## AS 16 – Borrowing Costs: Core Principle

Borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset must be capitalised — added to the cost of that asset. All other borrowing costs are expensed to Profit & Loss.

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## Key Definitions

Term	Definition
Borrowing Costs	Interest and other costs incurred in connection with borrowing of funds
Qualifying Asset	An asset that necessarily takes a substantial period of time (generally ≥ 12 months) to get ready for its intended use or sale

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## Two Mandatory Conditions for Capitalisation

Both must be satisfied simultaneously:

1. A loan must have been taken (borrowing must exist)

2. The loan proceeds must be spent on a qualifying asset

> If either condition fails → borrowing cost goes to P&L, not the asset.

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## Types of Borrowing Costs Covered Under AS 16

Type	Description
Interest charges on borrowings	Bank loans, debentures, etc.
Amortisation of discount or premium	E.g., debenture redeemed at premium: Face ₹100, redeemed ₹110 → ₹10 amortised over life
Ancillary costs of arranging borrowings	Loan processing fees, arrangement fees, legal fees
Finance charges on finance lease assets	Per AS 19
Exchange differences on foreign loans	To the extent treated as adjustment to interest

## What AS 16 Does NOT Cover

Funds raised by issuing equity share capital — no interest obligation
Funds raised by issuing preference share capital — not a borrowing in AS 16 sense

Worked example

### Example 1

Both conditions met → Capitalise:

A company takes a ₹100 cr loan to construct a building that takes 18 months. Interest = ₹12 cr.

→ Loan taken ✓, qualifying asset (building under construction 18 months) ✓

→ ₹12 cr added to the cost of building.

### Example 2

No loan taken → Cannot capitalise:

A company constructs a building over 18 months using only own funds (no borrowing).

→ No borrowing cost exists → nothing to capitalise.

### Example 3

Loan taken but non-qualifying use → Expense it:

A company takes a loan to purchase ready-made finished goods inventory.

→ Inventory purchased ready-made is NOT a qualifying asset → interest goes to P&L.

### Example 4

Debenture premium as borrowing cost:

Debentures issued at face value ₹100, redeemable at ₹110. The ₹10 premium is amortised annually. This amortised charge is a borrowing cost eligible for capitalisation if funds are used for a qualifying asset.

⚠️ Common exam mistakes

Capitalising interest on loans used for working capital or day-to-day expenses — these are not qualifying assets
Forgetting that BOTH conditions (loan taken AND qualifying asset) must be satisfied simultaneously
Treating dividends on preference share capital as borrowing costs — AS 16 explicitly excludes equity and preference share capital
Ignoring loan processing/arrangement fees — these are borrowing costs eligible for capitalisation
Capitalising interest after the asset is ready for use — capitalisation must stop at completion

Bare-Act text Para 6 · AS 16 – Borrowing Costs · click to expand

Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. Other borrowing costs should be recognised as an expense in the period in which they are incurred.

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AS 16 – Borrowing Costs: Introduction, Definitions & Scope

Worked example

⚠️ Common exam mistakes