To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation by applying a capitalisation rate to the expenditures on that asset. The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period.
What if a company has interest free loans from shareholders in addition to interest-bearing loans from financial institutions? Do you take into account the effective interest income due to the interest-free loan (effectively lowering the WACC)? This is quite common as banks often only finances a construction project partially, and the rest of the funds are added by shareholders.
Your feedback would be must appreciated!
To apply IAS23;
For borrowings taken out specifically to finance the asset in question, the borrowing costs are those that arise directly i.e. interest, arrangement fees, premiums on borrowings, net of any income earned on the temporary investment of the borrowings. Where the funds used are taken from a general pool of borrowings, a ‘capitalisation rate’ must be calculated in order to determine the interest element that may be capitalised. This rate is the weighted average of the borrowing costs that arise on the general pool of funds.
Then you should include borrowings from shareholders in the pool in order to calculate Capitalisation Rate. If these borrowings are specifically to construction.
The question is whether they could be capitalised under IAS 23, which mentions in its scope that it does not deal with the actual or imputed cost of equity including preferred capital not classified as liability. Whether the charge for imputed interest should or should not be capitalised would require judgement based on the specifics of the case, the financing policy of the entity and the interpretation of IAS 23 recognition rules which is silent on the subject being discussed.
I agree with your deferred tax assessment. But, I do not understand what you mean by concessionary loans. An interest-free loan from shareholders may be designated as FV through P and L, or as loans and receivables, i.e measured at amortized cost (AC). The AC should approximate the FV and therefore there will be an element of imputed interest income.
Do you agree that in the situation where generally borrowed funds are used to determine the capitalisation rate, then these loans will lower the Weighted Average Cost of Borrowings (WACB)?
An interest free or a low interest loan would be concessionary – just a usage of language since both types are at a ‘concession’. The use of English language being taken care of, let us get to the point!
In actual practice, I have never come across a situation where the concession has been capitalised or used to reduce the interest cost capitalised in a ‘qualifying asset’. Fellow IFRS Listers may have and I would be keen to hear from them on this one!
Assuming that your query was of an actual case and not one of academic interest per se, I suggest you look at the terms of the shareholder loan for actual classification. If it is an interest free loan with no repayment terms, then the fair value on intial recognition would pose a problem as one needs a repayment date. If they are on demand loans, then they would be classifed as current liabilities and the fair value of a demand loan is its fair value at transaction price.
An analysis of this issue would help you to determine whether to lower the WACC or not and I am loathe to answer the question with a yes or no unless all facts are known as the analysis and interpretations would be affected.
If anyone has come across this situation before, I would welcome their input.
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