Capitalisation of Borrowing cost

A. Facts of the Case

• A public sector company, is engaged in mining of bauxite, manufacturing of alumina and aluminum, generation of power in the captive power plant for use in the smelter.
• A massive expansion programme to increase the production capacity at an estimated expenditure of Rs. 4,207 crores started in December 1996. The expansion activities were financed from the internal accruals of the company till May 2001 and no working capital borrowing was raised during this period.
• The first borrowing was raised in June 2001 in the form of Export Packing Credit (EPC) and subsequently, some of the borrowings were specifically taken for expansion activities. During the year 2001-02 & 2002-03, the company has incurred Rs. 23.49 crore and Rs. 44.18 Crore respectively. In order to allocate borrowing costs on general borrowed funds that were attributable to acquisition/construction of fixed assets, the company considered paragraphs 12, 14 and 15 of AS 16.
• The company has stated that in the absence of a clear definition of ‘expenditure on qualifying assets’ in the Accounting Standard, it is more appropriate to consider “capital expenditure incurred during each year on cash basis” as expenditure on qualifying asset because of following reasons:
  • A significant portion of capital expenditure incurred initially was met out of internal resources only.
  • The cumulative capital expenditure upto the relevant year with or without borrowing costs does not have direct correlation with the borrowings and the borrowing costs.
  • As per paragraph 12 of AS 16, capitalisation rate is to be applied to the expenditure on the asset, which is the guiding factor. Paragraph 15 of the Standard is a guideline, but is not mandatory in the view of the company.

B. Query

The company had sought the opinion that whether the view of the company is appropriate. If not, what is the appropriate interpretation of “Expenditure on qualifying assets” and its method of computation.

C. Opinion

On the basis of the above, the opinion in respect of the query raised by the company:

• At the outset, paragraph 15 of AS 16 is not a guideline as contended by the company. It may be mentioned that paragraph 15 is an explanatory paragraph which explains the principles stated in paragraph 14. Thus, once a Standard is specified to be of mandatory nature, the entire Standard is mandatory.
• With regard to the computation of capitalization amount of borrowing costs, the expenditure incurred prior to raising of the borrowings cannot be considered since during that period the expenditure is met by internal accruals and not with the borrowings. Subsequent to the raising of borrowings the expenditure incurred on the qualifying assets, which has been met from the general borrowings should be considered.
• The expenditure arrived at above should be given weightage by the period involved in order to arrive at the average expenditure and then capitalisation rate should be applied so as to compute the borrowing cost to be capitalised. This amount to be capitalised should not exceed the amount of borrowing costs incurred during the period.

The above opinion was affirmed by the ICAI-Expert Advisory Committee.

Taran Arora, Audit Associate, SW India