Ind AS 23 Borrowing Costs: The Capitalisation vs Expensing Decision

One of the trickiest topics in CA Final accounts is deciding whether borrowed money spent on an asset should be added to that asset's cost or written off as an expense right away. Ind AS 23 governs this, and examiners love testing your understanding of the timing of recognition. Let me walk you through the core logic.

The Basic Principle

When you borrow money, you pay interest. That interest cost is usually an expense of the current year. But there's a catch: if you're using that borrowed money to construct or develop a long-term asset (like a factory, a building, or equipment), the interest during the construction period can become part of the asset's cost. This is called capitalisation.

Why? Because you haven't yet started earning from that asset, so it makes sense to add the cost to the asset itself, and then recover it gradually through depreciation once the asset is in use.

When Do You Capitalise Interest?

Capitalisation is allowed only when three conditions are met:

1. There Is a Qualifying Asset

A qualifying asset is one that takes time to get ready for use. Think:

  • A building under construction
  • Manufacturing equipment being assembled
  • A self-constructed intangible asset (software, patents)
  • Investment property being developed

It does not include:

  • Inventory (even if production takes time)
  • Assets already in use
  • Financial assets
  • Assets acquired ready-made

2. Borrowing Costs Are Incurred

This includes:

  • Interest paid or payable on debt
  • Amortisation of discounts or premiums on borrowings
  • Exchange differences on foreign-currency borrowings (sometimes)
  • Finance charges on lease obligations

3. Expenditure on the Asset Is Actually Incurred

You must have spent money directly on that qualifying asset. This includes:

  • Materials and labour
  • Professional fees
  • Payment to contractors

The Capitalisation Period: When It Starts and Stops

This is where exam questions often get tricky.

Capitalisation Begins When:

  • You have incurred expenditure on the asset
  • You have incurred borrowing costs
  • You are undertaking activities necessary to prepare the asset for use

Activities include design, construction, administration, and obtaining permits—anything that must happen before the asset is ready.

Capitalisation Stops When:

  • The asset reaches the condition it was intended for
  • Substantially all construction is complete
  • Even if minor work or testing remains

If construction is suspended, capitalisation pauses. If you deliberately delay completion, capitalisation may still pause.

The Identification of Borrowing Costs

Here's the practical logic:

Specific Borrowing

If you borrowed money specifically to build or develop the qualifying asset, you identify the actual interest paid on that borrowing and capitalise it—up to the amount of expenditure incurred on the asset.

Example (logic, not memorised):

You took a loan of ₹100 lakhs specifically to build a factory. Interest is 10% per annum = ₹10 lakhs per year. You spent ₹60 lakhs on construction in Year 1. You capitalise ₹6 lakhs (10% of ₹60 lakhs) and expense ₹4 lakhs.

General Borrowing

If you used general borrowings (overdraft, general term loan, existing debt), you calculate a weighted average interest rate on all general borrowings and apply it to the net expenditure on the qualifying asset.

Example (logic):

Your general borrowings are:

  • Loan A: ₹50 lakhs at 8% = ₹4 lakhs interest
  • Loan B: ₹30 lakhs at 12% = ₹3.6 lakhs interest

Total interest = ₹7.6 lakhs on ₹80 lakhs = 9.5% rate

You spent ₹40 lakhs on a qualifying asset in the year. Capitalised interest = 9.5% × ₹40 lakhs = ₹3.8 lakhs.

Expensing Borrowing Costs

All other borrowing costs (not on qualifying assets, or after the asset is ready) are expensed immediately in the profit-and-loss statement.

Exam Timing Questions

Examiners often ask: "At what point does the company stop capitalising interest?"

The key word is substantially complete. Once the asset is available for use—even if there's minor adjustment, testing, or finishing work—capitalisation stops.

Common trap: Students think "complete" means 100% done. No. Substantially complete (usually 85%–95%) is the threshold.

A Worked Logic (Not Copied)

Co. X began construction of a factory on 1 April 20X1. It borrowed ₹200 lakhs at 9% p.a. specifically for this. By 31 March 20X2, it spent ₹80 lakhs on construction and ₹20 lakhs on other purposes. The factory became substantially ready for use on 31 December 20X1.

Capitalisation period: 1 April 20X1 to 31 December 20X1 = 9 months.

Interest for 9 months = 9% × ₹200 lakhs × (9/12) = ₹13.5 lakhs.

But was the factory under construction for all 9 months? Yes. Was the expenditure incurred during this 9-month period? ₹80 lakhs was—assuming it was spent during construction.

Capitalised interest = ₹13.5 lakhs (added to the asset's cost).

Expensed interest (for 3 months after readiness) = 9% × ₹200 lakhs × (3/12) = ₹4.5 lakhs.

Key Pointers for Your Revision

  • Always ask: Is this a qualifying asset? If no, expense all interest.
  • Identify the precise period from expenditure start to substantial readiness.
  • For specific borrowing, use actual interest; for general borrowing, use a weighted rate.
  • Once substantially complete, capitalisation ends—the asset enters the income statement via depreciation.
  • Always disclose the amount of capitalised borrowing costs in the notes.

FAQs

Q1: Can we capitalise interest on inventory?

A: No. Inventory, even with long production cycles, is not a qualifying asset under Ind AS 23. All interest is expensed.

Q2: If we borrow money but the qualifying asset construction is delayed, what happens to interest?

A: If the delay is not deliberate and the company is still preparing the asset, capitalisation continues. If deliberately delayed for other reasons, capitalisation may pause and interest is expensed.

Q3: How do we treat interest on a lease used to finance construction?

A: Finance charges on the lease obligation (as per Ind AS 116) can be capitalised if the leased asset is a qualifying asset under construction.

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Mastering Ind AS 23 comes down to practice and precision. Use our free day-by-day study planner at https://caparveensharma.com/free-planner?src=article to map out your Ind AS revision week by week. And when you're ready to test your logic on real scenario-based questions, explore our free case-scenario practice at https://caparveensharma.com—you'll find questions that mirror the complexity of CA Final papers.

Keep revising, keep questioning, and you'll master this topic. All the best!