Intermediate Accounting,Eighth Canadian Edition

1CHAPTER 10Appendix 10ACapitalization of Borrowing CostsTENTH CANADIAN EDITIONKieso Weygandt Warfield Young Wiecek McConomy

INTERMEDIATE ACCOUNTINGPREPARED BY: Dragan Stojanovic, CARotman School of Management, University of TorontoBorrowing CostsUnder 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.#Copyright John Wiley & Sons Canada, Ltd.2L01Capitalization of Borrowing CostsFour 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?#Copyright John Wiley & Sons Canada, Ltd.3L01Qualifying AssetsAssets that take a substantial period of time to get ready for intended use or saleExamples of assets that do not qualify: Assets ready for use or sale when acquiredAssets produced over a short period of timeAssets not undergoing development to get them ready for use#Copyright John Wiley & Sons Canada, Ltd.4L01Capitalization PeriodCapitalization period begins when all three conditions are present:Expenditures for the asset have been madeActivities for readying the asset are in progressBorrowing costs are being incurredCapitalization continues for as long as these three conditions existCapitalization ends when asset is substantially complete and ready for use#Copyright John Wiley & Sons Canada, Ltd.5L01Amount to CapitalizeBorrowing costs must be directly related to assetLower of actual borrowing costs or avoidable borrowing costscost of capital for shareholders equity is not included in borrowing costsWeighted-average accumulated expenditures (WAAE) method is used to find borrowing costs to be capitalized#Copyright John Wiley & Sons Canada, Ltd.6L01Borrowing Costs Capitalization IssuesAmount of capitalized interest is based on the intended use of the land purchasedIntended Use:Capitalized Interest Cost Attached to:Lot SalesDeveloped land Specific PurposeLandStructure SiteStructureInvestmentInterest costs should not be capitalized#Copyright John Wiley & Sons Canada, Ltd.7L01

Calculating Avoidable Borrowing CostsTo calculate avoidable borrowing costs, follow four steps: Determine qualifying asset expendituresDetermine avoidable borrowing costs relating to asset-specific debtDetermine avoidable borrowing costs relating to non-asset-specific debtDetermine final avoidable borrowing costs#Copyright John Wiley & Sons Canada, Ltd.8L01

Shalla Corporation ExampleGiven: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 landPayments made in 2014:January 1 $ 210,000March 1 $ 300,000May 1 $ 540,000December 31 $ 450,000Total $1,500,000Building completed December 31, 2014#Copyright John Wiley & Sons Canada, Ltd.9L01

Shalla Corporation ExampleDebt outstanding at December 31, 2014Specific Construction Debt:15%, three year notedated December 31, 2013$750,000Other Debt:10%, five year notedated December 31, 2010$550,00012%, ten year bondsdated December 31, 2007$600,000Interest on debt is payable each December 31#Copyright John Wiley & Sons Canada, Ltd.10L01

Shalla Corporation ExampleSTEP 1: Determine qualifying asset expendituresWeighted-Average Accumulated Expenditures:Jan. 1$ 210,000 x 12/12=$210,000Mar. 1 300,000 x 10/12= 250,000May. 1 540,000x 8/12= 360,000Dec. 31 450,000x 0/12= 0WAAE$820,000Note: Land payment is included in WAAENext step: Avoidable interest and appropriateinterest rate calculation#Copyright John Wiley & Sons Canada, Ltd.11L01

Shalla Corporation ExampleSTEP 2: Determine avoidable borrowing costs relating to asset-specific debt$750,000 x 15% = $112,500#Copyright John Wiley & Sons Canada, Ltd.12L01

Shalla Corporation ExamplePrincipalBorrowing cost5-year note$550,000$ 55,00010-year note$600,000 72,000Total $127,000Weighted-Average Interest Rate =Total Interest Total Principal(Do not include Construction Specific Debt)$127,000 (550,000 + 600,000) = 11.04%STEP 3: Determine avoidable borrowing costs relating to non-asset-specific debt#Copyright John Wiley & Sons Canada, Ltd.13L01

Shalla Corporation ExampleTotal WAAE$820,000Less: financed by specific loan$750,000WAAE financed by general borrowings$70,000X avoidable borrowing cost on general11.04%Avoidable costs on general debt$7,728#Copyright John Wiley & Sons Canada, Ltd.14L01

Shalla Corporation ExampleSTEP 4: Determine total borrowing costs to capitalizeAvoidable borrowing costsOn asset-specific debt$112,500On general debt $7,728TOTAL$120,228Actual Interest:$750,000x15%=$112,500 550,000x10%= 55,000 600,000x12%= 72,000Total actual interest paid $239,500#Copyright John Wiley & Sons Canada, Ltd.15L01

Shalla Corporation ExampleAvoidable interest = $120,228Actual interest = $239,500

The lesser of these two amounts is capitalized

Journal Entry:Dr.Building120,228 Cr. Interest Expense120,228#Copyright John Wiley & Sons Canada, Ltd.16L01

Interest Capitalization SignificanceCapitalized interest increases net income for the periodImpact on EPS can be significant#Copyright John Wiley & Sons Canada, Ltd.17L01

DisclosuresTwo disclosures required: Amount capitalizedCapitalization rate#Copyright John Wiley & Sons Canada, Ltd.18L01

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