determine the amount of borrowing costs for the purposes of paragraph
4(e) of AS 16:
(i) Interest for the period = USD 10,000 x 5% x Rs. 48/USD = Rs. 24,000
(ii) Increase in the liability towards the principal amount = USD 10,000 x (48-45) = Rs. 30,000
(iii) Interest that would have resulted if the loan was taken in Indian currency
= USD 10,000 x 45 x 11% = Rs. 49,500
(iv) Difference between interest on local currency borrowing and foreign currency borrowing
= Rs. 49,500 – Rs. 24,000 = Rs. 25,500

Therefore, out of Rs. 30,000 increase in the liability towards principal amount, only Rs. 25,500 will be considered as the
borrowing cost. Thus, total borrowing cost would bè 49,500 being the aggregate of interest of Rs. 24,000 on foreign
currency borrowings (covered by paragraph 4(a) of AS 16) plus the exchange difference to the extent of difference
between interest on local currency borrowing and interest on foreign currency borrowing of Rs. 25,500.

Thus, Rs. 49,500 would be considered as the borrowing cost to be accounted for as per AS 16 and the remaining Rs.
4,500 would be considered as the exchange difference to be accounted for as per Accounting Standard (AS) 11, The
Effects of Changes in Foreign Exchange Rates.
 AS 16 Borrowing cost CA P.S. Beniwal (9990301165)

In the above example, if the interest rate on local currency borrowings is assumed to be 13% instead of 11%, the entire
exchange difference of Rs. 30,000 would be considered as borrowing costs, since in that case the difference between the
interest on local currency borrowings and foreign currency borrowings (i.e., Rs. 34,500 (Rs. 58,500 – Rs. 24,000)) is
more than the exchange difference of Rs. 30,000. Therefore, in such a case, the total borrowing cost would bè 54,000 (Rs.
24,000 + Rs. 30,000) which would be accounted for under AS 16 and there would be no exchange difference to be
accounted for under AS 11 ‘The Effects of Changes in Foreign Exchange Rates’.

Part II

15. XYZ Limited acquired a bank loan of Rs. 40 lacs on interest rate of 20%per annum on 1st July 2013. The said loan was
utilized by the company for three transactions as under:

(i) Construction of factory shed Rs. 10,00,000

(ii) Purchase of plant and Machinery Rs. 25,00,000
(iii) Balance loan was unallocated and generally for the
purpose of business
The accountant of the company has charged the total interest to the profit and Loss account. Comment in view of
provisions of AS 16. (Nov 14)

16. How would you deal with the following in the annual accounts of a company for the year ended 31st March, 1996 ? The
company has obtained Institutional Term Loan of Rs. 580 lakhs for modernisation and renovation of its Plant &
Machinery. Plant & Machinery acquired under the modernisation scheme and installation completed on 31st March,
1996 amounted to Rs. 406 lakhs, Rs. 58 lakhs has been advanced to suppliers for additional assets and the balance loan
of Rs. 116 lakhs has been utilised for working capital purpose. The Accountant is on a dilemma as to how to
account for the total interest of Rs. 52.20 lakhs incurred during 1995-96 on the entire Institutional Term Loan of Rs. 580
lakhs. (3 marks)(May 1996)
Answer: Interest to be capitalized Rs. 41.76 in lakhs and Interest to be charged to profit and loss account Rs. 10.44 in
lakhs

17. X Co. Ltd., has obtained an Institutional Loan of Rs. 680 lakhs for modernisation and renovation of its plant & machiney,
Plant & machinery acquired under the modernis ation scheme and installation completed on 31.3.98 amounted to Rs. 520
lakhs, 30 lakhs has been advanced to suppliers for additional assets and the balance loan of Rs. 130 lakhs has been
utilized for working capital purpose. The total interest paid for th e above loan amounted to Rs. 62 lakhs during 1997-98.
You are required to state how the interest on the institutional loan is to be accounted for in the year 97-98. (May 1999)
Answer: Interest to be capitalized Rs. 50.15 in lakhs and Interest to be charged to profit and loss account Rs. 11.85 in
lakhs

18. Axe Limited began construction of a new plant on 1st April, 2008 and obtained a special loan of Rs.4,00,000 to finance
the construction of the plant. The rate of interest on loan was 10%.
The expenditure that were made on the project of plant were as follows:

Rs.
1st April, 2008 5,00,000
1st August, 2008 12,00,000
1st January, 2009 2,00,000
The company’s other outstanding non-specific loan was Rs.23,00,000 at an interest rate of 12%.
The construction of the plant completed on 31st March, 2009. You are required to:
(a) Calculate the amount of interest to be capitalized as per the provisions of AS 16 “Borrowing Cost”.
(b) Pass a journal entry for capitalizing the cost and the borrowing cost in respect of the plant.

Answer: Total expenses to be capitalised for borrowings as per AS 16 “Borrowing Costs”:

Rs.
Cost of Plant (5,00,000 + 12,00,000 + 2,00,000) 19,00,000
Add: Amount of interest to be capitalised (W.N.2) 1,54,000
20,54,000

Journal Entry
Rs. Rs.
31st March, 2009 Plant A/c Dr. 20,54,000
To Bank A/c 20,54,000
[Being amount of cost of plant and borrowing cost thereon capitalised]
 AS 16 Borrowing cost CA P.S. Beniwal (9990301165)

Working Notes:
1. Computation of average accumulated expenses
Rs.
1st April, 2008 (Rs.5,00,000) * 12/12 5,00,000
1st August, 2008 (Rs.12,00,000) *8/12 8,00,000
1st January, 2009 (Rs.2,00,000) * 3/12 50,000
13,50,000
2. Amount of interest capitalised
Rs.
On specific borrowing (Rs. 4,00,000 ×10%) 40,000
On non-specific borrowings (Rs. 13,50,000 – Rs. 4,00,000) × 12% 1,14,000
Amount of interest to be capitalised 1,54,000

19. Fee Ltd. borrows a sum of Rs 20 crore from Cofee Ltd., repayable as a single bullet payment at The end of 5 years. The
interest thereon @5%p.a.is payable at yearly rests. Since the Market is 8%Fee Ltd. paid an origination fee of Rs 2.40
crores to Cofee Ltd to compensate Cofee Ltd. for the lower rate of interest.Apart from the above,there are no other
transactions.
Borrowing cost capitalized on general borrowings is Rs 19,06,800 which is less the actual Borrowing cost.

Theory Questions:-

20. When capitalisation of borrowing cost should cease as per Accounting Standard 16?
Answer:- Capitalisation of borrowing costs should cease when substantially all the activities necessary to prepare the
qualifying asset for its intended use or sale are complete.
An asset is normally ready for its intended use or sale when its physical construction or production is complete even
though routine administrative work might still continue. If minor modifications such as the decoration of a property to the
user’s specification, are all that are outstanding, this indicates that substantially all the activities are complete.
When the construction of a qualifying asset is completed in parts and a completed part is capable of being used while
construction continues for the other parts, capitalisation of borrowing costs in relation to a part should cease when
substantially all the activities necessary to prepare that part for its intended use or sale are complete.

21. Briefly indicate the items, which are included in the expression “borrowing cost” as explained in AS 16.
(6 marks) (May, 2001)
Answer: Borrowing costs : Borrowing costs are interest and other costs incurred by an enterprise in
connection with the borrowing of funds.
As per para 4 of AS 16 on Borrowing Costs, borrowing costs may include:-
(a) interest and commitment charges on bank borrowings and other short-term and long-term borrowings;
(b) amortisation of discounts or premiums relating to borrowings;
(c) amortisation of ancillary costs incurred in connection with the arrangement of borrowings;
(d) finance charges in respect of assets acquired under finance leases or under other similar arrangements; and
(e) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an
adjustment to interest costs.