Moses Company Borrowing Costs Analysis Problem 25-5 IAA

This article delves into the intricacies of accounting for borrowing costs, specifically focusing on Problem 25-5 involving Moses Company. The scenario presented involves Moses Company securing a P4,000,000 loan at a 10% interest rate to finance the construction of a new warehouse for its own use. In addition to this, the company also has an existing P6,000,000 mortgage payable with a 12% interest rate on its office building. Understanding how to properly account for these borrowing costs is crucial for accurate financial reporting and decision-making.

Capitalization of Borrowing Costs: An In-Depth Look

The core concept at play here is the capitalization of borrowing costs. According to accounting standards, specifically IAS 23 (Borrowing Costs), an entity is required to capitalize borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset. A qualifying asset is defined as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. In Moses Company's case, the new warehouse under construction clearly fits this definition, making it a qualifying asset. Capitalizing borrowing costs means adding these costs to the cost of the asset, which will then be depreciated over the asset's useful life. This approach aligns the borrowing costs with the period in which the asset generates revenue.

However, not all borrowing costs can be capitalized. Only those costs that are directly attributable to the qualifying asset are eligible for capitalization. This principle requires careful consideration of the specific circumstances surrounding the borrowing. In Moses Company's situation, we have two sources of borrowing: the specific loan for the warehouse and the existing mortgage on the office building. Determining the capitalizable borrowing costs involves several steps, including identifying the qualifying asset, determining the capitalization period, calculating the capitalizable interest, and dealing with excess borrowing.

Identifying the Qualifying Asset and Capitalization Period

The first step is straightforward: the qualifying asset is the new warehouse being constructed. The capitalization period begins when the company incurs expenditures for the asset, incurs borrowing costs, and undertakes activities necessary to prepare the asset for its intended use or sale. The capitalization period continues until substantially all the activities necessary to prepare the asset for its intended use or sale are complete. This means that the capitalization period starts from the date of the loan and ends when the warehouse is ready for use.

Calculating Capitalizable Interest: Specific and General Borrowings

The next crucial step involves calculating the amount of borrowing costs that can be capitalized. IAS 23 distinguishes between two types of borrowings: specific borrowings and general borrowings. Specific borrowings are those obtained specifically for the purpose of acquiring a qualifying asset, while general borrowings are funds borrowed for general purposes and used for various activities, including the construction of a qualifying asset. Moses Company's P4,000,000 loan for the warehouse falls under the category of specific borrowing. The interest expense incurred on this loan is directly attributable to the warehouse construction and is therefore eligible for capitalization.

However, the treatment of the existing mortgage on the office building, which is a general borrowing, requires a different approach. To determine the capitalizable portion of the general borrowing, we need to apply a capitalization rate to the expenditures on the qualifying asset. The capitalization rate is the weighted average of the borrowing costs applicable to the general borrowings of the entity during the period. This calculation ensures that only a reasonable portion of the general borrowing costs is capitalized to the qualifying asset.

Excess Borrowings and the Capitalization Ceiling

Another important aspect to consider is the concept of excess borrowings. If the funds borrowed specifically for the qualifying asset exceed the expenditures on the asset, the interest income earned from the temporary investment of these excess funds should be deducted from the capitalizable borrowing costs. This ensures that the company is not capitalizing interest costs that are offset by investment income. Additionally, the amount of borrowing costs capitalized during a period cannot exceed the total borrowing costs incurred during that period. This serves as a capitalization ceiling, preventing the overstatement of asset costs.

Disclosure Requirements

In addition to the calculation and capitalization of borrowing costs, accounting standards also require specific disclosures in the financial statements. These disclosures provide transparency and allow users of the financial statements to understand the impact of borrowing costs on the company's financial position and performance. The disclosures typically include the amount of borrowing costs capitalized during the period, the capitalization rate used for general borrowings, and the nature of the qualifying assets.

Applying the Concepts to Moses Company: A Detailed Analysis

Now, let's apply these concepts to Moses Company's situation. We have a specific borrowing of P4,000,000 at 10% interest and a general borrowing of P6,000,000 at 12% interest. To determine the capitalizable borrowing costs, we need additional information, such as the expenditures incurred on the warehouse construction during the period and the capitalization period itself. Let's assume, for the sake of illustration, that the expenditures incurred on the warehouse during the year amounted to P5,000,000 and the construction period spanned the entire year.

Calculating Capitalizable Interest from Specific Borrowing

The interest expense on the specific borrowing is calculated as 10% of P4,000,000, which amounts to P400,000. This amount is directly attributable to the warehouse construction and is therefore eligible for capitalization.

Calculating Capitalization Rate for General Borrowing

To calculate the capitalization rate for the general borrowing, we need to consider the interest expense on the mortgage payable, which is 12% of P6,000,000, amounting to P720,000. The weighted average interest rate, or capitalization rate, is calculated by dividing the total interest expense on general borrowings by the total amount of general borrowings. In this case, the capitalization rate is P720,000 / P6,000,000 = 12%.

Determining Capitalizable Interest from General Borrowing

Next, we apply the capitalization rate to the expenditures on the warehouse. Since the expenditures are P5,000,000, the potentially capitalizable interest from general borrowing is 12% of P5,000,000, which is P600,000. However, we need to consider that the specific borrowing of P4,000,000 already covers a portion of the expenditures. Therefore, we only capitalize the interest on the portion of the expenditures financed by general borrowings, which is P1,000,000 (P5,000,000 - P4,000,000). The capitalizable interest from general borrowing is then 12% of P1,000,000, which is P120,000.

Total Capitalizable Borrowing Costs

The total capitalizable borrowing costs are the sum of the interest from specific borrowing and the interest from general borrowing, which is P400,000 + P120,000 = P520,000. This amount will be added to the cost of the warehouse and depreciated over its useful life.

Disclosure in the Financial Statements

Moses Company would disclose in its financial statements that it capitalized P520,000 of borrowing costs related to the construction of the new warehouse. The disclosure would also include the capitalization rate of 12% used for general borrowings and a brief description of the accounting policy for borrowing costs.

Conclusion: The Importance of Accurate Borrowing Cost Accounting

In conclusion, understanding the principles of borrowing cost accounting, as outlined in IAS 23, is crucial for accurate financial reporting. Companies like Moses Company, undertaking significant construction projects, must carefully identify and capitalize borrowing costs that are directly attributable to qualifying assets. This ensures that the financial statements reflect the true cost of the asset and provide a more accurate picture of the company's financial performance. By following the guidelines and principles discussed in this article, businesses can confidently navigate the complexities of borrowing cost accounting and ensure compliance with accounting standards.

The scenario presented in Problem 25-5 highlights the importance of distinguishing between specific and general borrowings, calculating the appropriate capitalization rate, and understanding the capitalization period. Proper application of these concepts leads to a more transparent and reliable representation of a company's financial position and performance.

• Borrowing Costs
• IAS 23
• Capitalization
• Qualifying Asset
• Specific Borrowing
• General Borrowing
• Capitalization Rate
• Moses Company
• Financial Reporting
• Accounting Standards