- 20 Marks
FR – L2 – Q28 – Borrowing Costs
Question
Roonwood Ltd has recently finished building a new item of plant for its own use. The item is a press for use in the manufacture of industrial diamonds. Roonwood Ltd commenced construction of the asset on 1st April 20X2 and completed it on 1st April 20X4.
1st January 20X2, Roonwood Ltd took out a loan to finance the construction of the asset. Interest is charged on the loan at the rate of 5% per annum. The annual interest must be paid in four equal instalments at the end of each quarter. Roonwood Ltd capitalises interest on manufactured assets in accordance with the rules in IAS 23 Borrowing Costs.
The costs (excluding finance costs) of manufacturing the asset were GH¢28 million.
Required
(a). State the IAS 23 requirements on the capitalisation of borrowing costs, calculate the cost of the asset on initial recognition and explain the amount of borrowing cost capitalised.
(b). The press comprises two significant parts, the hydraulic system and the ‘frame.’ The hydraulic system has a three year life and the ‘frame’ has an eight year life. Roonwood Ltd depreciates plant on a straight line basis. The cost of the hydraulic system is 30% of the total cost of manufacture.
Roonwood Ltd uses the IAS 16 revaluation model in accounting for diamond presses and revalues these assets on an annual basis.
Revaluation surpluses or deficits are apportioned between the hydraulic system and the ‘frame’ on the basis of their year-end book values before the revaluation.
Required
Explain the IAS 16 requirements on accounting for significant parts of property, plant and equipment and show the accounting treatment of the diamond press in the financial statements for the financial years ending:
(i) 31st March 20X5 (assume that the press has a fair value of GH¢21 million)
(ii) 31st March 20X6 (assume that the press has a fair value of GH¢19.6 million).
Answer
(a). IAS 23 should be applied in accounting for borrowing costs.
Borrowing costs are recognised as an expense in the period in which they are incurred unless they are capitalised in accordance with IAS 23 which says that borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset can be capitalised as part of the cost of that asset.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
Borrowing costs that are directly attributable to acquisition, construction or production are taken to mean those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made.
When an enterprise borrows specifically for the purpose of funding an asset, the identification of the borrowing costs presents no problem as the amount capitalised is the actual borrowing costs net of any income earned on the temporary investment of those borrowings.
If funds are borrowed, generally, the amount of borrowing costs eligible for capitalisation is determined by applying a capitalisation rate to the expenditures on that asset calculated as the weighted average of the borrowing costs applicable to general borrowings.
IAS 23 also contains rules on commencement of capitalisation, suspension of capitalisation and cessation of capitalisation.
Amount capitalised
| GH¢000 | |
|---|---|
| Cost of manufacture | 28,000 |
| Interest capitalised (GH¢20m × 5% × 2 years) | 2,000 |
| 30,000 |
(b). Rule
IAS 16 requires that each part of an item (that has a cost that is significant in relation to the total cost) is depreciated separately. Therefore the cost recognised at initial recognition must be allocated to each part accordingly.
Accounting
(i) 31st March 20X5
| Carrying Value 1.4.20X4 | Depreciation | Fair value | Revaluation loss (to profit and loss) | |
|---|---|---|---|---|
| Hydraulic system | GH¢000 | GH¢000 | GH¢000 | GH¢000 |
| 9,000 | 3,000 | 6,000 | ||
| “Frame” | 21,000 | 2,625 | 15,000 | 3,375 |
| 30,000 | 21,000 |
(ii) 31st March 20X6
| Carrying Value 1.4.20X5 | Depreciation | Fair value | Revaluation loss (to profit and loss) | |
|---|---|---|---|---|
| Hydraulic system | GH¢000 | GH¢000 | GH¢000 | GH¢000 |
| 6,000 | 3,000 | 2,800 | 200 | |
| “Frame” | 15,000 | 1,875 | 16,800 | |
| 21,000 | 19,600 |
- Tags: Depreciation, Diamond Press, IAS 16, Revaluation, Significant Parts
- Level: Level 2
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