When should borrowing costs be capitalized under IAS 23?

IAS 23 requires capitalization of borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset. Both IFRS and US GAAP require capitalization (IFRS since 2009 revision; US GAAP under ASC 835-20), though the mechanics differ slightly.

What is a qualifying asset?

An asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples:

• A factory under construction (12+ months)
• Real estate development projects
• Power plants being built
• Inventory that requires aging (wine, whiskey)

Not qualifying: Assets purchased ready to use (a delivery truck, office furniture) or financial assets.

Two scenarios for calculating capitalized borrowing costs:

Scenario 1 — Specific borrowing:

If Hartwell Construction borrows $5,000,000 specifically to build a warehouse at 6% annual interest, the capitalizable amount is straightforward:

Capitalized interest = $5,000,000 x 6% = $300,000 per year

Deduct any investment income earned on temporarily invested surplus funds from the specific borrowing.

Scenario 2 — General borrowings (the tricky one):

When general funds are used, you calculate a weighted average capitalization rate from all general borrowings.

Example: Ridgecrest Industries is building a new plant using general funds. Expenditures on the plant during the year total $3,200,000. Ridgecrest has two general borrowings:

• Loan A: $4,000,000 at 5.5%
• Loan B: $6,000,000 at 7.0%

Weighted average rate = ($4M x 5.5% + $6M x 7.0%) / ($4M + $6M)

= ($220,000 + $420,000) / $10,000,000 = 6.4%

Capitalizable amount = $3,200,000 x 6.4% = $204,800

Three conditions must all be met to start capitalizing:

1. Expenditures on the asset have been incurred
2. Borrowing costs have been incurred
3. Activities necessary to prepare the asset are in progress

Capitalization ceases when the asset is substantially complete and ready for use.

Exam tip: CFA Level I loves testing the weighted average rate calculation for general borrowings. Always check that the amount capitalized does not exceed total actual interest incurred. The capitalized cost increases the asset's value on the balance sheet, which increases future depreciation expense.

For more IAS 23 practice problems, check our CFA Level I question bank.