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Borrowing costs capitalization and consolidation?!

9 May 2010 7,590 views 10 Comments

Could you please help with the following situation.

Mother company (company A) has given loan to its 100% subsidiary (company B), which on the other hand capitalizes the borrowing costs since the loan is used to build a qualifying asset. In order to be able to provide loan to its 100% subsidiary, the mother company has obtained loan from the ultimate parent (company C) in the same amount but with different interest rate. Now, for the purpose of the the consolidated financial statements of company A (which includes company B as well) what intercompany eliminations should be made?!?!

The interest income in company A should be eliminated against what? Because company B does not have  interest expense in its income statement since it is fully capitalized?? Should the elimination be against the qualifying asset? And in what amount should it be? Should it be in the amount of the interest between company A and B or between company C and A since this is actually the expense to the group (Companies A+B). Could you please advise how to proceed with this?!?

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  • Wallace Consulting Group said:

    In broad terms, I think the consolidated accounts need to eliminate all interest paid/received between A and B, and recalculate the borrowing costs attributable to B’s qualifying asset with reference to the actual borrowing costs of the group (i.e. as charged by C)

  • riyer0018 said:

    Borrowing cost only to the extent of the actual interest incurred by the group should be capitalised in the consolidated financial statements. The excess of actual interest over the interest income should be capitalised to the cost of qualifying asset.

    Please download PWC’s guide to capitalisation of borrowing costs. If you cannot find it online. Please mail me a request at riyer0018@gmail.com.

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  • yahya mohamed said:

    please need the elimination entries in conslidation
    as the borrowing costs are capitlised in the stand alone
    and if there is a need to adjust of depreaciation in later years


    In the account of coy B the borroowing cost should be capitalized

    In the consolidated account of coy A, the interest income element accruing to A from B on the loan should be eliminated against the catalized cost of the asset in the consolidated account.

    In the consolidated account of coy C, the interest entries should be eliminated entirely as a coy cannot grant loan to itself.

  • sanjiche (author) said:

    Thanks guys!
    Your comments have been very helpful to me!

  • stl1231 said:

    Your question is a good one and the answer is complex. In consolidated financial statements, the question to the amounts to be capitalized should be viewed at the group level in accordance with IAS 23R. Any resulting intercompany transactions should be eliminated in consolidation in accordance with IAS 27R regardless of whether or not the intercompany amounts were capitalized or expensed (intercompany sales of inventory is a good and simple example of this theory). I can give you some thoughts but there is not enough information to give you a complete answer: Some groups of companies with little or no borrowings have subsidiaries that are constructing assets and in these circumstances, the advances (principle and interest) would be eliminated in consolidation regardless of how the subsidiary accounted for the borrowing costs. In these circumstances, the underlying asset would have a different basis in consolidation. The theory is the group as a whole has not incurred interest on those borrowings at the consolidated level. However, to the extent a group member has borrowed externally (the parent company, for example) and lends to the subsidiary, the interest or a portion thereof would remain as a capitalized part of the asset in consolidation. At the group level, external indirect borrowings would be considered and may be capitalized as a part of the asset. Hopefully, this makes sense. Let me know if you need further clarification.

  • Mladek said:

    The “entity” referred to in IAS 23 is the consolidated whole, not the wholly-owned sub. Since subsidiary did not borrow specifically to acquire the asset it cannot capitalize borrowing costs per IAS 23.12. It would be able to do so only if the creditor was a third party (such as a bank) that is outside of the consolidated group.

    Consequently, the pertinent paragraph is 14. IAS 23.14 states “…The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the [consolidated] entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. …”

    Since the parent is generally the only part of the group that can calculate/determine the general borrowing rate, the parent is the one that should be doing the eliminating.

    It should do so by crediting the group’s (consolidated) interest expense for interest debited to the asset by the sub.

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