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ASLB 5 Borrowing Costs

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Accounting Standard for Local Bodies (ASLB) 5

Borrowing Costs

Contents
Paragraphs
OBJECTIVE
SCOPE 1-4
DEFINITIONS 5-13
Borrowing Costs 6
Economic entity 7-9
Net Assets/Equity 12
Qualifying Assets 12A-13
RECOGNITION 14-39
Borrowing Costs Eligible for Capitalisation 21-29A
Excess of the Carrying Amount of the qualifying
Asset over recoverable Amount 30
Commencement of Capitalisation 31-33
Suspension of Capitalisation 34-35
Cessation of Capitalisation 36-39
DISCLOSURE 40
Appendices :
Appendix A : Illustration 1
Appendix 1 : Comparison with IPSAS 5, Borrowing Costs
Compendium of ASLBs

Accounting Standard for Local Bodies (ASLB) 5

Borrowing Costs
(This Accounting Standard includes paragraphs set in bold italic type and plain
type, which have equal authority. Paragraphs in bold italic type indicate the main
principles. This Accounting Standard should be read in the context of its objective
and the Preface to the Accounting Standards for Local Bodies1)

The Accounting Standard for Local Bodies (ASLB) 5, ‘Borrowing Costs’, issued
by the Council of the Institute of Chartered Accountants of India, will be
recommendatory in nature in the initial years for use by the local bodies. This
Standard will be mandatory for local bodies in a State from the date specified in
this regard by the State Government concerned2.

The following is the text of the Accounting Standard for Local Bodies.

Objective
This Standard prescribes the accounting treatment for borrowing costs.

Scope
1. This Standard should be applied in accounting for borrowing costs.

2. This Standard applies to the entities described as Local Bodies in the
Preface to the Accounting Standards for Local Bodies3.

3. [Refer to Appendix 1]

1
Attention is specifically drawn to paragraph 4.2 of the ‘Preface to the Accounting
Standards for Local Bodies’,according to which Accounting Standards are intended to
apply only to items which are material.
2
Reference may be made to the paragraph 7.1 of the ‘Preface to the Accounting Standards
for Local Bodies’ providing the discussion on the compliance with the Accounting
Standards for Local Bodies.
3
Refer paragraph 1.3 of the ‘Preface to the Accounting Standards for Local Bodies’.
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Borrowing Costs

4. This Standard does not deal with the actual or imputed cost of net assets/
equity. Where a capital charge is applied to individual entities, judgement will
need to be exercised whether the charge meets the definition of borrowing
costs or whether it should be treated as an actual or imputed cost of net assets/
equity. Charges will be treated as borrowing costs only if it meets the definition
of borrowing costs.

Definitions
5. The following terms are used in this Standard with the meanings
specified:

Borrowing costs are interest and other costs incurred by an entity in
connection with the borrowing of funds.

Control is the power to govern the financial and operating policies of
another entity so as to benefit from its activities.

Controlled entity is an entity that is under the control of another entity
(known as the controlling entity).

Controlling entity is an entity that has one or more controlled entities.

Economic entity means a group of entities comprising a controlling entity
and one or more controlled entities.

Net assets/equity is the residual interest in the assets of the entity after
deducting all its liabilities.

Qualifying asset is an asset that necessarily takes a substantial period of
time to get ready for its intended use or sale.

Borrowing Costs

6. Borrowing costs may include:

(a) interest and commitment charges on bank borrowings and other
short-term and long-term borrowings;
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Compendium of ASLBs

(b) amortisation of discounts or premiums relating to borrowings;

(d) finance charges in respect of assets acquired under finance leases
or under similar arrangements; and

(e) exchange differences arising from foreign currency borrowings to
the extent that they are regarded as an adjustment to interest
costs. Exchange differences arising from foreign currency
borrowings and considered as borrowing costs are those exchange
differences which arise on the amount of principal of the foreign
currency borrowings to the extent of the difference between interest
on local currency borrowings and interest on foreign currency
borrowings. Thus, the amount of exchange difference not exceeding
the difference between interest on local currency borrowings and
interest on foreign currency borrowings is considered as borrowing
costs to be accounted for under this Standard and the remaining
exchange difference, if any, will be accounted for under Accounting
Standard for Local Bodies (ASLB) on ‘The Effects of Changes in
Foreign Exchange Rates’ 4. For this purpose, the interest rate for
the local currency borrowings is considered as that rate at which
the entity would have raised the borrowings locally had the entity
not decided to raise the foreign currency borrowings. Guidance on
accounting for the effects of changes in foreign exchange rates
can be found in Accounting Standard (AS) 11, ‘The Effects of
Changes in Foreign Exchange Rates’, until the ASLB on this subject
is formulated.

The application of this explanation is illustrated in the Appendix A.

Economic Entity

7. The term “economic entity” is used in this Standard to define, for financial
reporting purposes, a group of entities comprising the controlling entity and any
controlled entities.
4
The Accounting Standard for Local Bodies is under preparation.
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Borrowing Costs

8. Other terms sometimes used to refer to an economic entity include
“administrative entity”, “financial entity”, “consolidated entity” and “group”.

9. An economic entity may include entities with both social policy and
commercial objectives. For example, a local body XYZ (controlling entity) may
control by way of majority voting power in an entity ABC (controlled entity) that
provides services of health care for a nominal charge, as well as another entity
PQR (controlled entity) that provides transport services on a commercial basis.
The group of entities comprising local body XYZ and the controlled entities, viz.,
ABC and PQR, is the economic entity.

10-11. [Refer to Appendix 1]

Net Assets/Equity

12. “Net assets/equity” is the term used in this Standard to refer to the residual
measure in the balance sheet (assets less liabilities). Net assets/equity may be
positive or negative. Other terms may be used in place of net assets/equity,
provided that their meaning is clear.

Qualifying Assets

12A. What constitutes a substantial period of time primarily depends on the
facts and circumstances of each case. However, ordinarily, a period of twelve
months is considered as substantial period of time unless a shorter or longer
period can be justified on the basis of facts and circumstances of the case. In
estimating the period, time which an asset takes, technologically and
commercially, to get ready for its intended use or sale should be considered.

13. Examples of qualifying assets are office buildings, hospitals, infrastructure
assets such as roads, bridges and power generation facilities, and inventories
that require a substantial period of time to bring them to a condition ready for
use or sale, and investment properties. Other investments and those inventories
that are routinely produced over a short period of time, are not qualifying assets.
Assets that are ready for their intended use or sale when acquired also are not
qualifying assets.

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Compendium of ASLBs

Recognition
14-16. [Refer to Appendix 1]

17. Borrowing costs should be recognised as an expense in the period in
which they are incurred, except to the extent that they are capitalised in
accordance with paragraph 13.

18. Borrowing costs that are specifically incurred for the acquisition,
construction or production of a qualifying asset should be capitalised as
part of the cost of that asset. The amount of borrowing costs eligible for
capitalisation should be determined in accordance with this Standard.

19. 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 or service
potential to the entity and the costs can be measured reliably. Other borrowing
costs are recognised as an expense in the period in which they are incurred.

20. [Refer to Appendix 1]

20A. When an entity borrows funds generally and uses them for the purposes
of obtaining a qualifying asset, the entity recognises an expense for the borrowing
costs in respect of such funds in the period in which they are incurred.

Borrowing Costs Eligible for Capitalisation

21. When an entity borrows funds specifically for the purpose of obtaining a
particular qualifying asset, the borrowing costs that directly relate to that qualifying
asset can be readily identified. Funds sourced from general borrowings of the
entity are not specifically incurred and costs related to such borrowings are not
eligible for capitalisation.

22. Funds that have been borrowed centrally may be transferred to other
entities within the economic entity as a loan, a grant or a capital injection. Some
loans may be interest-free or require that only a portion of the actual interest
cost be recovered and grants or capital injections do not normally incur interest.
Borrowing costs in respect of such borrowings do not qualify for capitalisation.

80
Borrowing Costs

23. To the extent that an entity borrows funds specifically for the purpose
of acquiring, constructing or producing a qualifying asset, the entity should
determine the amount of borrowing costs eligible for capitalisation as the
actual borrowing costs incurred on that borrowing during the period less
any income on the temporary investment of those borrowings.

24. The financing arrangements for a qualifying asset may result in an entity
obtaining borrowed funds and incurring associated borrowing costs before some
or all of the funds are used for expenditures on the qualifying asset. In such
circumstances, the funds are often temporarily invested pending their
expenditures on the qualifying asset. In determining the amount of borrowing
costs eligible for capitalisation during a period, any income earned on temporary
investment of such funds is deducted from the borrowing costs incurred.

25. [Refer to Appendix 1]

26. If a controlling entity borrows funds which are then loaned to a controlled
entity, the controlled entity may captalise only those borrowing costs which it
itself incurs specifically in relation to the acquisition, construction or production
of a qualifying asset. Such costs will normally be documented in loan agreement
with the controlling entity. Where a controlled entity receives an interest-free
capital contribution or capital grant, it will not incur any borrowing costs and
consequently will not capitalise any such costs.

27. When a controlling entity transfers funds at partial cost to a controlled
entity, the controlled entity may capitalise that portion of borrowing costs which
it itself has incurred specifically for the acquisition, construction or production of
a qualifying asset. These borrowing costs are not necessarily identical to the
borrowing costs incurred by the controlling entity. In the financial statements of
the economic entity, the full amount of borrowing costs specifically incurred for
the acquisition, construction or production of a qualifying asset can be capitalised
as part of the cost of that qualifying asset, provided that appropriate consolidation
adjustments have been made to eliminate those costs capitalised by the controlled
entity.

28. When a controlling entity has transferred funds at no cost to a controlled
entity, neither the controlling entity nor the controlled entity would meet the
criteria for capitalisation of borrowing costs in their separate financial statements.
However, if the economic entity met the criteria for capitalisation of borrowing
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Compendium of ASLBs

costs, it would be able to capitalise the borrowing costs to the qualifying asset in
its financial statements.

29. [Refer to Appendix 1]

29A. When a controlling entity borrows funds generally, and lends part of those
funds to a controlled entity specifically for the acquisition, construction or
production of a qualifying asset, the borrowing costs of the controlling entity are
not eligible for capitalisation either by that controlling entity in its separate financial
statements or by the economic entity in its consolidated financial statements.
The borrowing costs of the controlled entity may, however, be eligible for
capitalisation in the controlled entity’s separate financial statements. If the
controlling entity borrows funds specifically for the acquisition, construction or
production of a qualifying asset by a controlled entity, those borrowing costs, if
transferred to the controlled entity, are capitalised in the separate financial
statements of the controlled entity and in the consolidated financial statements
of the economic entity.

Excess of the Carrying Amount of the Qualifying Asset over
Recoverable Amount

30. When the carrying amount or the expected ultimate cost of the qualifying
asset exceeds its recoverable amount or net realisable value, the carrying amount
is written down or written off in accordance with the requirements of other
Accounting Standards for Local Bodies. In certain circumstances, the amount of
the write-down or write-off is written back in accordance with those Accounting
Standards.

Commencement of Capitalisation

31. The capitalisation of borrowing costs as part of the cost of a qualifying
asset should commence when all the following conditions are satisfied:

(a) expenditure for the acquisition, construction or production of
qualifying asset is being incurred;

(b) borrowing costs are being incurred specifically for the
acquisition , construction or production of a qualifying asset;
and
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Borrowing Costs

32. Expenditures on a qualifying asset include only such expenditures that
have resulted in payments of cash, transfers of other assets or the assumption
of interest bearing liabilities. The expenditure is reduced by any progress
payments received and grants received in connection with the asset.

33. The activities necessary to prepare the asset for its intended use or sale
encompass more than the physical construction of the asset. They include
technical and administrative work prior to the commencement of physical
construction, such as the activities associated with obtaining permits prior to the
commencement of the physical construction. However, such activities exclude
the holding of an asset when no production or development that changes the
asset’s condition is taking place. For example, borrowing costs incurred while
land is under development are capitalised during the period in which activities
related to the development are being undertaken. However, borrowing costs
incurred while land acquired for building purposes is held without any associated
development activity do not qualify for capitalisation.

Suspension of Capitalisation

34. Capitalisation of borrowing costs should be suspended during
extended periods in which active development is interrupted. Such
borrowing costs are expensed.

35. Borrowing costs may be incurred during an extended period in which the
activities necessary to prepare an asset for its intended use or sale are
interrupted. Such costs are costs of holding partially completed assets and do
not qualify for capitalisation. However, capitalisation of borrowing costs is not
normally suspended during a period when substantial technical and administrative
work is being carried out. Capitalisation of borrowing costs is also not suspended
when a temporary delay is a necessary part of the process of getting an asset
ready for its intended use or sale. For example, capitalisation continues during
the extended period needed for inventories to mature or the extended period
during which high water levels delay construction of a bridge, if such high water
levels are common during the construction period in the geographic region
involved.

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Compendium of ASLBs

Cessation of Capitalisation

36. Capitalisation of borrowing costs should cease when substantially all
the activities necessary to prepare the qualifying asset for its intended use
or sale are complete.

37. An asset is normally ready for its intended use or sale when the physical
construction of the asset is complete even though routine administrative work
might still continue. If minor modifications, such as the decoration of a property
to the purchaser’s or user’s specification, are all that is outstanding, this indicates
that substantially all the activities are complete.

38. When the construction of a qualifying asset is completed in parts and
a completed part is capable of being used while construction continues
for the other parts, capitalisation of borrowing costs in relation to a part
should cease when substantially all the activities necessary to prepare
that part for its intended use or sale are completed.

39. Example of a qualifying asset for which each part is capable of being used
while construction continues for the other parts is an office development
comprising several buildings, each of which can be used individually. Examples
of qualifying assets that need to be completed before any part can be used
include an operating room in a hospital when all construction must be complete
before the room may be used; a sewage treatment plant where several processes
are carried out in sequence at different parts of the plant; and a bridge forming
part of a highway. In such cases, capitalisation of borrowing costs should be
continued.

Disclosure
40. The financial statements should disclose:

(a) the accounting policy adopted for borrowing
costs incurred specifically for the acquisition, construction or
production of a qualifying asset; and

(b) the amount of borrowing costs capitalised during the period.

41-43. [Refer to Appendix 1]
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Borrowing Costs

Appendix A

Illustration 1

Note: This appendix is illustrative only and does not form part of the Accounting
Standard. Its purpose is to assist in clarifying the meaning of the paragraph 6
(e) of the standard.

Facts:

Local Body XYZ has taken a loan of USD 10,000 on April 1, 20X3, for a specific
project at an interest rate of 5% p.a., payable annually. On April 1, 20X3, the
exchange rate between the currencies was Rs. 45 per USD. The exchange rate,
as at March 31, 20X4, is Rs. 48 per USD. The corresponding amount could
have been borrowed by Local Body XYZ in local currency at an interest rate of
11 per cent per annum as on April 1, 20X3.

The following computation would be made to determine the amount of borrowing
costs for the purposes of paragraph 6(e) of this Accounting Standard for Local
Bodies:

(i) Interest for the period = USD 10,000 x 5% x Rs. 48/USD =
Rs. 24,000

(ii) Increase in the liability towards the principal amount = USD10,000
x (48-45) = Rs. 30,000

(iii) Interest that would have resulted if the loan was taken in Indian
currency = USD 10,000 x 45 x 11% = Rs. 49,500

(iv) Difference between interest on local currency borrowing and foreign
currency borrowing = Rs. 49,500 – Rs. 24,000 = Rs. 25,500

Therefore, out of Rs. 30,000 increase in the liability towards principal amount,
only Rs. 25,500 will be considered as the borrowing cost. Thus, total borrowing
cost would be Rs. 49,500 being the aggregate of interest of Rs. 24,000 on
foreign currency borrowings (covered by paragraph 6(a) of this Accounting
Standard for Local Bodies) plus the exchange difference to the extent of difference
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Compendium of ASLBs

between interest on local currency borrowing and interest on foreign currency
borrowing of Rs. 25,500. Thus, Rs. 49,500 would be considered as the borrowing
cost to be accounted for as per this Accounting Standard for Local Bodies and
the remaining Rs. 4,500 would be considered as the exchange difference to be
accounted for as per Accounting Standard for Local Bodies (ASLB) on ‘The
Effects of Changes in Foreign Exchange Rates’ 5. Guidance on accounting for
the effects of changes in foreign exchange rates can be found in Accounting
Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’, until
the ASLB on this subject is formulated.

In the above example, if the interest rate on local currency borrowings is assumed
to be 13% instead of 11%, the entire exchange difference of Rs. 30,000 would
be considered as borrowing costs, since in that case the difference between the
interest on local currency borrowings and foreign currency borrowings (i.e., Rs.
34,500 (Rs. 58,500 – Rs. 24,000)) is more than the exchange difference of Rs.
30,000. Therefore, in such a case, the total borrowing cost would be Rs. 54,000
(Rs. 24,000 + Rs. 30,000) which would be accounted for under this Accounting
Standard for Local Bodies and there would be no exchange difference to be
accounted for under proposed ASLB on ‘The Effects of Changes in Foreign
Exchange Rates’.

5
The Accounting Standard for Local Bodies is under preparation.
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Borrowing Costs

Appendix 1

Note:This Appendix is not a part of the Accounting Standard for Local Bodies.
The purpose of this appendix is only to bring out the major differences between
this Accounting Standard for Local Bodies (ASLB) and the corresponding
International Public Sector Accounting Standard (IPSAS) 5, Borrowing Costs
issued by International Public Sector Accounting Standards Board.

Comparison with IPSAS 5, Borrowing Costs

1. Capitalisation of Borrowing Costs

IPSAS 5 prescribes the expensing of the borrowing costs as ‘benchmark
treatment’. However, in relation to the borrowing costs directly attributable, (both
specifically and generally incurred), to the acquisition, construction or production
of a qualifying asset, it provides an option of capitalising such borrowing costs
in the cost of that asset. Recently, International Public Sector Accounting
Standards Board (IPSASB) has issued ED 35 that proposes amendments to
IPSAS 5 which inter alia include that the borrowing costs related to general
borrowings are not eligible for capitalisation.

As compared to above, ASLB 5 does not prescribe expensing of borrowing
costs as in IPSAS 5. It requires capitalisation of borrowing costs. However,
keeping in view the initial stage of introduction of accrual accounting in Local
Bodies, the ASLB 5, ‘Borrowing Costs’, incorporates the amendments proposed
in the ED 35 requiring that only those borrowing costs that are specifically
incurred for the acquisition, construction or production of a qualifying asset
should be capitalised as part of the cost of that asset. Thus, ASLB 5 does not
require capitalisation of borrowing costs arising from general borrowings as
presently required in IPSAS 5. In this regard, paragraph 20A has been incorporate
to provide guidance.

2. Substantial Period of Time
IPSAS 5 does not provide the meaning of the expression ‘substantial period of
time’. It provides only examples of the qualifying Asset requiring the substantial
period of time. ASLB 5 provides the interpretation of the expression ‘substantial
period of time’. In this regard, paragraph 12A has been incorporate in the ASLB
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Compendium of ASLBs

5. It provides that ordinarily, a period of twelve months is considered as substantial
period of time unless a shorter or longer period can be justified on the basis of
facts and circumstances of the case.

3. Commitment Charges
ASLB 4 provides that the Borrowing Costs may include commitment charges on
bank borrowings. However, IPSAS 5 does not provide for including the
commitment charges on bank borrowings.

4. Paragraph Deleted
Following paragraphs have been deleted in ASLB 5. However, their numbers
have been retained in order to maintain consistency with the corresponding
IPSAS 5.
Paragraph 3 and 11 : Not relevant for Local Bodies as it pertain to Government
Business Enterprises (GBEs).
Paragraph 10 : Paragraph defining ‘Assets’ has been deleted in order to include
the same in ASLB 1 or Conceptual Framework for General Purpose Financial
Reporting by Local Bodies.

Paragraph 14-16 : Paragraph pertaining to expensing of borrowing as benchmark
treatment have been deleted.

Paragraph 20, 25 and 29 : Paragraphs pertaining to capitalisation of borrowing
costs in respect of general borrowings have been deleted.

Paragraph 41, 42 and 43 : Paragraphs pertaining to transitional provisions and
effective date have been deleted as the ASLBs would become mandatory for
Local Bodies in a State from the date specified by the State Government
concerned.