Question

Goodfood is a supermarket chain. During the current year it started building a new store. The directors are aware that in accordance with IAS23 Borrowing costs certain borrowing costs have to be capitalised.

Details relating to the construction of Goodfood’s new store:

Goodfood took out a €10 million loan with an interest rate of 7.5% per annum on 1 April 2017. The loan was specifically taken to finance the building of the new store which meets the definition of a qualifying asset in IAS23. Construction of the store started on 1 May 2017 and it was completed and ready for use on 28 February 2018.

Questions:

Goodfood’s new store meets the definition of a qualifying asset in IAS23. Which of the following describes a qualifying asset?

Group of answer choices

An asset that takes a substantial period of time to get ready for use or sale

A non-current asset that is classified as held-for-sale

An asset that is intended for use rather than sale

An asset that is ready for use or sale when purchased

Rather than take out a loan specifically for the new store Goodfood could have funded the store from existing borrowings which are:

• 10% bank loan of €50 million
• 8% bank loan of €30 million

In this case it would have applied a capitalisation rate to the expenditure on the asset. What would that rate have been?

Group of answer choices

9.25%

10%

9%

8.75%

What is the total of the finance costs which can be capitalized in respect of Goodfood’s new store?

Group of answer choices

€625,000

€750,000

€600,000

€500,000

Goodfood issued a loan on 1 April 2017. Three events or transactions must be taking place for capitalisation of borrowing costs to commence. Which one is NOT one of these?

Group of answer choices

Physical construction of the asset is nearing completion

Necessary activities are in progress to prepare the asset for use or sale

Borrowing costs are being incurred

Expenditure on the asset is being incurred

Answer 1

Question 1:Goodfood’s new store meets the definition of a qualifying asset in IAS23. Which of the following describes a qualifying asset?

Group of answer choices

1. An asset that takes a substantial period of time to get ready for use or sale
2. A non-current asset that is classified as held-for-sale
3. An asset that is intended for use rather than sale
4. An asset that is ready for use or sale when purchased

Correct Choice: An asset that takes a substantial period of time to get ready for use or sale

Reason :As per IAS23 ,Qualifying asset is an asset, that essentially takes a long or substantial time period to get ready for sale or intended use by the entity.Qualifying asset does not include assets which are ready for sale or use, at the time when these are acquired and the assets which are completed in the short interval.

Rather than take out a loan specifically for the new store Goodfood could have funded the store from existing borrowings which are:

• 10% bank loan of €50 million
• 8% bank loan of €30 million

Question 2 :Rather than take out a loan specifically for the new store Goodfood could have funded the store from existing borrowings which are:

• 10% bank loan of €50 million
• 8% bank loan of €30 million

In this case it would have applied a capitalisation rate to the expenditure on the asset. What would that rate have been?

Group of answer choices

1. 9.25%
2. 10%
3. 9%
4. 8.75%

Correct Choice:Correct answer is 9.25%

Existing Borrowing	Rate of Interest	Weight	Weighted Average Borrowing rate
50000000	10%	62.50%	6.25
30000000	8%	37.50%	3.00
80000000		100.00	9.25 %

Reason:The loan which is borrowed for the qualifying asset and general use in business both is called general loan. In such situation the borrowing cost eligible for capitalization will be calculated as, the expenditure on the qualifying asset during the accounting period will be multiplied with weighted average borrowing cost percentage of the entity in respect of the loans which were outstanding during the accounting period.

Question 3:What is the total of the finance costs which can be capitalized in respect of Goodfood’s new store?

Group of answer choices

1. €625,000
2. €750,000
3. €600,000
4. €500,000

Correct Choice:Total of the finance costs which can be capitalized in respect of Goodfood’s new store is €625,000

Sr No	Particulars	Amount €
1	Borrowed Amount	€10000000
2	Rate of Interest	7.50%
3	Date of loan	Apr-17
4	Date of construction	May-17
5	Borrowing cost to be capitalised in 2017 = 8 months May 2017 tp Dec 2017	€10000000*7.50%*8/12 months=€500000
6	Borrowing cost to be capitalised in 2018 I.e January & February 2018	€10000000*7.50%*2/12 months=€125000
7	Total Borrowing cost to be capitalised in respect of Goodfood’s new store (5+6)	€625000

Reason:The capitalization of borrowing cost will commence when:

• The expenditure on the asset has been started;
• Borrowing cost is being incurred;
• The activities necessary to complete the asset are in progress

But borrowing cost will not be capitalized, when development of the asset is suspended, or when the construction is completed or the construction was not started
, therefore the borrowing cost for the month of April 2017 will not be capitalized and will be charged to profit and loss as expense.

• Borrowing Cost to be charged to profit or loss ( April 2017 )= €10,000,000 x 1/12 = €62500

• The borrowing cost that relates to the qualifying asset and which will be capitalized is €625000.

Question 4:Goodfood issued a loan on 1 April 2017. Three events or transactions must be taking place for capitalisation of borrowing costs to commence. Which one is NOT one of these?

Group of answer choices

1. Physical construction of the asset is nearing completion
2. Necessary activities are in progress to prepare the asset for use or sale
3. Borrowing costs are being incurred
4. Expenditure on the asset is being incurred

Correct Choice:Physical construction of the asset is nearing completion

Following are theThree events or transactions that must be taking place for capitalisation of borrowing costs to commence.

1. Necessary activities are in progress to prepare the asset for use or sale
2. Borrowing costs are being incurred
3. Expenditure on the asset is being incurred

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