The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing costs include interest on bank overdrafts and borrowings, finance charges on finance leases and exchange differences on foreign currency borrowings where they are regarded as an adjustment to interest costs. Show
Key definitionsBorrowing cost may include: [IAS 23.6]
This standard does not deal with the actual or imputed cost of equity, including any preferred capital not classified as a liability pursuant to IAS 32. [IAS 23.3] A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use or sale. [IAS 23.5] That could be property, plant, and equipment and investment property during the construction period, intangible assets during the development period, or "made-to-order" inventories. [IAS 23.6] Scope of IAS 23Two types of assets that would otherwise be qualifying assets are excluded from the scope of IAS 23:
Accounting treatmentRecognition Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset and, therefore, should be capitalised. Other borrowing costs are recognised as an expense. [IAS 23.8] Measurement Where funds are borrowed specifically, costs eligible for capitalisation are the actual costs incurred less any income earned on the temporary investment of such borrowings. [IAS 23.12] Where funds are part of a general pool, the eligible amount is determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate will be the weighted average of the borrowing costs applicable to the general pool. [IAS 23.14] Capitalisation should commence when expenditures are being incurred, borrowing costs are being incurred and activities that are necessary to prepare the asset for its intended use or sale are in progress (may include some activities prior to commencement of physical production). [IAS 23.17-18] Capitalisation should be suspended during periods in which active development is interrupted. [IAS 23.20] Capitalisation should cease when substantially all of the activities necessary to prepare the asset for its intended use or sale are complete. [IAS 23.22] If only minor modifications are outstanding, this indicates that substantially all of the activities are complete. [IAS 23.23] Where construction is completed in stages, which can be used while construction of the other parts continues, capitalisation of attributable borrowing costs should cease when substantially all of the activities necessary to prepare that part for its intended use or sale are complete. [IAS 23.24] Company A partners with Investor B, an unrelated financial investor, for the development of selected compounds that are in Phase II development. Investor B commits a specified dollar amount to fund the research and development of the selected compounds. In exchange for the funding, Investor B will receive royalties on future sales of product resulting from the compounds being developed. Investor B will not be repaid if the compounds are not successfully developed (i.e., the transfer of financial risk for the research and development is substantive). Investor B does not participate in any of the development or commercialization activities. Question: What factors should Company A consider to determine the most appropriate accounting model for the research and development funding? SolutionWhile ASC 730–20 only relates to research and development funding, ASC 470–10–25 does not specifically exclude research and development funding arrangements from its scope. If the research and development risk is substantive, such that it is not yet probable the development will be successful, the guidance in ASC 730-20 would generally be followed. However, if the successful completion of the research and development is already probable at the time the funding is received, the guidance in ASC 470-10-25 is applicable. Company A should assess whether the contractual arrangement with Investor B meets all of the characteristics of a derivative, and if so, whether any of the scope exceptions to derivative accounting are applicable. Since Investor B would only receive royalties on future sales (assuming the development is successful), the settlement provisions under this contract are based on specified volumes of items sold. Therefore, the royalty exception would apply and Company A would not account for this arrangement as a derivative. To conclude that a liability does not exist, the transfer of financial risk involved with the research and development from Company A to Investor B must be substantive and genuine. When assessing the substance of the transfer of financial risk, Company A should consider any explicit or implicit obligations to repay any or all of the funding and consider the examples in ASC 730-20-25-6. If Company A determines that there is significant risk associated with the research and development and that successful development is not probable, Company A would apply the guidance in ASC 730-20 to evaluate whether the research and development funding is a liability to repay the funding party or an obligation to perform contractual services. In this example, Company A has no explicit or implicit obligation to repay any of the funds and therefore determines that the arrangement is an obligation to perform contractual research and development services. Relevant guidanceASC 730-20-05, Research and development arrangements, this subtopic provides guidance on research and development arrangements. Research and development arrangements have been used to finance the research and development of a variety of new products, such as…medical technology, experimental drugs… ASC 730-20-25-1: This Subtopic deals with transactions in which the issue is whether, at the time an entity enters into a research and development arrangement:
ASC 470-10-25-1: An entity receives cash from an investor and agrees to pay to the investor for a defined period a specified percentage or amount of the revenue or of a measure of income (for example, gross margin, operating income, or pretax income) of a particular product line, business segment, trademark, patent, or contractual right. It is assumed that immediate income recognition is not appropriate due to the facts and circumstances. ASC 815-10-15-59(d): Contracts that are not exchange-traded are not subject to the requirements of this Subtopic if the underlying on which the settlement is based is any one of the following… Specified volumes of sales or service revenues of one of the parties to the contract. (This scope exception applies to contracts with settlements based on the volume of items sold or services rendered, for example, royalty agreements. This scope exception does not apply to contracts based on changes in sales or revenues due to changes in market prices.) Which is not be considered a qualifying asset?Financial assets, and inventories that are manufactured, or otherwise produced, over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired are not qualifying assets.
Which of the following items is not a qualifying asset for purposes of capitalizing borrowing costs?investment property. This is an example of an asset that does not qualify.
When capitalization of borrowing cost should be started for a qualifying asset?Borrowing costs are capitalised as part of the cost of a qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred. 8.
Which of the following may not be considered a qualifying asset under PAS 23 *?Therefore, the correct option is (b) An expensive private jet that can be purchased from a local vendor.
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For purposes of capitalization of borrowing cost, which of the following is not a qualifying asset?
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