IAS 23 borrowing costs: what you can add to an asset instead of expensing

IAS 23 borrowing costs are the interest and other costs a business pays when it borrows money. Most of the time, those costs are simply an expense in profit or loss: you borrowed, you paid interest, it reduced your profit for the year. But IAS 23 has one important exception, and it matters a lot if your business ever builds, constructs, or produces something big with borrowed money.

The exception is this: borrowing costs that are directly attributable to acquiring, constructing, or producing a qualifying asset must be added to the cost of that asset instead of being expensed. That process is called capitalisation, and it changes both your balance sheet and your profit in the years the asset is being built.

IAS 23 borrowing costs and the qualifying asset

IAS 23 borrowing costs only get capitalised for a qualifying asset. A qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale. Think of a factory building under construction, a production plant being assembled, or a large piece of custom equipment being built to order. A warehouse that takes eighteen months to construct qualifies. Stock that is routinely manufactured in a few weeks does not, and neither does an asset that is ready for use as soon as you buy it.

The word "substantial" is deliberately not a fixed number of months. It depends on the facts. What matters is that the asset genuinely needs a long preparation period before it can be used or sold. If your business buys a finished machine and plugs it in, there is nothing to capitalise — the interest on the loan that funded it is an expense, full stop.

IAS 23 borrowing costs: which costs can be capitalised

Borrowing costs under IAS 23 are broader than just the interest rate on the loan. They include interest expense calculated using the effective interest method, finance charges on finance leases (under the older terminology the standard still references), and exchange differences on foreign currency borrowings that are treated as an adjustment to interest costs. For a small business, the practical case is usually straightforward: the interest on the loan taken out to fund the project.

But not every borrowing cost on every loan qualifies. Only the costs that are directly attributable to the qualifying asset count. If you borrowed specifically for the construction project, the link is clear. If you borrowed generally and used some of the money for the project, you need a calculation, which we come to below.

IAS 23 borrowing costs on a specific loan

When you borrow funds specifically to obtain a qualifying asset, the amount you capitalise is the actual borrowing costs incurred on that loan during the period, less any investment income you earned by temporarily investing the borrowed money before spending it.

That last point catches people out. Suppose you borrow 1,000,000 for a building project, but construction starts three months after the loan is drawn, and in the meantime you park the money in a deposit earning interest. That deposit interest is deducted from the borrowing costs you capitalise. You cannot capitalise gross interest while quietly pocketing the investment income. The logic is that only the net cost of carrying the loan for the project belongs in the asset's cost.

Capitalisation begins when three conditions are all met: you are incurring expenditures on the asset, you are incurring borrowing costs, and activities necessary to prepare the asset for its intended use or sale are in progress. If any one of those stops, capitalisation logic changes.

IAS 23 borrowing costs on general borrowings

Most small businesses do not take out a dedicated loan for each project. They borrow generally — an overdraft, a term loan, a revolving facility — and fund several things from the same pot. IAS 23 handles this with a capitalisation rate: the weighted average of the borrowing costs of all general borrowings outstanding during the period, excluding borrowings made specifically for a qualifying asset.

You apply that rate to the expenditures on the qualifying asset to work out how much to capitalise. And there is a ceiling: the amount capitalised in a period must not exceed the total borrowing costs actually incurred in that period. You cannot capitalise more interest than you paid.

A simple illustration, using round numbers purely to show the mechanics: suppose your general borrowings cost an average of 8% for the year, and you spent 500,000 on constructing a qualifying asset during the year. The borrowing costs eligible for capitalisation would be around 40,000 (8% of 500,000), provided your total borrowing costs for the year were at least that much. That 40,000 goes into the asset's cost rather than into profit or loss.

IAS 23 borrowing costs: when to suspend and when to stop

Capitalisation is suspended during extended periods when active development of the asset is interrupted. A construction project paused for six months because of a planning dispute is the classic case: interest during that pause is expensed, not capitalised, because the asset is not progressing. Brief interruptions that are a normal part of the process — a short weather delay, for example — do not trigger suspension.

Capitalisation ceases when substantially all the activities necessary to prepare the asset for its intended use or sale are complete. A building that is finished apart from minor finishing touches is substantially complete. When a qualifying asset is built in parts and each part can be used independently — say, units in a development completed one at a time — capitalisation stops for each part as that part becomes ready, even while work continues on the rest.

IAS 23 borrowing costs: why this matters for small businesses

Capitalising borrowing costs does not make interest free. It spreads the cost: instead of hitting profit during construction, the interest becomes part of the asset and reaches profit gradually through depreciation once the asset is in use. That matches the cost with the revenue the asset will generate, which is the whole point of the rule.

But it also flatters profit during the construction period, and lenders and tax authorities may see the same numbers differently. Tax rules on deducting interest often differ from the accounting treatment, which can create the kind of temporary difference that gives rise to deferred tax. And IAS 23 requires disclosure: the amount of borrowing costs capitalised during the period, and the capitalisation rate used for general borrowings. Anyone reading your accounts should be able to see how much interest was moved from expense into asset cost.

For a small business owner, the practical takeaway is simple. If you borrow to build something that takes a long time to get ready, ask your accountant early — before the project starts — whether IAS 23 borrowing costs should be capitalised, and keep your loan and expenditure records clean enough to support the calculation. Decided at the end of the year, with mixed records, it becomes an expensive reconstruction exercise. Decided at the start, it is a straightforward calculation that gives your accounts a fairer picture of what the asset really cost.

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