costs borrowing - national treasury

ACCOUNTING GUIDELINE

GRAP 5

Borrowing

Costs

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posting the amended terms on NT's Web site.

Note that this document is not part of the GRAP standard. The GRAP takes precedence while this guideline is used mainly to provide further

explanations on the concepts already in the GRAP.

GRAP 5 on Borrowing Costs

Issued February 2020 of 13

Contents

1. Introduction .................................................................................................................. 4

2. Scope .......................................................................................................................... 5

3. Identification ................................................................................................................. 5

4. Initial Recognition and Measurement ........................................................................... 6

4.1 Capitalising and expensing borrowing costs ....................................................... 6

4.2 Borrowing costs eligible for capitalisation ............................................................ 6

4.3 Specific borrowings ............................................................................................. 6

4.4 General borrowings............................................................................................. 8

4.5 Deferred settlement terms................................................................................... 9

4.6 When to capitalise borrowing costs ................................................................... 12

5. Subsequent Measurement ......................................................................................... 12

5.1 Cession of capitalisation of borrowing costs ...................................................... 12

5.2 Suspending capitalisation of borrowing costs .................................................... 13

6. Useful links and references ........................................................................................ 13



1. Introduction

This document provides guidance on the accounting treatment of borrowing costs.

The contents should be read in conjunction with GRAP 5.

For purposes of this guide, “entities” refer to the following bodies to which the standard of

GRAP relate to, unless specifically stated otherwise:

Public entities

Constitutional institutions

Municipalities and all other entities under their control

Trading entities and government components applying the standards of GRAP

Parliament and the provincial legislatures

TVET and CET colleges

Explanation of images used in manual:

Definition

Take note

Management process and decision making

Example



2. Scope

GRAP 5 is applicable to all entities preparing their financial statements on the accrual basis of

accounting to account for borrowing costs.

3. Identification

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

Examples include, interest on bank overdrafts, short- and long-term borrowings, as well as finance charges in respect of finance leases recognised under GRAP 13 on Leases.

A qualifying asset in accordance with GRAP 5 is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

Examples include property, plant and equipment that are manufactured or constructed, which can include buildings, infrastructure assets such as roads, bridges and power generation facilities, and inventories that takes a substantial period to complete.

The following are not qualifying assets:

Inventories produced in large quantities on a repetitive basis or inventories produced over a short period of time;

Investment property measured at fair value;

Biological assets;

Assets that is ready for their intended use or sale on acquisition date.

‘Substantial period’ is not defined in GRAP 5, therefore judgement needs to be exercised by management in order to determine if the period of acquisition, construction or production of a qualifying asset is substantial or not.



4. Initial Recognition and Measurement

4.1 Capitalising and expensing borrowing costs

Borrowing costs that are directly attributable to the acquisition, construction or production of a

qualifying asset should be capitalised to the cost of the asset. All other borrowing costs should

be recognised as an expense in the period in which it is incurred.

Situations may arise where it is difficult to link the borrowing requirement of an entity directly

to the nature of the expenditure to be funded. For example, an entity borrows funds for the

construction of an office building and to incur maintenance on the buildings currently owned.

In such a situation, the entity might be unable to distinguish whether the borrowings were

incurred for capital or current expenditure.

Any borrowing cost incurred under such circumstances should be recognised as an expense.

4.2 Borrowing costs eligible for capitalisation

As stated earlier, only borrowing costs incurred that are directly attributable to the acquisition,

construction of production of a qualifying asset can be capitalised to the cost of the asset.

GRAP 5 identifies two types of borrowings (i.e. specific and general) for which the amount of

borrowing costs to be capitalised will differ depending on the type of borrowings. These are

discussed in more detail below.

4.3 Specific borrowings

When an entity borrows funds specifically to obtain a qualifying asset, and therefore there is

a direct link between the asset and the borrowing costs that will be incurred, the amount to be

capitalised is the actual borrowing costs incurred during the period, less any investment

income on the temporary investment of those funds.

Example: Specific borrowings – expenditure incurred evenly

Entity Four-Five borrowed R1 million on 1 April 20X7 from DBSA to construct a machine (which meets the requirements of a qualifying asset). The reporting date is 31 March 20X8. An amount of R800,000 was spent evenly throughout the year. The interest rate on the loan is 20% per annum. The surplus funds are invested at an interest rate of 15% per annum. Interest is paid and received annually on 31 March.

Calculation of borrowing costs incurred:

Total borrowing costs incurred is R200, 000 (R1 million x 20%)



Calculation of interest earned on surplus funds:

Loan at 1 Apr 20X7 R1,000,000

Loan at 31 Mar 20X8 R200,000 (R1,000,000 – R800,000)

Average used during the year R600,000 [(R1,000,000 + R200,000) / 2]

Interest on surplus funds R90, 000 (R600, 000 x 15%)

Calculation of borrowing costs to be capitalised:

Borrowing cost to be capitalised R110,000 (R200,000 – R90,000)

Example: Specific facility – expenditure incurred evenly

If we take the same information as in Example 1 above, but assume that it was a specific facility instead of a specific loan that was received, the borrowing costs eligible for capitalisation would be as follows:

The expenses were incurred evenly throughout the year and therefore the average balance outstanding would be R400,000 (R800, 000 / 2). The borrowing costs incurred would then be R80,000 (R400,000 x 20%).

Example: Specific borrowings – expenditure incurred at specific points

Entity Four-Five borrowed R1 million on 1 April 20X7 from DBSA to construct a machine. The reporting date is 31 March 20X8.

An amount of R400,000 was spent immediately on the qualifying asset and another R250,000 was spent on the asset on 31 August 20X7. The interest rate on the loan is 20% per annum. The surplus funds are invested at an interest rate of 15% per annum. Interest is paid and received annually on 31 March.

Calculation of borrowing costs incurred:

Total borrowing costs incurred is R200,000 (R1 million x 20%)

Note the difference between a specific loan and a specific facility.

With a loan, the total proceeds are received on day 1 and any surplus funds are invested until needed (as shown in the example above).

With a facility (e.g. overdraft facility), cash is withdrawn as needed. As a result there are no surplus funds to invest and interest is paid only on those amounts withdrawn.



Calculation of interest earned on surplus funds:

Loan received R1,000,000

Expenditure incurred 1 Apr 20X7 (R400,000)

Balance at 1 April 20X7 R600,000

Interest on surplus funds at 31 Aug 20X7 R37,500 (R600,000 x 15% x 5/12)

Balance at 31 Aug 20X7 R600,000

Expenditure incurred 31 Aug 20X7 (R250,000)

Balance at 31 Mar 20X8 R350,000

Interest on surplus funds at 31 Mar 20X8 R30,625 (R350,000 x 15% x 7/12)

Total interest on surplus funds: R68,125 (R37,500 + R30,625)

Calculation of borrowing costs to be capitalised:

Borrowing costs to be capitalised R131,875 (R200,000 – R68,125)

4.4 General borrowings

To determine the borrowing costs eligible for capitalisation where general borrowings were

used to obtain a qualifying asset, a capitalisation rate should be applied to the expenditure on

that asset.

The capitalisation rate should be a weighted average rate applied to those general borrowings

of the entity that are outstanding during the period.

If the calculated borrowing costs exceed the actual borrowing costs incurred, the amount to

be capitalised should be limited to the actual amount of borrowing costs incurred during the

period.

Example: General borrowings

Entity Four-Five started with the construction of a qualifying asset that is expected to take two years to complete. The reporting date is 31 March 20X8. The following information relates to the asset under construction:

Expenditure incurred during the period:

31 May 20X7 200,000

31 January 20X8 300,000

500,000



Borrowings raised at 1 April 20X7:

Bank overdraft at 15% 1,500,000

Bank loan at 18% 1,200,000

2,700,000

Total interest for the period ended:

15% x 1,500,000 (whole year) 225,000

18% x 1,200,000 (whole year) 216,000

442,000

Weighted average rate is calculated as:

Total interest for the period / weighted average total loans

442,000 / 2,700,000 = 16.37%

Borrowing cost to be capitalised:

16.37% x 200,000 x (10/12) 27,283

16.37% x 300,000 x (2/12) 8,185

35,468

Note that the above calculation could also have been done based on the cumulative expenditure, and would have been as follows:

16.37% x 200,000 x (8/12) 21,827

16.37% x 500,000 x (2/12) 13,641

35,468

4.5 Deferred settlement terms

There may be situations where an entity is allowed to settle payment for an asset beyond

normal credit terms. In such a case, the relevant standard of GRAP (e.g. GRAP 16, 17, 31

and 103) requires that the difference between the cash price equivalent and the total payments

be recognised as interest over the period, unless it is capitalised in accordance with GRAP 5.

As indicated previously, borrowing costs can only be capitalised to the cost of a qualifying

asset. Therefore, for an asset acquired on deferred settlement terms, the finance cost to be

paid over the period of the deferred settlement can only be capitalised to the cost of the related

asset if the asset is a qualifying asset.



Example: Deferred settlement terms

An entity purchases a machine for R5 million, but a lot of work still has to be done to it before it can be used as intended by management. Management estimates that it will take at least 6 months for the machine to be fully operational (assume 6 months is a ‘substantial period of time’).

The machine will be accounted for in accordance with GRAP 17 as property, plant and equipment.

The supplier allows the entity to settle payment for the machine after 6 months, but charges interest on the outstanding amount at 15% per annum, payable at the end of the settlement period. The normal credit terms of the entity are 30 days.

The machine meets the definition of a qualifying asset as it will take a substantial period of time to get ready for its intended use. Furthermore, the machine falls within the scope of GRAP 5, as it is an item of property, plant and equipment.

Based on the above, and if we assume that all the other relevant recognition criteria as stipulated in GRAP 5 are met, the difference between the capital amount (purchase price) of R5,000,000 and the total payments (capital plus interest) of R5,386,916, will be capitalised to the cost of the machine over the period of 6 months. The total payments (including interest) were calculated as follows:

PV = R5,000,000

I = 15%/12

N = 6

Comp FV = R5,386,916. This can be calculated by using MS Excel or a financial calculator.

Therefore the borrowing costs to be capitalised over 6 months is R386,916 (R5,386,916 - R5,000,000).

The journal entries will be as follows:

Acquisition date Debit Credit

R R

Machine 5,000,000

Creditor 5,000,000

Recognise machine purchased on acquisition date

At the end of 6 months Debit Credit

R R

Machine 386,916

Creditor 386,916

Capitalise interest accrued to the cost of the machine



Note that the interest over the six months has been aggregated for the purposes of this example. The actual monthly calculation of the interest will be as follows:

Period Interest Total

Month 1 (R5,000,000 x 15% / 12) R 62,500 5,062,500

Month 2 (R5,062,500 x 15% / 12) R 63,281 5,125,781

Month 3 (R5,125,781 x 15% / 12) R 64,073 5,189,854

Month 4 (R5,189,853 x 15% / 12) R 64,873 5,254,727

Month 5 (R5,254,726 x 15% / 12) R 65,684 5,320,411

Month 6 (R5,320,410 x 15% / 12) R 66,505 5,386,916

Total interest is therefore R386,916


R R

Creditor 5,386,916

Bank 5,386,916

The creditor paid

Assume the same information as above, but:

On acquisition date the machine was ready for its intended use. Thus the entity could already start using the machine as intended and would also start depreciating the asset.

Consequently, the machine does not meet the definition of a qualifying asset as it is ready for its intended use on acquisition date.

Based on above, the interest of R386,916 should be recognised in surplus or deficit.

The journal entries will be as follows:

Acquisition date Debit Credit

R R

Machine 5,000,000

Creditor 5,000,000

Recognise machine purchased on acquisition date


R R

Finance cost 386,916

Creditor 386,916

Expense interest accrued to surplus or deficit



Note that the interest over the six months has again been aggregated for the purposes of this example.


R R

Creditor 5,386,916

Bank 5,386,916

The creditor paid

4.6 When to capitalise borrowing costs

Borrowing costs should be capitalised from the date when the entity:

Incurs expenditure on the qualifying asset;

Incurs borrowing costs; and

Commences activities that are necessary to get the asset ready for its intended use or

sale.

5. Subsequent Measurement

5.1 Cession of capitalisation of borrowing costs

Capitalisation of borrowing costs should cease when substantially all the activities necessary

to get the asset ready for use or sale are complete.

In situations where routine administrative work still continues or minor modifications are still

outstanding, capitalisation of borrowing costs should still cease as these are not considered

to be substantial activities necessary to get the asset ready for use or sale.

Where construction of a qualifying asset is done in parts, and each part can be used or sold

separately, capitalisation of borrowing costs should cease on the completed parts while being

continued on the other parts that are still being constructed. For example, if an entity

constructs a business park that consists of several different office blocks which can be sold or

occupied separately, the capitalisation of borrowing costs will cease on the completed office

blocks as soon as they are ready for occupation, whilst continuing on the other office blocks

that are still under construction.



5.2 Suspending capitalisation of borrowing costs

When active development of a qualifying asset is interrupted for extensive periods, the entity

should suspend the capitalisation of borrowing costs during such periods.

However, capitalisation continues during the extended period if, for example, strong winds or

heavy rains delay construction of a bridge, if strong winds or such heavy rains are common

during the construction period in the geographical region involved.

6. Useful links and references

Reference Location of reference

Frequently Asked Questions (FAQs)

on the Standards of GRAP

ASB website:

http://www.asb.co.za/frequently-asked-questions/

IGRAP 2 on Changes in Existing

Decommissioning, Restoration and

Similar Liabilities

ASB website:

http://www.asb.co.za/interpretations-approved-

and-effective/

Guideline on The Application of

Materiality to Financial Statements

ASB website:

http://www.asb.co.za/guidelines/

Standard Chart of Accounts for Local

Government (mSCOA)

National Treasury website:

http://mfma.treasury.gov.za

(mSCOA – Municipal Standard Chart of Accounts)

Illustrative Financial Statements for

local government

National Treasury website:

http://mfma.treasury.gov.za

(mSCOA – Municipal Standard Chart of Accounts)

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