Ricardo Limited is constructing a Power Plant which was completed on 31st December 2023. The company obtained a bank loan of R1,000,000 at a rate of 15% per annum to construct the Power Plant on 1st January 2023. As of 31st December 2023, Ricardo Limited also had the following loans outstanding:
18% 5-year loan Note of R1,500,000
14% Debentures of R1,000,000
Expenditures on the project were made as follows:
On the 31st March 2023, R600,000 was incurred;
R800,000 was incurred on 30th June 2023;
The final expenditure incurred was R300,000 on 31st December 2023.
During the year Ricardo Limited invested R400,000 of the bank loan for 2 months at an interest of 9% per annum.
Define Borrowing costs and the accounting standard
Borrowing costs are the interest and other costs that an entity incurs in relation to borrowing funds. These costs include interest expenses, commitment fees, and other ancillary costs incurred in obtaining a loan or issuing debt securities.
The accounting standard that governs borrowing costs is International Accounting Standard (IAS) 23, "Borrowing Costs." This standard provides guidance on the capitalization of borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset. Qualifying assets are assets that take a substantial period of time to get ready for their intended use or sale.
Under IAS 23, borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset should be capitalized as part of the cost of that asset. This capitalization period starts when the entity incurs borrowing costs and makes expenditures for the qualifying asset and ends when the asset is substantially ready for its intended use or sale.
However, borrowing costs that are not directly attributable to the acquisition, construction, or production of a qualifying asset should be recognized as an expense in the period in which they are incurred.
In the case of Ricardo Limited, the bank loan obtained to construct the Power Plant and the 5-year loan Note and Debentures outstanding are all examples of borrowing costs. The interest expenses on these loans should be accounted for in accordance with the requirements of IAS 23.