Impact of revision of Borrowing Costs per GRAP 5 (2014)

A revised version of GRAP 5 Borrowing Costs was approved and issued by the Accounting Standards Board, effective for annual financial statements covering periods beginning on or after 1 April 2014. In terms of this revised version, a new benchmark treatment is prescribed (GRAP 5.07) as to recognise borrowing costs as an expense in the period it’s incurred, regardless of how the borrowings are applied. Ducharme has issued an article on the impact of the changes to GRAP 5 and the practical implementation in the 2014/15 AFS accounting period.

In terms of this revised version, the burning question arises for borrowing costs (“interest”): Should borrowing costs be expensed or capitalised?

The answer can be found in GRAP 5. GRAP 5 provides guidance on the accounting treatment for borrowing costs. Before the accounting treatment is discussed, we first have to understand the definition of borrowing costs. Borrowing costs more simply defined is interest or any other expenses related to the borrowing of funds, which can be split between two types: (i) specific borrowings (i.e. specific loan or a specific facility) and (ii) general borrowings. Examples of borrowing costs include (GRAP 5.05):

• a) interest expense calculated using the effective interest method as described in the Standard of GRAP on Financial Instruments;
• b) finance charges in respect of finance leases and service concession arrangements; and
• c) exchange differences arising from foreign currency borrowings, to the extent that they are regarded as an adjustment to interest costs.

Accounting treatment for borrowing costs

GRAP 5 allows two different options for the treatment of borrowing costs:

Option 1 – Expense

Borrowing costs is recognised as an expense in the period it’s incurred, regardless of how the borrowings are applied. Revised GRAP 5 prescribes this method as the benchmark treatment (GRAP 5.07).

Option 2 – Capitalise to a qualifying asset

This method is more complex and involves capitalising borrowing costs directly attributable (see details below) to the acquisition, construction, or production of a qualifying asset (see details below) as part of the cost of that asset. This method is defined as the allowed alternative (GRAP 5.10).

What is a qualifying asset?

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale (GRAP 5.04). Qualifying asset examples (GRAP 5.06) include:

• • • office buildings;
    • hospitals;
    • infrastructure assets such as roads, bridges, power generation facilities;
    • intangible assets;
    • properties that will become self-constructed items of property, plant and equipment once their construction or development is complete;
    • investment properties measured at cost that are being redeveloped; and
    • inventories.

What is directly attributable?

Directly attributable borrowing costs are those borrowing costs that would have been avoided if the outlays on the qualifying asset had not been made. 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 (GRAP 5.14)

If option 2 (Capitalisation of borrowing cost) is selected, an entity has to be consistent in its application and as a result all borrowing costs that are directly attributable to the acquisition, construction, or production of all qualifying assets of the entity, should be capitalised.

Practical difficulties may arise, such as where borrowing costs are incurred for dual purposes, for example constructing a building and the maintenance of another completed building. If the borrowing costs cannot be divided and linked between the capital and maintenance expenditure, the entire amount is expensed.

Borrowing cost: Simplified example*

Entity A decides to enter into a contract to build a children’s hospital building at an amount of R10 million, financed through a loan from Bank A until the building is finished. Bank A charges a special interest rate (prime less 5%) for these types of developments. Entity A is to repay the outstanding bank loan upon transfer of the building. The Building is completed within 6 months and in the same financial year as when the construction begun.

1 Underlying transaction                                                   Debit                                     Credit

               Asset: Building                                             R 10,000,000

                            Liability (Bank loan)                                                                        R 10,000,000

Interest charge on loan, as borrowing costs, set out per these two options above. The interest for the period on the loan amounted to R400,000 for the period. Payment was made subsequent to construction. The net of the transactions during the period can be summarised as:

                     2 Interest on loan                                                                Debit                                     Credit

Option 1       2.1 Expense         Liability (Bank loan)

                                  Interest/ Borrowing cost                                  R 400,000

Liability (Bank loan)                                                                           R 400,000

Option 2         2.2 Capitalised

            Asset: Building                                                       R 400,000

                               Liability (Bank loan)                                                                           R 400,000

3 Payment                                                                                Debit                                     Credit

                Credit Liability (Bank loan)                          R 10,400,000

                                   Bank                                                                                               R 10,400,000

Note: In option 2, the capitalised borrowing cost are charged to the Statement of Performance over the useful life of the asset (i.e. through depreciation and / or impairments), whereas in option 2, the borrowing costs is charged immediately to the Statement of Performance.

* Example excludes commence date for capitalisation (GRAP 5.24) and where period of commencement and period of asset completion differs (GRAP5.29). It also assumed that the cost of the completed qualifying asset exceeds the recoverable amount / net realisable value (GRAP 5.23)).

Transitional provisions

As part of GRAP 5’s transitional provisions, GRAP5.35 states that the current amendments to GRAP 5 (allowed expense or capitalising of borrowing costs shall be applied prospectively) with the changes are applicable to be the effective for financial periods beginning on or after 1 April 2014 (GRAP5.39). In terms of this, borrowing costs incurred both before and after the effective date of the amendment in GRAP 5 and related to qualifying assets for which the commencement date for capitalisation is prior to the effective date of GRAP 5, shall be recognised in accordance with the entity’s previous accounting policies.

Should an entity choose to change its accounting policy on borrowing costs, for period subsequent to the initial adoption of these amendments in GRAP 5 (i.e. periods commencing on or after 1 April 2015), GRAP 3.20 needs to be considered. According to GRAP 3.20:

• a) an entity shall account for a change in accounting policy resulting from the initial application of a Standard or an Interpretation in accordance with the specific transitional provisions, if any, in that Standard or Interpretation; and
• b) when an entity changes an accounting policy upon initial application of a Standard or an Interpretation that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively.

As such, the requirement as per GRAP3.20(a) is guided by the transitional provisions in GRAP 5 which is only applicable for the first effective period for the amended GRAP 5. In consideration, GRAP3.20(b) will then be applicable and will require a retrospective application. Entities should be aware of the extent of qualifying assets as well as the various considerations on the commencement, suspension and cessation of capitalisation of borrowing costs applicable to the prior periods before a decision to change its accounting policy (subsequent to the transitional provisions period) is made.

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