IAS 23 Borrowing Costs — Core Rule
Borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset must be capitalised as part of the cost of that asset; all other borrowing costs are expensed as incurred (IAS 23.1).
How IAS 23 Borrowing Costs Works
- Qualifying assets defined: A qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale (IAS 23.5). Common examples include property, plant and equipment under construction, investment property development, and inventory requiring extended manufacturing. Short-term inventory or ready-to-sell assets do not qualify.
- Capitalisation period: You must capitalise borrowing costs from when three conditions are met: (1) expenditures for the asset are being incurred, (2) borrowing costs are being incurred, and (3) activities that are necessary to prepare the asset for its intended use or sale are in progress (IAS 23.17). Capitalisation ceases when substantially all activities necessary to prepare the qualifying asset are complete (IAS 23.21).
- Measurement of capitalisable amount: The actual borrowing costs incurred on funds borrowed specifically to finance a qualifying asset are capitalised in full (IAS 23.11). If the borrowing is general (not asset-specific), you calculate the capitalisation rate by applying a weighted average interest rate on general borrowings to the weighted average expenditure on the asset during the period (IAS 23.12). The amount capitalised cannot exceed the total borrowing costs incurred in the period.
- Disclosure requirements: Entities must disclose the amount of borrowing costs capitalised during the period, the capitalisation rate used for general borrowings, and the nature of the qualifying assets under construction (IAS 23.26). This transparency helps users understand the timing impact of capitalisation on net income and asset values.
- Deemed acquisition cost: Once capitalised, borrowing costs become part of the asset's cost base. They are then depreciated or amortised over the useful life of the qualifying asset alongside other capitalised costs (IAS 23.1). There is no separate depreciation schedule for the interest component—it is fully integrated into the asset's gross book value.
IAS 23 Borrowing Costs — Practical Example
A pharmaceutical company commences construction of a new manufacturing facility on 1 January 20X1. The project will take 24 months to complete. The company borrows €50 million on 1 January 20X1 at 6% per annum, specifically for this facility.
Capitalised borrowing costs in 20X1:
- Total interest incurred: €50m × 6% = €3,000,000
- All €3,000,000 qualifies for capitalisation because the borrowing is directly attributable to the qualifying asset.
Journal entry on 31 December 20X1 (accrual and capitalisation):
| Account | Dr (€) | Cr (€) |
|---|
| Plant under construction | 3,000,000 | |
| Interest payable | | 3,000,000 |
If the company had mixed borrowings and spent an average of €40m on the asset during 20X1:
Assume total general borrowings outstanding average €120m at a weighted average rate of 5%.
Capitalisation rate: 5% applied to average asset expenditure.
Capitalisable amount: €40m × 5% = €2,000,000 (capped at actual borrowing costs incurred on general borrowings of €6m, so €2,000,000 is acceptable).
The remaining €1,000,000 of interest on the €50m specific borrowing would also be capitalised, and any interest on general borrowings attributable to periods when the asset was not yet being prepared is expensed.
When the facility is complete in December 20X2, capitalisation ceases. If the facility has a 20-year useful life, the total capitalised cost (including all construction costs and interest) will be depreciated from the date of completion.
IAS 23 Borrowing Costs — Common Pitfalls
- Capitalising interest during idle periods: Practitioners sometimes capitalise interest throughout the construction period without assessing whether activities necessary to prepare the asset are suspended. If construction halts for extended periods (e.g., regulatory delays), capitalisation must be suspended; interest incurred during these gaps is expensed (IAS 23.20). Auditors routinely challenge this.
- Misidentifying qualifying assets: Routine inventory production, even if it takes time, does not automatically qualify unless the manufacturing cycle is unusually extended (e.g., spirits ageing, ship-building). Classifying short-cycle inventory as qualifying overstates assets and understates expense.
- Applying the capitalisation rate incorrectly: Entities often forget that the weighted average rate must reflect the actual weighted average interest rate on outstanding borrowings, not the coupon rate or a notional rate. This requires tracking multiple loan tranches and their average outstanding balances period-by-period.
IAS 23 Borrowing Costs — Key Paragraphs
- IAS 23.1: Core principle—capitalise or expense borrowing costs.
- IAS 23.5: Definition of qualifying asset.
- IAS 23.17: Three conditions for beginning capitalisation.
- IAS 23.21: When to cease capitalisation.
- IAS 23.11–12: Measurement of actual and calculated capitalisable amounts.
- IAS 23.26: Disclosure requirements.
