- 10 Marks
PSAF – L2 – Q9.1 – International Public Sector Accounting Standards
Question
The Ministry of Transport decided to construct a tunnel that will link two major cities in the country to ease traffic congestion. The project, which commenced in January 2023, is expected to take two years to complete. The financing for the project includes the following borrowings:
- Bank Term Loans: GHc50 million at 7% interest per annum
- Institutional Borrowings: GHc70 million at 8% interest per annum
- Corporate Bonds: GHc100 million at 9% interest per annum
The total borrowings amount to GHc220 million, of which GHc20 million was used for routine maintenance of existing roads, and the remaining was for the tunnel construction. During the year, the Ministry earned GHc5 million from temporary investments of the borrowed funds.
Required:
(a) Explain the accounting treatment for the borrowing costs under the benchmark treatment option (expense recognition) for the year ended 31st December 2023.
(b) Explain the accounting treatment for the borrowing costs under the alternative treatment option (capitalization of borrowing costs) for the year ended 31st December 2023.
Answer
(a) Benchmark Treatment Option (Expense Recognition)
Under the benchmark treatment, all borrowing costs are expensed in the period in which they are incurred. This includes the interest on loans and other financing charges. The temporary income earned from the investment of borrowed funds does not reduce the borrowing costs.
The Ministry of Transport has the following borrowing costs:
| Borrowing Type | Terms | GHc million |
|---|---|---|
| Bank Term Loans | 50 × 0.07 | 3.5 |
| Institutional Borrowings | 70 × 0.08 | 5.6 |
| Corporate Bonds | 100 × 0.09 | 9.0 |
| Total borrowing cost | 18.1 |
Under the benchmark treatment, the Ministry will record the total borrowing cost of GHc18.1 million as an expense in its statement of financial performance for the year ended 31st December 2023. The GHc5 million income from the temporary investment of borrowed funds does not reduce the borrowing costs under this treatment. The investment income will be recognized separately as revenue in the statement of financial performance.
(b) Alternative Treatment Option (Capitalization of Borrowing Costs)
Under the alternative treatment, borrowing costs directly attributable to the construction of a qualifying asset (in this case, the tunnel) are capitalized as part of the cost of the asset. Only the portion of the borrowing costs that relates to the construction period is capitalized.
A qualifying asset is one that takes a substantial period of time to get ready for its intended use or sale. Since the tunnel construction takes two years, it qualifies.
Borrowing cost remained GHc18.1 million as determined in (a), the portion of the borrowing cost relating to the maintenance should be expensed. This borrowing cost associated with the maintenance is 20/220 × 18.1 = 1.645 million. Further, the temporary investment of GHc5 million should be deducted from the borrowing cost. Thus, the net borrowing cost is GHc11.455 million (GHc18.1 – 1.645 – 5).
The treatment is that the net borrowing cost of GHc11.455 million is capitalized as part of the cost of constructing the tunnel and will be included in the asset’s cost on the statement of financial position. Borrowing Costs Related to Routine Maintenance amounting to GHc1.645 million is recognized as an expense in the statement of financial performance for the year ended 31st December 2023.
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