Introduction

Many companies unknowingly misapply IAS 23 — leading to misstated profits, audit issues or regulatory scrutiny.
At first glance, IAS 23 looks simple:

“If you borrow money and spend it on something, just decide if the interest should go into expense or asset cost.”

Easy, right? But here’s the catch, IAS 23 may appear straightforward, but it has hidden secrets that often lead to misinterpretation or oversight in practice.

What is IAS 23 about?

IAS 23 prescribes the accounting treatment for borrowing costs. The main principle is that borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset must be capitalised. All other borrowing costs are expensed in the period in which they are incurred.
 

The twist (the hidden complexity):

  • Not all assets qualify.
  • Not all interest can be capitalised.
  • Timing matters a lot, even though what constitutes qualifying period was not specifically defined (use of judgement).

Golden rule:

  • If loan creates something long term - Capitalise
  • If loan supports day-to-day running - Expense
     

Key definitions under IAS 23

Borrowing costs are defined as interest and other costs incurred by an entity in connection with the borrowing of funds (IAS 23.6). Examples include:

  • Interest on short-term and long-term borrowings
  • Interest in respect of lease liabilities
  • Exchange differences on foreign currency borrowings (to the extent they are considered an adjustment to interest costs)
  • Interest and other costs incurred by an entity in connection with the borrowing of funds. (IAS 23.6) Examples include:

Qualifying asset is an asset that necessarily takes a substantial period to get ready for its intended use or sale. (IAS 23.6) E.g. manufacturing plants, real estate developments, infrastructure projects and self-constructed intangible assets.

IAS 23 does not define a specific time frame for what constitutes a “substantial period of time.” This determination is based on management judgement, considering the asset’s nature and industry practices.

Key recognition principles

  1. Capitalisation: Borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset are capitalised as part of the asset's cost. (IAS 23.8)

When to start capitalising: (all three conditions below must be met simultaneously):

  • Expenditures for the asset are being incurred;
  • Borrowing costs are being incurred; and
  • Activities necessary to prepare the asset for its intended use or sale are in progress.

When to pause: IAS 23 allows for suspension of capitalisation during extended periods where development is interrupted. (IAS 23.17) 

When to stop: Capitalisation ceases when the asset is substantially ready for its intended use or sale. (IAS 23.20)

  1. Measurement

For specific borrowings (IAS 23.12), capitalisation is based on the actual interest incurred on those borrowings. 

For general borrowings used for qualifying assets (IAS 23.14), a weighted-average borrowing rate is applied to the expenditures incurred (Note: the weighted-average rate is based on the borrowing costs of all general borrowings outstanding during the period, excluding specific borrowings).

  1. Disclosure Requirements

Under IAS 23.26, entities are required to disclose the following in their financial statements:

  • The aggregate amount of borrowing costs capitalised during the reporting period (this gives stakeholders visibility into how much borrowing cost has been included in the cost of qualifying assets); and
  • The capitalisation rate applied during the period to determine the amount of borrowing costs eligible for capitalisation (for general borrowings) (this helps users understand the basis of measurement and compare with industry norms).
     

Caveat

This publication has been prepared by RSM Eastern Africa LLP, and the views are those of the firm, independent of its Partners, employees and associates. This publication is for general guidance, and does not constitute professional advice. Accordingly, RSM Eastern Africa LLP,  its Partners, employees, associates and its agents accept no liability for the consequences of anyone acting, or refraining from acting, in reliance on the information contained herein or for any decision based on it. No part of the newsletter may be reproduced or published without prior written consent. RSM Eastern Africa LLP is a member firm of RSM, a worldwide network of accounting and consulting firms. RSM does not offer professional services in its own name and each member firm of RSM is a legally separate and independent national firm.