In order to continue its operation, an entity needs funds. If the funds within the organization are short, then the entity has to take loan from outside parties usually from a bank or from a financial institution. Once the loan is taken out, the entity has to pay interest cost and other cost associated with obtaining the loan. This cost is called as Borrowing cost.
Borrowing cost formula
Borrowing cost = interest on bank overdrafts + interest on short term borrowings + interest on long term borrowings + finance charges on finance lease + exchange differences arising on foreign currency borrowings to the extent of extra interest payments
When Capitalization of Borrowing Cost?
The borrowing cost can only be capitalized when it is directly attributable to the acquisition and construction of a qualifying asset. If the cost is not directly attributable, then such cost should be recorded as an expense in theincome statement. By qualifying asset we mean the asset for which the entity has taken the loan and which takes substantial amount of time to get completed for the intented use. Under US GAAP, you are not allowed to capitalize the borrowing cost at any cost. Instead, it is charged as an expense in the period to which it relates.
Examples of Qualifying Assets
- Power generation facilities
- Manufacturing plants
- Investment properties
