In this article, we share the main differences in the accounting requirements for borrowing costs under MPSAS 5, MFRS 123 and Section 25 of MPERS. For this purpose, we compare the requirements in MPSAS 5 and how are they different from MFRS 123 and Section 25 of MPERS.
This comparison is particularly helpful for entities planning to move from MPSAS to MFRS/MPERS framework and vice versa. If you wish to refresh your understanding on determining which accounting framework an entity should be using, head out to Financial reporting frameworks in Malaysia.
Let’s now go into the details.
What is the definition of borrowing cost?
MPSAS 5 defines borrowing cost as interest and other expenses incurred by an entity in relation to the funds borrowed. Borrowing cost includes the following type of costs:
- Interest on bank borrowings (both short term and long term) as well as bank overdrafts.
- Amortisation of discounts or premiums relating to borrowings.
- Amortisation of ancillary costs incurred in connection with the arrangement of borrowings.
- Finance charges in relation to finance leases and service concession arrangements.
- Exchange differences from foreign currency borrowings, to the extent that they are regards as an adjustment to interest costs.
Does the concept of borrowing costs different in MFRS 123 and Section 25 of MPERS? The definition of borrowing cost is the same between the three standards. However, there is a slight difference in the types of borrowing cost. MFRS 123 has deleted the reference made to amortisation of discounts or premiums and amortisation of ancillary costs. The same also applies to Section 25 as the section does not make any reference to the amortisation as borrowing costs.
What is the accounting treatment for borrowing costs?
MPSAS 5 provides an option either to capitalise the eligible borrowing costs or to expense them off. The method to expense off borrowing cost is called the “benchmark treatment” which generally used for simplification. While the option to capitalise it is called the “allowed alternative treatment” under MPSAS 5.
The allowed alternative treatment
Under this method, entities capitalise borrowing costs to the extent that they are eligible for capitalisation. Entities capitalise borrowing costs when they are directly attributable to the (i) acquisition, (ii) construction; or (iii) production of a qualifying asset. In such a situation, entities capitalise it as part of the costs of the qualifying asset when:
- it is probable that they will result in future economic benefits or service potential to the entity; and
- entities can measure the costs reliably.
Entities expense off non-eligible borrowing costs when incurred. The capitalisation of borrowing cost requires entities to exercise profession judgment in determining:
- whether there is a qualifying asset;
- whether the borrowing costs are considered as “directly attributable”;
- the amount of borrowing costs eligible to be capitalised; and
- the commencement, suspension and cessation of capitalisation of borrowing costs.
We will explain the 4 areas in detail in the later part of this article.
How is the treatment in MFRS 123 and Section 25 of MPERS? Are they the same as MPSAS 5? The answer is a no. As a high-level summary, MFRS 123 and Section 25 do not provide an option to account for borrowing costs. Both standards only allow for one of the treatments stated in MPSAS 5.
The accounting treatment in Section 25 of MPERS
Under Section 25 of MPERS, entities expense off all borrowing costs to profit or loss – similar to the “benchmark treatment”. It does not allow for entities to capitalise on any of it. This treatment adopted in MPERS is to simplify the accounting requirements by the private entities. Capitalisation of borrowing costs involves lots of significant judgments in the 4 areas as stated above.
The accounting treatment in MFRS 123
MFRS 123 on the other hand, requires an entity to capitalise eligible borrowing costs, similar to the “allowed alternative treatment”. Entities expense off borrowing costs that are not eligible for capitalisation in profit or loss in the period in which entities incur them. The treatment for an immediate recognition as expense in MFRS 123 was deleted in March 2007.
Let us now discuss the 4 judgement areas for the capitalisation of borrowing costs under MPSAS 5 and MFRS 123.
What is a qualifying asset under MPSAS 5 and MFRS 123?
Both standards define a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. The standards also provide examples of qualifying assets with examples given in MPSAS 5 are more relevant for public sector entities.
However, both MPSAS 5 and MFRS 123 did not provide further guidance on “substantial period of time”. In practice, some entities consider 6 months and above as a substantial period of time. Some other entities consider anything more than 12 months as a substantial period of time.
Because the standards are silent on this, entities develop their own accounting policy. Entities then apply the accounting policy chosen consistently. Take note that assets that are ready for their intended use or sale when acquired or obtained are not qualifying assets.
What is “directly attributable”?
Another area of judgment for capitalisation is in determining if borrowing costs are directly attributable to the acquisition, construction, or production of a qualifying asset. What does it mean by “directly attributable”?
MPSAS 5 and MFRS 123 refer them as borrowing costs that would have been avoided if the outlays or expenditure on the qualifying asset had not been made. Generally, if an entity borrowed fund to specifically fund for the acquisition or construction of a particular qualifying asset, borrowing costs that relate to the qualifying asset is directly and clearly identifiable. The tricky part is when there is no direct relationship between the borrowings and a qualifying asset. For example, when parent entity secured borrowings centrally for its group while the qualifying asset sits in another entity of the group
How to determine borrowing costs that are eligible for capitalisation?
For borrowings obtained specifically for the purpose of obtaining the qualifying assets, the amount of borrowing costs eligible for capitalisation are the actual amount of borrowing costs incurred during the period. Entities deduct this amount against any investment income on the temporary investment of those borrowings. Investment income comes from a temporary investment of the borrowings. It is common for entities to invest the borrowings obtained in short term investment like fixed deposits or money market to earn interest, pending their utilisation.
The capitalisation rate
However, if entities use general borrowings to obtain qualifying assets, MPSAS 5 and MFRS 123 require entities to determine the capitalisation rate. The capitalisation rate determines the capitalisation amount. So, how do we calculate this capitalisation rate? The capitalisation rate is the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, excluding borrowings made specifically the purpose of obtaining qualifying assets (i.e., specific borrowings).
The Annual Improvement to MFRS Standards 2015 — 2017 Cycle clarifies that entities account borrowing costs incurred for specific borrowing as general borrowing when substantially all the activities necessary to prepare that specific qualifying asset for intended use or sale are complete (i.e., such an asset is no longer a qualifying asset for the specific borrowing).
This clarification however is not available in MPSAS 5. Nevertheless, we believe that entities may apply the same principle as MFRS 123 consistent with IPSAS 5. MPSAS 5 is yet to adopt the improvements.
The amount of borrowing costs that an entity capitalises during the period should not exceed the amount of borrowing costs it incurred during the same period.
When is the commencement, suspension and cessation of capitalisation?
Both standards are consistent regarding the commencement, suspension and cessation of capitalisation of borrowing costs.
The commencement of capitalisation
Capitalisation starts when the entity meets all of the following criteria:
- It incurs outlays or expenditures for the asset;
- It incurs borrowing costs; and
- It undertakes activities that are necessary to prepare the asset for its intended use or sale (i.e., activities are in progress).
Both standards require entities to suspend the capitalisation during extended period where active development of the asset is suspended or interrupted. A difficulty then arises in determining when is the suspension of active development. Both standards clarify that capitalisation of borrowing costs continues during the period when entities carry out substantial technical and administrative works, not necessarily physical construction of the asset. The term ‘substantial technical and administrative works’ is however, left open for interpretation by preparers of the financial statements.
MFRS 5 and MFRS 123 further state that the capitalisation of borrowing costs should also continue even if there is a temporary delay. This is only if the delay is a necessary part of the process of getting the asset ready for its intended use or sale. Again, entities need to apply lots of judgment in interpreting the term “temporary delay” and hence justify the capitalisation.
The cessation of capitalisation
How about cessation? How does an entity know when it should stop capitalising? Both standards state that the capitalisation of borrowing costs should stop when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
Generally, asset is ready for its intended use when entities completes the physical construction. Nevertheless, entities may still need to do administrative works or minor modification on the constructed asset. This is another area where entities need to exercise professional judgment to determine “substantially completed”.
Complexity arises when entities completes the asset asset in parts and each part is capable of being used while construction continues on the other parts. This is because entities can only capitalise borrowing costs for the parts that are still on-going while capitalisation ceases for the completed parts. A lot of judgments involved in determining whether each part is “capable of being used individually”.
What are the disclosures requirements?
Both MPSAS 5 and MFRS 123 require entities to disclose:
- The amount of borrowing costs capitalised during the period.
- The capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.
However, as MPSAS 5 gives the options (i.e., benchmark treatment vs allowed alternative treatment), it requires entities to disclose the accounting policy adopted.
For borrowing costs expensed off, entities need to disclose finance costs and total interest expense in the financial statements.
Conclusion
The full details of MPSAS 5, MFRS 123 and Section 25 of MPERS are available on the respective issuing bodies website for your reference.
We will continue to discussion other differences in our upcoming articles. Meanwhile, you can read other relevant articles in Financial Accounting section.