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INTERMEDIATE

ACCOUNTING
TENTH CANADIAN EDITION
Kieso Weygandt Warfield Young Wiecek McConomy

CHAPTER 10
Appendix 10A
Capitalization of
Borrowing Costs

PREPARED BY:

Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto

Borrowing Costs
Under IFRS, borrowing costs that can be directly
attributed to acquisition, construction, or
development of qualifying assets should be
capitalized.
Under ASPE, management has a choice of
capitalizing or expensing such costs.

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Capitalization of Borrowing
Costs
Four questions must be answered:
What are the qualifying assets?
What is the capitalization period?
What is the amount of interest to be
capitalized?
What disclosures are needed?

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Qualifying Assets
Assets that take a substantial period of time to get ready
for intended use or sale
Examples of assets that do not qualify:
Assets ready for use or sale when acquired
Assets produced over a short period of time
Assets not undergoing development to get them ready for
use

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Capitalization Period

Capitalization period begins when all three


conditions are present:
1. Expenditures for the asset have been
made
2. Activities for readying the asset are in
progress
3. Borrowing costs are being incurred
Capitalization continues for as long as these
three conditions exist
Capitalization ends when asset is substantially
complete and ready for use
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Amount to Capitalize
Borrowing costs must be directly related to
asset
Lower of actual borrowing costs or
avoidable borrowing costs
cost of capital for shareholders equity is not
included in borrowing costs

Weighted-average accumulated
expenditures (WAAE) method is used to
find borrowing costs to be capitalized
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Borrowing Costs
Capitalization Issues
Amount of capitalized interest is based on the intended
use of the land purchased
Intended Use

Capitalized Interest Cost Attached to:

Specific Purpose

Land

Structure Site

Structure

Lot Sales

Developed land

Investment

Interest costs should not be capitalized


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Calculating Avoidable
Borrowing Costs
To calculate avoidable borrowing costs,
follow four steps:
1. Determine qualifying asset expenditures
2. Determine avoidable borrowing costs relating
to asset-specific debt
3. Determine avoidable borrowing costs relating
to non-asset-specific debt
4. Determine final avoidable borrowing costs

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Shalla Corporation
Example
Given:
November 1, 2013 contracts with Pfeifer Construction
Co. Ltd. to construct a $1.4 million building (on land
costing $100,000)
First payment made by Shalla to Pfeifer includes the payment for

the land
Payments made in 2014:

January 1
$ 210,000
March 1
$ 300,000
May 1
$ 540,000
December 31 $ 450,000
Total
$1,500,000
Building completed December 31, 2014

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Shalla Corporation
Example
Debt outstanding at December 31, 2014
Specific Construction Debt:
15%, three year note
dated December 31, 2013 $750,000
Other Debt:
10%, five year note
dated December 31, 2010 $550,000
12%, ten year bonds
dated December 31, 2007 $600,000

Interest on debt is payable each December 31


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Shalla Corporation
Example
STEP 1: Determine qualifying asset expenditures
Weighted-Average Accumulated Expenditures:
Jan. 1 $ 210,000 x 12/12 = $210,000
Mar. 1
300,000 x 10/12 = 250,000
May. 1
540,000 x 8/12 = 360,000
Dec. 31 450,000 x 0/12 =
0
WAAE
$820,000
Note: Land payment is included in WAAE
Next step: Avoidable interest and appropriate
interest rate calculation
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Shalla Corporation
Example
STEP 2: Determine avoidable borrowing costs
relating to asset-specific debt
$750,000 x 15% = $112,500

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Shalla Corporation
Example
STEP 3: Determine avoidable borrowing costs relating
to non-asset-specific debt
Principal
5-year note

$550,000

10-year note$600,000
Total

Borrowing cost
$ 55,000
72,000
$127,000

Weighted-Average Interest Rate =


Total Interest Total Principal
(Do not include Construction Specific Debt)
$127,000 (550,000 + 600,000) = 11.04%
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Shalla Corporation
Example
Total WAAE
$820,000
Less: financed by specific loan
$750,000
WAAE financed by general borrowings $70,000
X avoidable borrowing cost on general 11.04%
Avoidable costs on general debt
$7,728

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Shalla Corporation
Example
STEP 4: Determine total borrowing costs
to capitalize
Avoidable borrowing costs
On asset-specific debt
On general debt
TOTAL

$112,500
$7,728
$120,228

Actual Interest:
$750,000 x 15%
= $112,500
550,000 x 10%
=
55,000
600,000 x 12%
=
72,000
Total actual interest paid
$239,500
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Shalla Corporation
Example
Avoidable interest
= $120,228
Actual interest = $239,500
The lesser of these two amounts is capitalized
Journal Entry:
Dr. Building
120,228
Cr. Interest Expense 120,228

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Interest Capitalization
Significance

Capitalized interest increases net income for


the period
Impact on EPS can be significant

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Disclosures
Two disclosures required:
Amount capitalized
Capitalization rate

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Ltd.

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