capitalisation of borrowing costs - company · pdf filecapitalisation of borrowing costs: ......

Emerging Issues Capitalisation Of Borrowing Costs:

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Published on 4 September 2011. For more information, please email [email protected]

Introduction

This report focuses on companies that have capitalised borrowing costs and

assesses the extent to which they follow minimal requirements to disclose

the amount of borrowing costs capitalised and the capitalisation rate used.

Our sample consists of 14 European companies drawn from the S&P Europe

250 index that report under International Financial Reporting Standards.

Their reporting periods range from December 2009 to December 2010 and

all have been reviewed previously in a CR Monitor.

Summary

Our analysis of financial statements during 2010 has shown that companies

began to capitalise borrowing costs that they had previously expensed. This

was driven by revised IAS 23 “Borrowing costs” that required capitalisation of

borrowing costs directly attributable to the acquisition, construction or

production of a qualifying asset.

As the disclosure requirements of IAS 23 are entirely straightforward, we

believe it would have been reasonable to expect all companies to comply.

This expectation was not fulfilled. Whilst two out of our sample stated there

had been no significant impact, only six published what we considered to be

full disclosure.

Reporting framework

Previously, the benchmark treatment of IAS 23 was for borrowing costs to be

recognised as an expense in the period in which there were incurred. An

allowed alternative treatment was for capitalisation where they were

attributable to qualifying assets. Revisions were made to IAS 23 as part of

the convergence project conducted jointly by the International Accounting

Standards Board (IASB) and the US Financial Accounting Standards Board.

The IASB considered that application of only one treatment would enhance

comparability and, in a move that achieved convergence in principle with US

GAAP, decided to eliminate the previous benchmark treatment. For

accounting periods beginning on or after 1 January 2009, IAS 23 requires

that all borrowing costs directly attributable to the acquisition, construction or

production of a qualifying asset be capitalised as part of the cost of that

asset. Its disclosure requirements are minimal in that a company is required

only to disclose the amount of borrowing costs capitalised during the period

and the capitalisation rate used to determine the amount of borrowing costs

eligible for capitalisation.

CR Emerging Issues

summarise changes in

companies' reporting

practice and collate

changes identified

previously in our CR

Monitors. These reports

address the most

immediate issues facing

companies reporting under

IFRS, identify trends and

highlight areas of evolving

or divergent practices. The

sample of companies

covered reflects a mix of

country, auditor and

industrial classification. An

Extract focusing on each

company’s disclosure

accompanies the report.

This report examines the

extent to which companies

follow disclosure

requirements when

capitalising interest costs.

Our conclusion is that we

are puzzled as to why

some companies are

unable to comply with

what are minimal

disclosure requirements.






Companies under review

Early in the year, we noted that Danish biotechnology company Novozymes had adopted revised IAS 23 and

disclosed both the amount of interest capitalised and the rate used. Swiss pharmaceutical company Novartis

previously indicated that it did not expect revised IAS 23 to have a significant impact. It discloses $1 million costs have

been capitalised but does not specify a capitalisation rate. Finnish engineering company Wärtsilä states that there has

been no significant impact. Swedish paper manufacturer Holmen discloses amounts capitalised and that they have

been classified as work in progress and advance payments and the rate used. In contrast, whilst Swedbank states

that it has applied IAS 23, it omits any disclosure of amounts capitalised and the rate applied. French retailer Casino,

Guichard-Perrachon identifies that, although it continues to expense interest on projects that commenced before 1

January 2009, it has adopted revised IAS 23 prospectively. It discloses interest capitalised of €3 million and an

average rate of 7.43%. Although Austrian steel manufacturer voestalpine discloses that the costs capitalised during

the year are immaterial, it does disclose the average rate. Telecoms company BT and utility company Severn Trent,

both of the UK, follow IAS 23 in full by disclosing the amounts capitalised and the rates. In contrast, neither

broadcaster British Sky Broadcasting nor building materials supplier Wolseley make any disclosure. Meanwhile, UK

technology company Smiths indicates there has been no material impact while food producer Associated British

Foods discloses the amount capitalised but not the rate. Most recently, Danish Wind Turbine manufacturer Vestas

Wind Systems discloses that it has capitalised €1 million borrowing costs at a rate of 3.9%.

Conclusion

The requirement of IAS 23 that companies disclose the amount of borrowing costs capitalised during the period and

the capitalisation rate used is not onerous. Nevertheless, we are puzzled as to why not all companies covered by our

review have been able to follow this and it is not at all clear why they fail to make these minimal disclosures.






NOVOZYMES A/S

Period End: 31 December 2009 Industry classification (ICB): 4573 Biotechnology

Line of business: Production of enzymes for industrial applications

Listing status: S&P Europe 350

Auditors: PricewaterhouseCoopers, Bagsvaerd

Novozymes has also adopted revised IAS 23 which eliminates the option to expense borrowing costs eligible for

capitalisation. Its previous policy was to expense these costs. The company indicates that it commenced capitalisation

in 2009, costs capitalised during the year amount to DKK7 million (para 26(a)) and that the capitalisation rate used is

3.4%.






NOVARTIS AG

Period End: 31 December 2009 Industry classification (ICB): 4577 Pharmaceuticals

Line of business: Pharmaceuticals and consumer health


Auditors: PricewaterhouseCoopers, Basel

Novartis discloses that, from 1 January 2009, it has commenced capitalising borrowing costs associated with the

construction of property, plant and equipment, although such costs relating to projects commencing before that date

have been expensed. Prospective application follows revised IAS 23, though retrospective application is also

permitted.

Last year, the company stated that it did not expect adoption of revised IAS 23 to have a significant impact on its

financial statements. The company discloses that $1 million such costs are capitalised in the current year, but not the

capitalisation rate.






WÄRTSILÄ CORPORATION

Period End: 31 December 2009 Industry classification (ICB): 2757 Industrial Machinery

Line of business: Marine and energy power propulsion systems


Auditors: KPMG, Helsinki

Wärtsilä adopts revised IAS 23 and commences capitalising borrowing costs directly attributable to the acquisition,

construction or production, and completion of assets where this requires a considerable length of time. However, it

states that the change has no significant impact. We recently noted Novozymes and Novartis adopt revised IAS 23,

which is effective for periods beginning on or after 1 January 2009, with similar small scale effects in increased

capitalisation.

Basis of preparation

......






HOLMEN AB

Period End: 31 December 2009 Industry classification (ICB): 1737 Paper

Line of business: Production of paper, paperboard and timber


Auditors: KPMG, Stockholm

Holmen has adopted amended IAS 23 and commenced capitalisation prospectively from 1 January 2009. It discloses

in the note on property, plant and equipment that SEK1 million costs have been capitalised in the year, classified as

work in progress and advance payments to suppliers and that an interest rate of 3% has been used to determine the

amount.

Note 11 Property, plant and equipment

……






SWEDBANK AB

Period End: 31 December 2009 Industry classification (ICB): 8355 Banks

Line of business: Bank


Auditors: Deloitte, Stockholm

Swedbank states that the European Union approved in 2009 revised IAS 23, applicable from 1 January 2009 and it

has applied the Standard this year. This requires capitalisation of borrowing costs on qualifying assets. However,

there is no disclosure of the amount capitalised or of the capitalisation rate, falling short of the required disclosures.

CASINO, GUICHARD-PERRACHON SA

Period End: 31 December 2009 Industry classification (ICB): 5337 Food Retailers & Wholesalers

Line of business: Food and drug retailers


Auditors: Ernst & Young, Lyon and Didier Kling, Paris

Casino, Guichard-Perrachon (Casino) adopts revised IAS 23 prospectively from the start of the current year. The

company states that it now capitalises borrowing costs as part of the cost of an assets where they are directly

attributable to the acquisition, construction or production of a qualifying asset. However, it adds that interest

capitalised in the current year was only €3 million and that an average interest rate of 7.43% was applied. Casino

states that it continues to expense interest on projects with commencement dates prior to 1 January 2009. We have

recently seen Novozymes and Wärtsilä adopt revised IAS 23 from the start of 2009.






VOESTALPINE AG

Period End: 31 March 2010 Industry classification (ICB): 1757 Iron & Steel

Line of business: Production, working and distribution of steel products


Auditors: Grant Thornton, Vienna

voestalpine discloses that application of revised IAS 23 constitutes a change in its policy for borrowing costs directly

attributable to the acquisition, construction, or production of a qualifying asset. It states that these costs are now

capitalised whereas previously they were expensed and that 1 April 2009, the start of its current annual period, was

the commencement date for capitalisation. In contrast, we have seen some companies adopt revised IAS 23 and

designate a commencement date earlier than the beginning of their annual periods in which the adoption was made.

These include Diageo which applied revised IAS 23 in the annual period ending 30 June 2009 but designated July

2007 as the commencement date. voestalpine discloses that immaterial borrowing costs have been capitalised during

the year and that the average capitalisation rate is 4.4%.

9. Property, plant and equipment

……






BT GROUP PLC

Period End: 31 March 2010 Industry classification (ICB): 6535 Fixed Line Telecommunications

Line of business: Supply of telecommunication services and equipment

Listing status: S&P Europe 350, FTSE 100

Auditors: PricewaterhouseCoopers, London

Last year, BT expensed borrowing costs in the income statement as incurred. This year the company commences

capitalisation of borrowing costs relating to qualifying assets which take more than 12 months to complete, from 1

April 2009. This follows the adoption of revised IAS 23. The company discloses that it has capitalised £3 million

borrowing costs in the current year and that the assets concerned were property, plant and equipment under

construction and software development costs. It shows the amount as a deduction in its analysis of net finance

expense and discloses that the weighted average capitalisation rate on general borrowings was 7.9%.






SEVERN TRENT PLC

Period End: 31 March 2010 Industry classification (ICB): 7577 Water

Line of business: Supply of water, treatment and disposal of sewage


Auditors: Deloitte, London

Severn Trent has adopted revised IAS 23 and changes from expensing borrowing costs on qualifying assets to

capitalising such costs. It designates 1 April 2009 as the commencement date for capitalisation and discloses that

£2.6 million borrowing costs on its property, plant and equipment have been capitalised, using a 5.65% rate.






BRITISH SKY BROADCASTING GROUP PLC

Period End: 30 June 2010 Industry classification (ICB): 5553 Broadcasting & Entertainment

Line of business: Operation of pay television services


Auditors: Deloitte, London

Last year, British Sky Broadcasting expensed borrowing costs. This year, the company adopts revised IAS 23 and

explains that it capitalises borrowing costs directly attributable to the acquisition of qualifying assets. It explains that, to

the extent that the financing of a qualifying asset is part of its general borrowings, it calculates interest to be

capitalised based on its weighted average cost of borrowing, excluding any specific borrowings. However, no figures

are disclosed.

SMITHS GROUP PLC

Period End: 31 July 2010 Industry classification (ICB): 2727 Diversified Industrials

Line of business: Manufacture of security and medical equipment and seals



Smiths has adopted revised IAS 23 “Borrowing costs” in the year. Whilst it notes that this had not yet had a material

impact, the company discloses that development projects expected to take a substantial period of time and which

commenced on or after the start of the current year will include attributable borrowing costs. The company currently

has £87 million development costs on its balance sheet.

Accounting policies

Basis of preparation

......






WOLSELEY PLC

Period End: 31 July 2010 Industry classification (ICB): 2797 Industrial Suppliers

Line of business: Distribution of plumbing and other building materials



This year, Wolseley states that borrowing costs directly attributable to long-term construction or production of an asset

are capitalised. Last year, it stated that borrowing costs attributable to assets under construction were charged to the

income statement as incurred. This coincides with revision to IAS 23, though the company does not refer to this.






ASSOCIATED BRITISH FOODS PLC

Period End: 18 September 2010 Industry classification (ICB): 3577 Food Products

Line of business: Processing of food and retailing of textiles


Auditors: KPMG, London

Associated British Foods discloses that it has changed accounting policy prospectively to capitalise interest on

qualifying assets from the current year. This follows revision to IAS 23 which requires interest to be capitalised as part

of the cost where conditions are met. The company discloses in the note on property, plant and equipment that £1

million interest is capitalised, but not the interest rate applied. We recently noted Severn Trent in 2010 commence

capitalising interest from the current year, disclosing also the interest rate applied; whilst Diageo in 2009 designated a

2007 commencement date.






VESTAS WIND SYSTEMS A/S

Period End: 31 December 2010 Industry classification (ICB): 0583 Renewable Energy Equipment

Line of business: Development, manufacture and sale of wind power turbines


Auditors: PricewaterhouseCoopers, Copenhagen

The company discloses that it has capitalised €1 million borrowing costs relating to property, plant and equipment and

development projects at a rate of 3.9%. This follows IAS 23.

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