Lecture 04 IAS 23 Borrowing Costs IAS 20 Government Grants Sajid Shafiq ACA IAS 23Overview Objectives Scope and Definitions Which Cost should be capitalized When should capitalisation ID: 662670
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Slide1
E-14 Advanced Accounting and Financial Reporting
Lecture 04IAS 23 Borrowing Costs IAS 20 Government Grants
Sajid
Shafiq, ACASlide2
IAS 23-Overview
Objectives, Scope and DefinitionsWhich Cost should be capitalized?When should capitalisation of BC commence and suspend?Ceasing
capitalising
Class Practice Questions
1-Jan-11
2
IAS 23 & 20Slide3
Objectives, scope and Definitions
1-Jan-11
IAS 23 & 20
3
Objectives
BC that are directly attributable to the acquisition, construction or production of a QA form part of the cost of that asset.
Other BC are
recognised
as an expense.
Scope
This IAS is applied in accounting for BC
This IAS does not deal with the actual or imputed cost of equity, including preferred capital not classified as a liability.
An entity is not required to apply the Standard to BC directly attributable to the acquisition, construction or production of:
(a)
a QA measured at FV, for example a biological asset; or
(b)
inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis.
Definitions
Borrowing Costs
are interest and other costs that an entity incurs in connection with the borrowing of funds.
BC may include:
interest on bank overdrafts and short-term and long-term borrowings;
amortisation
of discounts or premiums relating to borrowings;
amortisation
of ancillary costs incurred in connection with the arrangement of borrowings;
finance charges in respect of finance leases
recognised
in accordance with IAS 17 Leases; and
exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
A
Qualifying Assets
is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Depending on the circumstances, any of the following may be QA:
Inventories
manufacturing plants
power generation facilities
intangible assets
investment properties.
Financial assets, and inventories that are manufactured, or otherwise produced, over a short period of time, are not QA. Assets that are ready for their intended use or sale when acquired are not QA.Slide4
Capitalisation
of BCThe Core Principle:BC that are directly attributable to the acquisition, construction, or production of a QA form part of the cost of that asset, and should be
capitalised
as part of that asset. Other BC are
recognised
as an expense in profit or loss.Illustration 1
An entity has a bank overdraft of CU500,000 and a loan of CU1 million which was taken out to finance the expansion of the entity several years ago. The entity has just commissioned the construction of a new factory to expand the business. The factory will cost CU2 million to build and this will be financed by a new loan.
The finance costs on the new loan only (i.e. loan of CU2 million) should be
capitalised
as part of the cost of the new factory. Finance cost on earlier loans and bank overdraft are not included. The entity should also
capitalise
the ancillary costs incurred in connection with setting up the new borrowing facility.
Capitalisation
and purpose of borrowings:
Where funds are specifically borrowed
to finance the construction of an asset, the specific BC incurred can be readily identified.
However, the asset may also be financed from borrowings made for general use within the entity or group. The amount of borrowings that should be capitalised is calculated by applying to the expenditure on the asset a capitalisation rate
calculated by reference to a weighted average of the costs of all the 'general use' borrowings. The weighted average calculation will exclude any borrowings used to finance a specific purchase or construction.1-Jan-11IAS 23 & 204Slide5
Capitalisation
of BCIllustration 2 (capitalization rate)An entity already has a number of general loan arrangements:Loan 1 of CU800,000, interest paid at 9%;
Loan 2 of CU2 million, interest paid at 8%; and
Loan 3 of CU400,000, interest paid at 7.5%.
The entity has commissioned a new printing press to be constructed on its behalf. The total cost will be CU800,000 and the entity will be able to fund the purchase from its existing borrowings since it has arranged for stage payments to be made.
The construction takes six months.
The weighted average (
capitlalzation
rate)is calculated as follows:
(800,000 x 0.09) + (2,000,000 x 0.08) + (400,000 x 0.075)
=
8%
(800,000 + 2,000,000 + 400,000)
BC to be
capitalised:Cost of asset 800,000 x 8% x 6/12 = CU32,000
1-Jan-11
IAS 23 & 205Slide6
Capitalisation
of BCSpecific borrowings and idle funds Where the funds specifically borrowed to finance the asset are not wholly
utilised
immediately but are instead invested until they are required, the finance cost to be
capitalised
should be reduced by any investment income received on the excess funds invested.Illustration 3
An entity borrowed CU5 million to fund the construction of a new building. Interest is payable on the loan at 8%. Stage payments were due throughout the construction period and therefore excess funds were reinvested during that period. By the end of the project investment income of CU150,000 had been earned and the construction took twelve months to complete.
Interest
capitalised
as part of the cost of the asset is the actual interest cost less income earned on the temporary investment of the surplus funds.
Interest cost
: CU5,000,000 x 8% = CU400,000
Total BC
capitalised: CU400,000 - CU150,000 = CU250,000
The amount of BC that should be capitalised
is limited by the requirement that the carrying amount of the asset (including BC) should not exceed the asset’s recoverable amount.1-Jan-11
IAS 23 & 206Slide7
When should
capitalisation of BC commence and suspend?Commencement:
BC of the asset should be
capitalised
when
ALL the following three conditions have been met:expenditure on the acquisition, construction, or production of the asset is being incurred;
BC are being incurred; andactivities are taking place that are necessary to prepare the asset for its intended use or sale.
Activities necessary to prepare the asset for use include more than just the actual construction and may include, for example, drawing up plans and obtaining permits for a building where the land has been purchased. However, merely holding assets for use or development without any associated development activity does not qualify for
capitalisation
.
1-Jan-11
IAS 23 & 20
7
Suspension:
There may be periods when the development of an asset is temporarily suspended. During such inactive periods the
capitalisation
of BC should be discontinued and instead finance costs incurred during this period should be immediately
recognised in profit or loss.It is possible that a temporary delay is part of the production or construction process, and during such periods BC should continue to be capitalised. Examples include where the maturity of an asset is an essential part of the production process or where there is expected non-activity due to geological features (such as periods of very high tides and floods).Slide8
Illustration 4
The following events take place:An entity buys some land on 1 December.Planning permission is obtained on 31 January.Payment for the land is deferred until 1 February.The entity takes out a loan to cover the cost of the land and the construction of the building on 1 February.
Due to adverse weather conditions there is a delay in starting the building work for six weeks and work does not commence until 15 March.
In the above scenario the key dates are:
Expenditure on the acquisition is incurred on 1 February when construction commences.
BC start to be incurred from 1 February.
Although work was being undertaken on planning permission etc. during December and January, no BC were incurred during this period.
During the six-week inactive period BC should not be
capitalised
.
Capitalisation
of BC should commence from 15 March.
1-Jan-11
IAS 23 & 20
8Slide9
Ceasing Capitalisation
Capitalisation should cease when substantially all the activities necessary to get the asset ready for its intended use or sale are complete. It is the availability for use which is important, not when the asset is actually brought into use. An asset is normally ready for its intended use or sale when its physical construction is complete.Some assets are completed in parts. Where each part is capable of being used separately while other parts continue to be constructed, for example the construction of separate buildings within a new business park, the cessation of
capitalising
BC should be assessed on the substantial completion of each part.
1-Jan-11
IAS 23 & 20
9Slide10
Class Practice Question
Mork Inc. is constructing a warehouse that will take about 18 months to complete. It began construction on January 1, 20X2. The following payments were made during 20X2:
IAS 23 & 20
10
$000
Medium-term loan (see description above)
800
Bank overdraft (The weighted average amount outstanding during the year was $750,000 and total interest charged by the bank amounted to $33,800 for the year)
1,200
A 10 percent, 7-year note dated October 31, 19X7 with simple 9,000 interest payable annually at Dec-31
9,000
$000
Jan 31
200
Mar 31
450
Jun 30
100Oct 31
200
Nov 302501,200
The first payment on January 31 was funded from the entity’s pool of debt. However, the entity succeeded in raising a medium-term loan for an amount of $800,000 at March 31, 20X2, with simple interest of 9 percent per annum. These funds were specifically used for this construction. Excess funds were temporarily invested at 6 percent per annum monthly in arrears. The pool of debt was again used to an amount of $200,000 for the payment on November 30, which could not be funded from the medium-term loan.
The construction project was temporarily halted for 2 weeks in May when substantial technical and administrative work was carried out. Additionally, the company had to suspend work in entire July due to unexpected continuous rainfall. The following amounts of debt were outstanding at the balance sheet date, December 31, 20X2
:
1-Jan-11Slide11
IAS-20 Overview
Objectives, Scope and DefinitionsRecognition and MeasurementNon-Monetary Government GrantsPresentation of GG
Grants Related to Assets
Grants Related to Income
Other Issues
Repayment of Government GrantsNo Specific Relation to Operating Activities
Class Practice QuestionsSlide12
Objectives, scope and Definitions
1-Jan-11
IAS 23 & 20
12
Objectives
Sets
out the accounting requirements when an entity receives a form of
Government
Assistance(GA).
The reference to ‘government’
includes,
government agencies and similar local, national or international bodies.
Scope
Does
not deal with:
the
issues that arise in accounting for
GG in FS reflecting
the effect of changing
prices;
the
accounting treatment of tax-related
GA;
government participation in the ownership of the enterprise; or GG received in relation to an entity’s agricultural activities and accounted for in accordance with IAS 41 Agriculture.
Definitions
GA
is
action by
government
designed to provide an
EB specific
to an entity or range of entities qualifying under certain criteria.
GA for
the purpose of this
IAS does
not include benefits provided only indirectly through action affecting general trading conditions, such as the provision of infrastructure in development areas or the imposition of trading constraints on competitors.
GG
are
assistance by
government
in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude those forms of
GA which
cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the
entity.(
also called subsidies, subventions, or
premiums)
Grants related to assets
are
GG whose
primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets. Subsidiary conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held.
Grants related to income
are
GG other
than
those related to assets
.
Forgivable loans
are loans which the lender undertakes to waive repayment of under certain prescribed conditions. Slide13
Recognition and Measurement
GG should only be recognised when there is reasonable assurance that
any
conditions
attaching to the grant will be complied with and the grant will
actually be received.Actual
receipt of the grant does not necessarily meet this requirement, since circumstances may exist where the grant will have to subsequently
be repaid
.
GG should
not be
recognised
on a cash basis as this is
not consistent
with the general accounting concepts addressed in IAS 1 The general principle is that a GG should be recognised as income in
the periods in which the costs that it is intended to compensate are
recognised. Where the grant has been received towards the cost of, say, a piece of machinery, the grant should be recognised as income when depreciation is charged in respect of the asset. The purpose of this treatment is to provide a matching effect. A systematic basis should be used
to recognise the grant income. If the receipt of a GG represents compensation for expenses already incurred by the entity, the grant should be recognised as income in the period in which it becomes receivable. Immediate recognition
will also be appropriate where the grant is given to provide immediate financial support and there are no future related
expenses expected to be incurred. These conditions equally apply to non-monetary (i.e. non-cash) grants that are measured
at fair value. 1-Jan-11IAS 23 & 20
13Slide14
Non-Monetary Government Grants
Where a grant is received in the form of a non-monetary asset (i.e. not in the form of cash) it is usual to
recognise
both the grant and the asset at
FV (although
nominal value is also permitted as an alternative).
Illustration 1
The
government makes a grant to a start-up entity writing teaching software
for children
with learning difficulties. The purpose of the grant is to help with
general financing
on start up, and there are no further conditions attaching to the grant.
The
grant should be recognised in full immediately that it is receivable. This grant has been provided for the purpose of giving immediate financial support to the entity.
A manufacturing entity sets up a plant in an area of high unemployment. A grant
of CU4 million is receivable if it continues to employ at least 100 people over a period of four years. It is highly probable it will do so. CU2 million of the grant is to be received immediately and a further CU2 million is receivable in four years’ time.Since
there is reasonable assurance that the conditions attaching to the grant will be met, the grant is recognised as income evenly over the four year period in which the entity incurs the costs of employing the 100 people.An agricultural research entity is given land that belonged to the government to set up a new laboratory and to investigate new farming methods.This is a grant related to a non-monetary asset and, as such, it should probably be
recognised when the costs of constructing the laboratory are incurred. Treatment
will depend on the specific circumstances and whether there are conditions relating to the gift of land.Free
technical advice is provided by government employees to help an export entity to market its new technology in North America.Free technical advice is likely to be a grant that cannot reasonably have a value placed upon it and therefore should not be recognised
.
1-Jan-11IAS 23 & 2014Slide15
Presentation of GG- Related to Asset
1-Jan-11IAS 23 & 20
15Slide16
1-Jan-11
IAS 23 & 2016
A
GG related
to income
should
be
recognised
in profit or loss when any conditions for their recognition
have been
met. Income related government grants may be presented as income and
shown separately
, or under ‘other income’ or deducted from the expenditure to which they relate.Slide17
Other Issues-Repayment of GG
Treated as a change in accounting estimateRelated to income Repayment shall be applied first against any unamortised deferred credit set up in respect of the grant. To the extent that the repayment exceeds any such deferred credit, or where no deferred credit exists, the repayment shall be
recognised
immediately as an expense.
Related to an asset
Repayment shall be recorded by reducing the deferred income
balance by the amount repayable with difference to P/L account, orRepayment shall be recorded by increasing the carrying amount of the asset. The cumulative additional depreciation that would have been recognised
to date as an expense in the absence of the grant shall be
recognised
immediately as an expense.
1-Jan-11
IAS 23 & 20
17Slide18
Other Issues-
No specific relation to operating activitiesSIC-10 considers the situation
where government assistance is given but there are no conditions that
relate specifically
to the entity’s operating activities. Such government assistance is given,
for example, to encourage an entity to operate in a particular industry or area.
Although such government grants do not relate to specific activities of the entity, they
meet the
definition of a government grant and should therefore be
recognised
in
accordance with
the general requirements of IAS 20
.
1-Jan-11IAS 23 & 20
18Slide19
Class Practice Questions
On 1 January 20X8 The Ebro Company commenced trading to provide
key skills
education facilities in a region identified for technology development
. Also
on 1 January 20X8, the company received two grants from its government for setting up its operations in this location:
Grant (a) – was paid to give financial assistance for start-up costs already incurred.
Grant (b) – was paid to
subsidise
the costs of purchasing computer
software over
the five-year period.
The company is almost certain to keep the facilities operational for the
next five
years.The company's accounting year end is 31 December. Are the following statements concerning recognition of the income from the two government grants true or false, according to IAS20
(1) Income from Grant (a) should be
recognised in full on receipt in 20X8.(2) Income from Grant (b) should be recognised in full at the end of 5 years.
1-Jan-11IAS 23 & 2019For Elbo Co.,Which TWO of the following statements are correct according to
IAS20?
A Any adjustment needed when a government grant becomes repayable is accounted for as a change in accounting estimate
B In respect of loans from the government at an interest rate of 0%, an imputed interest charge should be made in profit or lossC Where conditions apply to a government grant, it should only be recognised
when there is reasonable assurance that the conditions will
be metD A government grant should not be recognised until it is received in cashSlide20
Class Practice Questions
The Palila Company purchased a varnishing machine for CU150,000 on
1 January
20X7
. The
company received a government grant of CU13,500 in respect of this asset. Company policy was to depreciate the asset over 4 years on a straight-line basis
and to treat the grant as deferred income.Under IAS20
,
what should
be the
carrying amounts of the machine and the deferred income ("DI")
balance at
31 December 20X8?
Carrying
amount DI balanceA CU75,000 CU6,750B CU112,500 CU10,125
C CU81,750 CU6,750
D CU75,000 CU13,5001-Jan-11IAS 23 & 20
20The Perth Company purchased a jewel polishing machine for CU360,000 on 1 January 20X7 and received a government grant of CU50,000 towards the capital cost. Company policy is to treat the grant as a reduction in the cost of the asset. The machine was to be depreciated on a straight-line basis over 8 years
and was estimated to have a residual value of CU5,000 at the end of this period.
Under IAS20, what should be the depreciation expense in respect of the machine for the year ended
31 December 20X7?A CU38,750B CU76,250C CU44,375D
CU38,125