Borrowing Cost [PDF]

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THEORIES 1. Borrowing cost include which of the following? I. Interest expense on borrowings calculated using the effective interest method II. Finance charge with respect to finance lease III. Exchange difference arising from foreign currency borrowing that is regarded as an adjustment to the interest cost a. I and II only b. I and III only c. II and III only d. I, II and III only 2. Which of the following statements is true concerning capitalization of borrowing cost? I. If the borrowing is directly attributable to a qualifying asset, the borrowing cost is required to be capitalized as cost of the asset II. If the borrowing is not directly attributable to a qualifying asset, the borrowing cost shall be expensed as incurred a. I only b. II only c. Both I and II d. Neither I nor II 3. For purpose of capitalization of borrowing cost, which of the following is not a qualifying asset? a. Manufacturing plant b. Power and generation facility c. Investment property d. Asset that is ready for the intended use or sale 4. If the qualifying asset is financed by specific borrowing, the capitalizable borrowing cost is equal to a. Actual borrowing cost incurred b. Actual borrowing cost incurred up to completion of asset c. Actual borrowing cost incurred up to completion of asset minus any investment income from the temporary investment of the borrowing d. Zero 5. If the qualifying asset is financed by the general borrowing, the capitalizable borrowing cost is equal to a. Actual borrowing cost incurred b. Total expenditures on the asset multiplied by a capitalization rate c. Average expenditures on the asset multiplied by a capitalization rate or actual borrowing cost incurred, whichever is lower



d. Average expenditures on the asset multiplied by a capitalization rate or actual borrowing cost, whichever is higher 6. The recoverable amount of an asset is defined as: I. The asset’s resale value II. Its value to the firm as it is stored away in the warehouse III. Its value to the firm for internal use a. I only c. II and III only b. I and III only d. I, II and III only 7. What is the correct treatment for all eligible borrowing costs under IAS 23? a. Expensed b. Capitalized (All eligible borrowing costs must be capitalized under IAS 23 – Borrowing Costs) c. Both a and b d. None of these 8. Which of the following is not a “qualifying asset” under IAS 23 – Borrowing Costs? a. Mass produced inventory ( Mass produced inventory is not a qualifying asset under IAS 23 – Borrowing Costs as it does not take a substantial amount of time to get ready for its intended use or sale) b. Manufacturing plants c. Made to order inventory d. Investment property 9. Which of the following is not considered a “borrowing cost” under IAS 23? a. Interest expense calculated by the effective interest method under IAS 39 b. Finance charges in respect of finance leases recognized in accordance with IAS 17 Leases c. Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs d. Principal repayments on a loan for property, plant and equipment (Principal repayments are not a borrowing cost, they are a part repayment of the original loan) 10. When activities to prepare an asset for its sale or use are suspended, borrowing costs must be a. Capitalized b. Expensed (When activities to produce an asset are suspended or interrupted, the capitalization of borrowing costs must be suspended for the period. Any borrowing costs incurred during this time must be expensed. Once the activities recommence, the capitalization of borrowing costs may recommence.) c. Ignored d. Charged to equity



11. Big Group is constructing an office building and is capitalizing borrowing costs in accordance with IAS 23 – Borrowing Costs. The office is almost complete; the only remaining work is to install furniture. Is Big Group allowed to continue capitalizing the borrowing costs? a. Yes b. No (No. Substantially all the activities necessary to prepare the asset for its intended use or sale are complete. If only minor modifications are outstanding, this indicates that substantially all of the activities are complete. Therefore, the borrowing costs should no longer be capitalized. 12. Which of the following is not a condition to commence capitalization of borrowing costs? a. Expenditures are being incurred b. Borrowing costs are being incurred c. Repayment of borrowings has commenced (The repayment of borrowings does not have to commence in order to capitalize borrowing costs) d. Activities to produce the asset for its intended use or sale have commenced 13. Which of the following may not be considered a “qualifying asset”? a. A power generation plant that normally takes two years to construct b. An expensive private jet that can be purchased from a local vendor c. A toll bridge that usually takes more than a year to build d. A ship that normally takes one to two years to complete 14. Which of the following costs may not be eligible for capitalization as borrowing cost? a. Interest on bonds issued to finance the construction of a qualifying asset b. Amortization of discount or premium relating to borrowing that qualify for capitalization c. Imputed cost of equity d. Exchange difference arising from foreign currency borrowing to the extent that it is regarded as an adjustment to interest cost pertaining to a qualifying asset 15. Capitalization of borrowing cost a. Shall be suspended only during temporary period of delay b. May be suspended only during extended period of delay in which active development id delayed c. Shall never be suspended once capitalization commences d. Shall be suspended only during extended period of delay in which active development id delayed 16. Which of the following is a disclosure requirement in relation to borrowing cost? I. Amount of borrowing cost capitalized during the period II. Segregation of assets that are “qualifying assets” from other assets in the statement of financial position or as a disclosure in the notes to financial statements



III. a. b. c. d.



Capitalization rate used to determine the amount of borrowing cost eligible for capitalization I, II and III I and II only I and III only I only



17. An asset is being constructed for an entity’s own use. The asset has been financed with a specific new borrowing. The interest cost incurred during the construction period as a result of expenditures for the asset is a. Interest expense in the construction period b. A prepaid asset to be written off over the estimated useful life of the asset c. A part of the historical cost of acquiring the asset to be allocated over the term of the borrowing used to finance the construction of the asset 18. When computing the amount of interest cost to be capitalized, the concept of “avoidable interest” refers to a. The total interest cost actually incurred b. A cost of capital c. That portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made d. That portion of average accumulated expenditures on which no interest cost was incurred 19. Which of the following assets could be treated as qualifying asset for purpose of capitalizing borrowing cost a. Investment property b. Investment in financial instrument c. Inventory that is manufactured or produced in large quantity on a repetitive basis and takes a substantial period of time to get ready for use or sale d. Biological asset 20. Which of the following statements about capitalization of borrowing cost as part of the cost of a qualifying asset is true? a. If funds come from general borrowings, the amount to be capitalized is based on the weighted average amount of expenditures b. Capitalization always continues until the asset is brought into use c. Capitalization always commences as soon as expenditure of the asset is incurred d. Capitalization always commences as soon as interest on relevant borrowings is being incurred 21. Which of the following is required for borrowing cost incurred that is directly attributable to the construction of a qualifying asset?



I. II. a. b. c. d.



Recognize as an expense in the period incurred Capitalize as part of the cost of the asset I only II only Either I or II Neither I nor II



22. An entity is commencing a new construction project which is to be financed by borrowing, the key dates for the current year are as follows: May 15 Loan interest relating to the projects starts to be incurred. June 15 Technical site planning commences June 30 Expenditures on the project start to be incurred July 15 Construction work commence a. May 15 b. June 15 c. June 30 d. July 15 23. I. Interest on Bank overdrafts, short term and long term borrowings are the only items included in borrowing costs. II. Renting out an upgraded office building that you have purchased is an example of an investment property. This is an example of an asset that does not qualify. a. False, False c. False, True b. True, False d. True, True 24. I. The basis for treating Borrowing costs should be mixture of cash basis II. Borrowings can only be capitalized when it is likely that they will generate future economic benefits a. False, False c. True, False b. False, True d. True, True 25. I. Other borrowing costs, those which cannot be capitalized, should be recognized as an expense and written off in the period of incurrence. II. The general pool of funds used to complement borrowings for a qualifying asset may relate just to the subsidiary. If this is the case, then use the weighted average cost relating just to the borrowings of the subsidiary. a. False, False c. True, False b. False, True d. True, True



PROBLEM SOLVING For questions 1, 2, and 3 refer to the following: Stone D. Limited borrowed a loan from bank at 12% per annum amounting to P 1, 000,000 for the construction of power generation facilities of the company. The loan was received on January 01 and utilized P 300,000 on Qualifying Asset. On January 1, the company deposited the remaining amount in a bank yielding interest at 6%. Whole of the amount is withdrawn and paid to contractor on March 01. The company returned the loan to bank after 9 months i.e. on October 01. 1. How much is the Interest Income? A. -7000 B. 7000 Solution:



C. D.



10500 -10500



700,000 x 6% x 2/12 7,000



2. How much is the Borrowing Cost eligible for capitalization? A. 90 000 C. 83 000 B. 79 500 D. 80 000 Solution:



Interest paid to bank (1,000,000 x 12% x 9/12) Less: Interest income( 700,000 x 6% x 2/12) Borrowing cost eligible for capitalization



90,000 (7,000) 83,000



3. What is the total Capital expenditure? A. 1 083 000 C. 90 000 B. 927 000 D.911 000 Solution:



Interest paid to bank 1,000,000 x 12% x 9/12 Less: Interest income 700,000 x 6% x 2/12 Borrowing cost eligible for capitalization Borrowed loan Capital expenditure (P 1,000,000 + 83,000)



90,000 (7,000) 83,000 1,000,000 1,083,000



For numbers 4 - 7, use the following: CAD Inc. started the construction of an asset on 1 January 201X with a loan of $40,000 borrowed at an interest rate of 9% per annum. The loan was used on the asset as follows: 1 January 201X



15,000



1 May 201X



20,000



1 October 201X



5,000



The construction of the asset was completed on 31 December 201X. However, during the accounting period CAD Inc. has invested the surplus funds at an interest rate of 3% on temporary basis before these were required for spending. 4. How much is the total Income from temporary investment of funds? A. 250.6 C. 500 B. 312.50 D. 562.50 Solution:



(25,000 * 3%) * 4/12 + (5,000 * 3%) * 5/12 = $312.5



5. What is the Actual Borrowing cost? A. 2325 B. 312.50 Solution:



C. D.



3600 1500



$40,000 * 9% = 3600



6. How much is the Eligible Borrowing Cots? A. 1200 C. 312.50 B. 3600 D. 3287.50 Solution:



($40,000 * 9%) – $312.5 = $3,287.5



7. How much is the Cost of Asset at December 31, 201X? A. 43287.50 C. 40312.50 B. 43600 D. 42325 Solution:



($15,000+$20,000+$5,000) + $3,287.5 = $43,287.5



Use the following for questions 8-11 Manok N. Pla. started the construction of an asset on 1 January 2019. For this purpose three loans were outstanding at the start of the year as follows:



Amount, $’000



Interest Rate, %



Loan 1



80,000



11



Loan 2



70,000



15



Loan 3



40,000



17



The funds were used on the asset as follows: $’000 1 January 2019



25,000



1 May 2019



20,000



1 October 2019



15,000



The construction of the asset was completed on 31 December 2019. 8. What is the Average amount invested into the Asset? A. 55486 C. 42083 B. 20000 D. 57360 Solution:



$25,000 + $13,333 + 3750 = $42,083



9. What is the Weighted Average Cost Rate? A. 13.13% C. 14% B. 13.57% D. 13.74% Solution: ($80,000 / $190,000) * 11% + ($70,000 / $190,000) * 15% + ($40,000 / $190,000) * 17% = 13.74% 10. How much is the Eligible Borrowing cost? A. 5663 C. 5750 B. 5009 D. 5782 Solution:



$42,083 * 13.74% = $5,782



11. How much is the Cost of Asset by December 31, 2019? A. 60749 C. 64556 B. 65782 D. 63994.50 Solution:



(25,000+$20,000+$15,000) + 5,782 = $65,782



For problems 12-16: MIMI - YUH raised a $20 million loan having interest rate of 7.5% on 1 January 2020.The loan was specifically raised for the construction of an office building which meets the definition of a qualifying asset under IAS 23. The construction of the office building started on 1 February 2020 and the construction was completed on 30 November 2020. However, the construction of the office building was suspended for two months period because of the shortage of material and labor strikes during July and August 2020. The loan was temporarily invested for the month of January 2020 and earned interest of $80,000. 12. How much is the Borrowing cost to be charged to profit or loss? A. 505000 C. 500000 B. 1500000 D. 450000 Solution:



$1,500,000 x 4/12 = $500,000



13. What is the Actual borrowing cost? A. 1125000 C. B. 1000000 D. Solution:



875000 1500000



$1,500,000 x 8/12 = $1,000,000



14. What is the Income from temporary investments? A. 0 C. 1500000 B. 500000 D. 1000000 Solution:



0



15. How much is the borrowing cost to be capitalized? A. 1080000 C. 1000000 B. 920000 D. 80000 Solution:



($1,500,000 x 8/12) – 0 = $1,000,000



16. What is the cost of asset in the Statement of Financial Position? A. 2000000 C. 1000000 B. 3000000 D. 1420000 Solution:



$2,000,000 + $1,000,000 = $3,000,000



For problems 17 Mamamoo Company has the following loans outstanding as at December 31, 2005. Loan 1 Loan 2 Loan 3



6% (Due since opening date) 8% (Taken on 1 April, 2005) 9% (Taken on 1 July, 2005)



300,000 200,000 150,000



The company spent following amounts on construction of an asset. January 31, 2005 April 1, 2005 December 1, 2005



70,000 80,000 10,000



17. How much is the Total Interest? A. 18750 C. B. 6750 D. Solution:



18,000 + 12,000 + 6,750 = 36,750



18. What is the Weighted Average Loan? A. 375000 C. B. 525,000 D. Solution:



36750 24750



452000 550000



300,000 + 150,000 + 75,000 = 525,000



19. What is the Capitalization Rate? A. 8% C. 11% B. 4% D. 7% Solution:



36,750/525,000 * 100 = 7%



20. How much is Borrowing Cost chargeable as expense? A. 28000 C. 29000 B. 26500 D. 27250 Solution:



Total borrowing cost Borrowing cost eligible for capitalization Borrowing cost chargeable as expense



21. Total Capital Expenditure? A. 168500 B. 160000 Solution:



C. D.



36,750 (8,750) 28,000



166250 168750



Incurred cost Borrowing cost eligible for capitalization Total



160,000 8,750 168,750



For problems 22-25 use the following: BIB Infrastructures, Inc. (BIBI) is a company set up to build, own and operate all key public infrastructure projects in BIB. On 1 January 2019, it contracted Mahandra Inc. (MI) to build a bridge over Indus at a total cost of $8,000,000. Following is the schedule of payments made by BIBI to MI over the year: Payment Date 01-Jan-19 01-May-19 01-Sep-19 01-Dec-19



Expenditure 3,000,000 1,000,000 2,000,000 2,000,000



Half of the project cost is financed by a specific loan carrying annual interest rate of 8% and the rest is financed out of two general loans: a loan from MCB of $10,000,000 carrying 10% annual interest rate and another loan from UBL of $5,000,000 carrying 11% annual interest rate. MI ceases work on the project in the monsoon season i.e. July and August. 22. What is the weighted average expenditures? A. 4300000 C. 3833333 B. 4333333 D. 4500000 Solution:



01-Jan-19 01-May-19 01-Sep-19 01-Dec-19



3,000,000 1,000,000 2,000,000 2,000,000



12 months 8 months 4 months 1 month



1.00 0.67 0.33 0.08



3,000,000 666,667 666,667 166,667 4,500,000



23. How much is the total interest? A. 1550000 B. 1500000 Solution:



C. D.



1000000 1525000



MCB



10,000,000



10%



1,000,000



UBL



5,000,000



11%



550,000



15,000,000



1,550,000



24. What is the Weighted Average Interest Rate? A. 9.45% C. 10.33% B. 11.67% D. 7.77% Solution:



$1,550,000 = 10.33% $15,000,0000



25. How much is the Capitalized Interest? A. 371000 C. B. 371667 D. Solution:



351667 320000



Specific Loan



4,000,000



8%



320,000



General pool



500,000



10.33%



51,667 371,667