When to capitalize interest (borrowing cost) from a loan?

Pursuant to Section 2.a, Chapter 17 of the Government Accounting Manual for National Government Agencies (GAM for NGAs), borrowing cost is defined as follows:

Borrowing costs – are interest and other expenses incurred by an entity in connection with the borrowing of funds. (Par. 5, PPSAS 5)

Borrowing cost may include, among others, the interest on bank overdrafts and short-term and long-term borrowings.

When is borrowing cost capitalized?

Borrowing costs shall be recognized as an expense in the period in which they are incurred, except to the extent that they are capitalized (alternative treatment).

Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset shall be capitalized as part of the cost of that asset.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. (Par. 5, PPSAS 5)

Borrowing costs shall be capitalized when it is probable that they will result in future economic benefits or service potential to the entity and the costs can be measured reliably. (Pars. 17, 18 & 19, PPSAS 5)

For loans borrowed directly by the NGAs, the allowed alternative treatment shall be used and applied consistently to all borrowing costs that are directly attributable to the acquisition, construction, or production of all qualifying assets of the entity. (Par. 20, PPSAS 5)

Borrowing Costs Eligible for Capitalization

Specific Borrowings

To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization on that asset shall be determined as the actual borrowing costs incurred on that borrowing during the period, less any investment income on the temporary investment of those borrowings.

General Borrowings

To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization shall be determined by applying a capitalization rate to the outlays on that asset.

The capitalization rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset.

The amount of borrowing costs capitalized during a period shall not exceed the amount of borrowing costs incurred during that period. (Pars. 23 and 25, PPSAS 5)

To know more about Borrowing Cost, please refer to Chapter 17 of the Government Accounting Manual (GAM).

[Download Full Text of GAM]

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