Ifrs Finance Costs

Under International Financial Reporting Standards (IFRS), finance costs are defined as interest and other costs that an entity incurs in connection with borrowing funds. IAS 23, “Borrowing Costs,” specifically addresses the accounting treatment of these costs.

The standard mandates that finance costs should generally be recognized as an expense in the period in which they are incurred. This means that the cost is immediately charged to the profit or loss statement, reducing net income. This treatment reflects the principle that finance costs represent the cost of using funds to finance operations or investments.

However, there is a crucial exception: finance costs that are directly attributable to the acquisition, construction, or production of a *qualifying asset* are required to be capitalized. A qualifying asset is defined as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Examples include constructing a building, manufacturing a large piece of equipment, or developing a software product.

The capitalization of finance costs is permitted because they are considered part of the cost of bringing the qualifying asset to its intended condition and location. This aligns with the principle of matching costs with revenues. By capitalizing the finance costs, the expense is deferred and recognized over the useful life of the asset through depreciation or amortization. This more accurately reflects the economic benefits derived from the asset.

Determining which finance costs are directly attributable to a qualifying asset requires careful consideration. If the funds were borrowed specifically for the purpose of acquiring the asset, the attributable finance costs are straightforward to calculate. It is the actual interest expense incurred on that borrowing less any investment income earned on the temporary investment of those funds. However, if the funds were borrowed as part of a general borrowing pool, the attributable finance costs must be determined by applying a capitalization rate to the expenditure on the asset. The capitalization rate is calculated by weighting the average cost of the general borrowings.

Capitalization of finance costs begins when all the following conditions are met:

• Expenditures for the asset are being incurred.
• Borrowing costs are being incurred.
• Activities that are necessary to prepare the asset for its intended use or sale are in progress.

Capitalization is suspended during extended periods in which active development is interrupted. For instance, if construction of a building is halted for several months due to a strike, capitalization of finance costs would be suspended during that period.

Capitalization ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. This typically occurs when the asset is physically complete and ready for use, even if minor modifications are still required.

Disclosure requirements under IAS 23 include the amount of borrowing costs capitalized during the period and the capitalization rate used to determine the amount of borrowing costs eligible for capitalization.

Proper application of IAS 23 regarding finance costs is crucial for accurate financial reporting. It affects not only the current period’s profit or loss but also the balance sheet and future depreciation or amortization expenses.