Ind AS 23

Understanding Ind AS 23: The Standard for Borrowing Costs

Ind AS 23, “Borrowing Costs,” is an Indian Accounting Standard that prescribes the accounting treatment for borrowing costs. Its primary mandate is to require the capitalization of borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset as part of the cost of that asset. All other borrowing costs are generally recognized as an expense in the period in which they are incurred.

This standard provides specific guidance on when capitalization should commence, be suspended, and cease, along with the methods for determining the amount of borrowing costs eligible for capitalization.

The Genesis and Evolution of Ind AS 23

Ind AS 23 is a converged standard, meaning it has been formulated to align with its international counterpart, International Accounting Standard (IAS) 23, “Borrowing Costs,” issued by the International Accounting Standards Board (IASB). India embarked on its journey of convergence with IFRS (International Financial Reporting Standards) to enhance the global comparability and transparency of its financial reporting. The Ministry of Corporate Affairs (MCA) officially notified the Ind AS framework in 2015, mandating its adoption for specified classes of companies in a phased manner starting from April 1, 2016.

Historically, the accounting for borrowing costs has seen varied approaches globally, including immediate expensing or capitalization under certain conditions. The current framework under IAS 23 (and by extension, Ind AS 23) represents a consensus to permit, and in specific cases, require capitalization, recognizing that interest incurred during the construction or development phase of certain assets is a necessary cost to bring the asset to its intended use or sale. This approach aims to provide a more accurate representation of the asset’s total cost.

Delving Deeper: Core Principles of Ind AS 23

The core of Ind AS 23 revolves around specific definitions and conditions:

• Qualifying Asset: This is a crucial concept. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples include manufacturing plants, power generation facilities, real estate developments, large software projects (if they meet the capitalization criteria under Ind AS 38), and certain infrastructure projects like roads and bridges. Assets that are ready for their intended use or sale when acquired, or those that are routinely manufactured in large quantities on a repetitive basis, are typically not qualifying assets.
• Borrowing Costs: These are defined as interest and other costs that an entity incurs in connection with the borrowing of funds. They can include interest expense calculated using the effective interest method as per Ind AS 109 Financial Instruments, finance charges in respect of finance leases (as per Ind AS 116 Leases), and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Recognition Criteria:

Borrowing costs must be capitalized if they are directly attributable to the acquisition, construction, or production of a qualifying asset. This means the costs would not have been incurred had the expenditure for the qualifying asset not been made.

Commencement of Capitalization:

Capitalization of borrowing costs begins when all three of the following conditions are met:

1. Expenditures for the asset are being incurred.
2. Borrowing costs are being incurred.
3. Activities that are necessary to prepare the asset for its intended use or sale are in progress.

Suspension of Capitalization:

Capitalization of borrowing costs should be suspended during extended periods in which active development of a qualifying asset is interrupted. However, capitalization is not suspended during a temporary delay that is a necessary part of the process of getting an asset ready for its intended use or sale.

Cessation of Capitalization:

Capitalization of borrowing costs ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. If only minor modifications are outstanding, capitalization would typically cease. When the construction of a qualifying asset is completed in parts, and each part is capable of being used while construction continues on other parts, capitalization for each part ceases when it is substantially complete.

Measurement:

The amount of borrowing costs eligible for capitalization is determined as follows:

• Specific Borrowings: For funds borrowed specifically for the purpose of obtaining a qualifying asset, the actual borrowing costs incurred on that borrowing, less any investment income on the temporary investment of those borrowings, are capitalized.
• General Borrowings: For funds from general borrowings used for the purpose of obtaining a qualifying asset, the amount of borrowing costs to be capitalized is determined by applying a capitalization rate to the expenditures on that asset. The capitalization rate is the weighted average of the borrowing costs applicable to the entity’s general borrowings outstanding during the period. The amount capitalized cannot exceed the total borrowing costs incurred during that period.

Disclosure Requirements:

Entities must disclose the amount of borrowing costs capitalized during the period, and the capitalization rate used to determine the amount of borrowing costs eligible for capitalization (if applicable).

Why Ind AS 23 Matters: Impact on Business Reporting

Ind AS 23 holds significant importance for businesses primarily because it dictates how a substantial portion of a company’s financing costs for major projects is reported. This has several ramifications:

• Financial Statement Impact: Capitalizing borrowing costs directly affects the balance sheet by increasing the carrying amount of qualifying assets (e.g., Property, Plant & Equipment, Intangible Assets). This, in turn, impacts the profit and loss statement by reducing the immediate interest expense, leading to higher reported profits in the construction phase. However, it also leads to higher depreciation or amortization charges over the asset’s useful life.
• Decision Making & Valuation: Accurately reflecting the full cost of an asset (including finance costs directly attributable to its creation) provides a more realistic basis for project appraisal, capital budgeting decisions, and asset valuation. It can influence the perceived profitability and return on investment for long-term projects.
• Comparability and Transparency: Adherence to Ind AS 23 ensures consistency in accounting for borrowing costs across companies adopting Ind AS, thereby enhancing the comparability of financial statements and fostering greater transparency for investors and other stakeholders.
• Compliance and Audit: For companies mandated to follow Ind AS, compliance with Ind AS 23 is obligatory. Auditors rigorously examine the application of this standard, especially the judgment involved in identifying qualifying assets and determining the capitalization period and rate.

Ind AS 23 in Action: Practical Scenarios

Many industries and projects frequently encounter Ind AS 23:

• Real Estate Development: A real estate company constructing a large residential complex or a commercial office tower will capitalize interest costs incurred on borrowings specifically raised for the project, as well as an allocable portion of general borrowings, during the construction phase.
• Manufacturing Sector: A manufacturing firm building a new factory or significantly expanding an existing production line will capitalize the borrowing costs associated with the financing for these facilities until they are ready for production.
• Infrastructure Projects: Companies involved in constructing roads, bridges, power plants, or port facilities will apply Ind AS 23 extensively, as these projects typically involve substantial periods of construction and significant debt financing.
• Software Development: While more nuanced, if a company is developing a large-scale internal-use software that qualifies as an intangible asset and takes a substantial period to complete, borrowing costs directly attributable to its development might be capitalized under Ind AS 38, supported by the principles of Ind AS 23.

Navigating the Landscape: Related Concepts and Standards

Ind AS 23 does not operate in isolation but interacts with several other accounting standards and concepts:

• IAS 23 (International Accounting Standard 23): The international equivalent from which Ind AS 23 is largely converged.
• Ind AS 16 (Property, Plant & Equipment): Capitalized borrowing costs become part of the cost of assets covered by Ind AS 16.
• Ind AS 38 (Intangible Assets): Similarly, borrowing costs related to the development of qualifying intangible assets are capitalized under Ind AS 38.
• Ind AS 109 (Financial Instruments): This standard guides the initial recognition and measurement of financial liabilities, which include borrowings, and the calculation of interest expense using the effective interest method, which forms the basis for borrowing costs.
• Qualifying Asset: A central concept defined within Ind AS 23 itself.
• Capitalization Rate: The weighted average borrowing cost applied to general expenditures on qualifying assets.
• Effective Interest Method: The method prescribed by Ind AS 109 for calculating interest expense, which is a key component of borrowing costs.

Staying Current: Recent Updates and Clarifications

The core principles of Ind AS 23 have remained relatively stable since its initial notification. However, the interpretation and application of the standard can evolve due to various factors. The ICAI (Institute of Chartered Accountants of India) frequently issues guidance, FAQs, and educational material to clarify complex application areas, especially concerning interaction with other standards like Ind AS 109 (for effective interest rate computations) or Ind AS 116 (for finance lease charges). While there haven’t been major recent amendments to the text of Ind AS 23 itself, entities must remain vigilant about pronouncements from the ICAI and the IASB that might impact its application, particularly in areas involving judgment like the “substantial period of time” for a qualifying asset or the “active development” phase.

Who Needs to Know? Impacted Business Functions

A thorough understanding of Ind AS 23 is critical across several business departments:

• Finance and Accounting Department: This team is directly responsible for implementing the standard, making crucial judgments, calculating eligible borrowing costs, maintaining records, and ensuring accurate financial reporting and disclosures.
• Treasury Department: Manages the company’s borrowings, provides data on interest rates, loan terms, and specific vs. general funding, all of which are vital for applying Ind AS 23.
• Project Management and Operations: Provides key information on project timelines, expenditure incurrence, progress, and completion dates, which are essential for determining the capitalization period.
• Internal and External Auditors: Play a crucial role in reviewing the company’s application of Ind AS 23 to ensure compliance and the fair presentation of financial statements.
• Management and Executive Leadership: Need to understand the implications of Ind AS 23 on reported profits, asset values, and cash flows to make informed strategic decisions regarding capital expenditure and financing.

Looking Ahead: Potential Trajectories for Borrowing Cost Accounting

The future of Ind AS 23, while generally stable, may see some evolving trends:

• Increased Scrutiny: As financial reporting becomes more sophisticated, there may be increased auditor and regulatory scrutiny on the subjective judgments involved in applying Ind AS 23, such as the definition of a “substantial period of time” or the cessation of capitalization.
• Digital Transformation Impact: With the rise of large-scale IT projects, the application of borrowing cost capitalization to internally developed software (under Ind AS 38) might become more prevalent and complex, requiring clearer guidance on project phases and readiness for use.
• Sustainability and ESG Factors: While not directly impacting the accounting mechanics, the increasing focus on sustainable financing and green bonds might bring new types of borrowing costs or financing structures that require careful consideration under Ind AS 23.
• Further Convergence/Divergence: Any future amendments by the IASB to IAS 23 would likely prompt corresponding changes in Ind AS 23, maintaining convergence. However, unique Indian economic conditions or regulatory perspectives could lead to minor divergences if deemed necessary.
• Emphasis on Transparency: Continuous pressure for greater transparency in financial reporting could lead to enhanced disclosure requirements related to borrowing costs, providing more granular insights into how these costs are managed and reported.