Borrowing costs on qualifying construction assets · IAS 23

Why it matters

Failing to capitalize borrowing costs on a genuinely qualifying asset (or, conversely, capitalizing interest on assets that do not qualify, such as a standard fixed-price construction contract for a customer) directly misstates both the cost of the asset and finance costs in profit or loss, with a knock-on effect on future depreciation and reported margins for concession operators and asset owners funding multi-year construction with project debt.

Diagnostic questions

Is the asset under construction one your entity will own or control (such as your own concession infrastructure or self-built camps), rather than a service being performed for a customer under a standard IFRS 15 contract? Does construction necessarily take a substantial period of time to get the asset ready for its intended use? Are the borrowings specifically and directly attributable to that qualifying asset, or are they drawn from a general pool requiring a weighted average capitalization rate? Has any temporary investment income earned on unspent specific-borrowing proceeds been deducted from the capitalized amount?

Recognition

Confirm the asset is a 'qualifying asset', one that necessarily takes a substantial period of time to get ready for its intended use or sale (typically the operator's own concession infrastructure, self-constructed camps/facilities, or major plant under construction; NOT a standard customer construction contract, where the contractor is providing a service to the customer rather than constructing its own asset).
Begin capitalization when expenditures on the asset are being incurred, borrowing costs are being incurred, and activities necessary to prepare the asset for use are in progress.
For specific borrowings raised for the qualifying asset, capitalize the actual borrowing costs incurred on that borrowing, net of any investment income earned on temporarily investing the unspent funds.
For general borrowings, apply a weighted average capitalization rate to expenditures on the asset in excess of any specific borrowings.
Suspend capitalization during extended periods in which active development is interrupted.
Cease capitalization when substantially all activities necessary to prepare the asset for its intended use are complete.

Measurement

For specific borrowings, measure capitalized borrowing cost as actual interest incurred less any temporary investment income on unspent proceeds. For general borrowings used partly to fund the qualifying asset, derive a weighted average capitalization rate from all general borrowings outstanding during the period (excluding specific borrowings for other qualifying assets), and apply it to the qualifying asset expenditure not funded by specific borrowings, capped at the total borrowing costs actually incurred in the period. Capitalized amounts become part of the asset's cost and are subsequently depreciated/amortized over the asset's useful life or concession term.

Presentation & disclosure

Disclose: (1) the amount of borrowing costs capitalized during the period; (2) the capitalization rate used to determine the amount of eligible borrowing costs for general borrowings; (3) identification of the qualifying assets to which capitalization was applied; (4) total borrowing costs expensed versus capitalized in the period, reconciled to total finance costs.

Common mistakes

Capitalizing borrowing costs on a standard customer construction contract where the contractor does not own the asset being built (borrowing costs on the contractor'
s own working-capital facilities for such contracts are generally expensed, not capitalized, since the asset is not the contractor'
s own qualifying asset)
failing to suspend capitalization during a prolonged, unplanned construction halt
using the entity'
s overall average borrowing rate without excluding specific project borrowings already directly capitalized, causing double counting
continuing to capitalize after the asset is substantially ready for use even though minor finishing works continue
not netting temporary investment income earned on undrawn specific loan proceeds against capitalized interest.

Simple example

An operator building a SAR 800,000,000 toll facility under a concession funds construction partly with a SAR 500,000,000 project loan at 6% per annum, drawn down evenly and outstanding for the full year. Interest incurred on the specific borrowing for the year is SAR 30,000,000 (500,000,000 x 6%); the operator earned SAR 800,000 of interest by temporarily investing undrawn loan proceeds, which is netted against the capitalized amount.
Journal entry to capitalize borrowing costs during construction:
Dr Concession intangible/financial asset under construction 29,200,000
Dr Interest receivable / cash (temporary investment income) 800,000
Cr Interest payable / cash 30,000,000
(Net effect: 30,000,000 - 800,000 = 29,200,000 capitalized; the entry balances: 29,200,000 + 800,000 = 30,000,000)
For the portion of costs funded by general working capital borrowings rather than the specific project loan, a weighted average capitalization rate would similarly be applied and capitalized in the same manner.

Professional judgment

Determining whether infrastructure built for a customer under a standard fixed-price contract could ever be a 'qualifying asset' of the contractor is a key threshold judgment, generally it is not, because the contractor does not hold the asset as its own, but the analysis can differ for genuinely self-funded concession or PPP structures where the operator holds a financial or intangible asset of its own under IFRIC 12. Determining when 'substantially all activities necessary to prepare the asset for its intended use' are complete (ceasing capitalization) versus when only minor finishing work remains is judgmental, especially for phased openings (e.g. a toll road opened in sections). Deciding whether a construction pause is a genuine interruption warranting suspension of capitalization, versus a normal, expected part of the construction process (e.g. seasonal or technical delays), also requires judgment.

Source basis

IAS 23 · Borrowing Costs

Paragraph references

IAS 23.5IAS 23.8IAS 23.14IAS 23.17

Verified against the official standard texts used in the IFRS Expert skill.

IAS 23 Borrowing Costs

Issued: March 2007 (revised) · Effective: 1 January 2009

Related issues

Educational and navigation content only. Not professional advice. Does not reproduce official IFRS/IAS text. Consult the authoritative standards and qualified professionals; professional judgment may still be required.