AS – 16

REVISION TEST PAPERS ( RTP )

MAY 18
Q. In May, 2016, Capacity Ltd. took a bank loan to be used specifically for the
construction of a new factory building. The construction was completed in January,
2017 and the building was put to its use immediately thereafter. Interest on the actual
amount used for construction of the building till its completion was ` 18 lakhs,
whereas the total interest payable to the bank on the loan for the period till
31st March, 2017 amounted to ` 25 lakhs.
Can ` 25 lakhs be treated as part of the cost of factory building and thus be
capitalized on the plea that the loan was specifically taken for the construction of
factory building? Explain the treatment in line with the provisions of AS 16.

A. AS 16 clearly states that capitalization of borrowing costs should cease

when substantially all the activities necessary to prepare the qualifying asset
for its intended use are completed. Therefore, interest on the amount that
has been used for the construction of the building up to the date of
completion (January, 2017) i.e. ` 18 lakhs alone can be capitalized. It cannot
be extended to ` 25 lakhs.

NOV 18

Q. A company incorporated in June 2017, has setup a factory within a

period of 8 months with borrowed funds. The construction period of the
assets had reduced drastically due to usage of technical innovations by the
company. Whether interest on borrowings for the period prior to the date of
setting up the factory should be capitalized although it has taken less than
12 months for the assets to get ready for use. You are required to comment
on the necessary treatment with reference to AS 16.

A. As per para 3.2 to AS 16 ‘Borrowing Costs’, a qualifying asset is

an asset that necessarily takes a substantial period of time to get ready for
its intended use or sale.
 Further, Explanation to the above para states that what constitutes a
substantial period of time primarily depends on the facts and circumstances
of each case. However, ordinarily, a period of twelve months is considered as
substantial period of time unless a shorter or longer period can be justified on
the basis of facts and technologically and commercially, to get it ready for its
intended use or sale is considered.

It may be implied that there is a rebuttable presumption that a 12

months period constitutes substantial period of time.

Under present circumstances where construction period has reduced

drastically due to technical innovation, the 12 months period should at best
be looked at as a benchmark and not as a conclusive yardstick. It may so
happen that an asset under normal circumstances may take more than 12
months to complete. However, an enterprise that completes the asset in 8
months should not be penalized for its efficiency by denying it interest
capitalization and vice versa.

The substantial period criteria ensures that enterprises do not spend a

lot of time and effort capturing immaterial interest cost for purposes of
capitalization.

Therefore, if the factory is constructed in 8 months then it shall be

considered as a qualifying asset. The interest on borrowings for the same
shall be capitalised although it has taken less than 12 months for the asset to
get ready to use.

MAY 19
Q. Zen Bridge Construction Limited obtained a loan of ` 64 crores to be
utilized as under:

(i) Construction of Hill link road in Kedarnath ` 50 crores

(ii) Purchase of Equipment and Machineries ` 6 crores
(iii) Working Capital ` 4 crores
(iv) Purchase of Vehicles ` 1crore
(v) Advances for tools/cranes etc. ` 1crore
 (vi) Purchase of Technical Know how ` 2 crores
(vii) Total Interest charged by the Bank for the ` 1.6
year ending 31st March, 2018 crores
Show the treatment of Interest according to Accounting Standard by Zen Bridge
Construction Limited.

A. According to AS 16 ‘Borrowing costs’, qualifying asset is an asset that

necessarily takes substantial period of time to get ready for its intended use.
As per the standard, borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset should be
capitalized as part of the cost of that asset. Other borrowing costs should be
recognized as an expense in the period in which they are incurred.
Capitalization of borrowing costs is also not suspended when a temporary
delay is a necessary part of the process of getting an asset ready for its
intended use or sale.The treatment of interest by Zen Bridge Construction Ltd.
can be shown as:

Qualifyin Interest to Interest to

g Asset be be charged
capitalized to Profit &
` in crores Loss A/c `
in crores
Construction of hill Ye 1.2 1.6/64 x
road* s 5 50
Purchase of 0.15
equipment and N 0.10 1.6/64 x
machineries o 0.025 6
Working capital N 1.6/64 x
0.025 4
Purchase of o
1.6/64 x
vehicles N 0.0 1
Advance for tools, o 5
cranes etc. 1.2 0.3 1.6/64 x
Purchaseof N 5 5 1
technical
know-how 1.6/64 x
o 2
Total
N
 o

*Note: It is assumed that construction of hill road will normally take more than a year
(substantial period of time), hence considered as qualifying asset.

NOV 19
Q. In May, 2018, Capacity Ltd. took a bank loan to be used specifically for the
construction of a new factory building. The construction was completed in January,
2019 and the building was put to its use immediately thereafter. Interest on the actual
amount used for construction of the building till its completion was ` 18 lakhs,
whereas the total interest payable to the bank on the loan for the period till
31st March, 2019 amounted to ` 25 lakhs.
Can ` 25 lakhs be treated as part of the cost of factory building and thus be
capitalized on the plea that the loan was specifically taken for the construction of
factory building? Explain the treatment in line with the provisions of AS 16.

A. AS 16 clearly states that capitalization of borrowing costs should cease when

substantially all the activities necessary to prepare the qualifying asset for its intended
use are completed. Therefore, interest on the amount that has been used for the
construction of the building up to the date of completion (January, 2019) i.e. ` 18
lakhs alone can be capitalized. It cannot be extended to ` 25 lakhs.

MAY 20
Q. Govind Ltd. issued 12% secured debentures of ` 100 Lakhs on 01.04.2018, to
be utilized as under:

Particulars Amount (` in lakhs)

Construction of factory building 40
Purchase of Machinery 35
 Working Capital 25
In March 2019, construction of the factory building was completed and
machinery was installed and ready for its intended use. Total interest on debentures for
the financial year ended 31.03.2019 was ` 12,00,000. During the year 2018-19, the
company had invested idle fund out of money raised from debentures in banks' fixed
deposit and had earned an interest of ` 3,00,000.
You are required to show the treatment of interest under Accounting Standard
16 and also explain nature of assets.

A. According to AS 16 “Borrowing Costs”, borrowing costs that are directly

attributable to the acquisition, construction or production of a qualifying asset should
be capitalised as part of the cost of that asset. The amount of borrowing costs
eligible for capitalisation should be determined in accordance with this Standard.
Other borrowing costs should be recognised as an expense in the period in which
they are incurred.
It also states that to the extent that funds are borrowed specifically for the
purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for
capitalisation on that asset should be determined as the actual borrowing costs
incurred on that borrowing during the period less any income on the temporary
investment of those borrowings.
Thus, eligible borrowing cost
= ` 12,00,000 – ` 3,00,000
= ` 9,00,000

Sr. Particulars Nature Interest to Interest to

No. be be charged
of assets capitalized to Profit &
( `) Loss Account
(`)
i Construction Qualifying 9,00,000x40/100 NIL
of Asset = ` 3,60,000

factory
building
ii Purchase of Not a NIL 9,00,000x35/10
Qualifying 0
Machinery Asset = ` 3,15,000
iii Working Not a NIL 9,00,000x25/10
Qualifying 0
 Capital Asset = ` 2,25,000
Total ` 3,60,000 ` 5,40,000

NOV 20
Q. (a) Vital Limited borrowed an amount of `150 crores on 1.4.2019
for construction of boiler plant @ 10% p.a. The plant is expected to be
completed in 4 years. Since the weighted average cost of capital is 13%
p.a., the accountant of Vital Ltd. Capitalized 19.50 crores for the
accounting period ending on 31.3.2020. Due to surplus fund out of `150
crores, an income of ` 1.50 crores was earned and credited to profit and
loss account. Comment on the above treatment of accountant with
reference to relevant accounting standard.
(b) When capitalization of borrowing cost should cease as per
Accounting Standard 16? Explain in brief.

A. (a) Para 10 of AS 16 ‘Borrowing Costs’ states that to the extent the

funds are borrowed specifically for the purpose of obtaining a qualifying
asset, the amount of borrowing costs eligible for capitalisation on that asset
should be determined as the actual borrowing costs incurred on that
borrowing during the period less any income on the temporary investment
of those borrowings. The capitalisation rate should be the weighted average
of the borrowing costs applicable to the borrowings of the enterprise that
are outstanding during the period, other than borrowings made specifically
for the purpose of obtaining a qualifying asset. Hence, in the above case,
treatment of accountant of Vital Ltd. is incorrect. The amount of borrowing
costs capitalized for the financial year 2019-20 should be calculated as
follows:

Actual interest for 2019-20 (10% of ` 150 crores) ` 15.00

crores
Less: Income on temporary investment from
(` 1.50
 specific borrowings crores)
Borrowing costs to be capitalized during year 2019- ` 13.50
2020 crores

(b) Capitalisation of borrowing costs should cease when substantially all the
activities necessary to prepare the qualifying asset for its intended use or sale are
complete. An asset is normally ready for its intended use or sale when its physical
construction or production is complete even though routine administrative work might
still continue. If minor modifications such as the decoration of a property to the user’s
specification, are all that are outstanding, this indicates that substantially all the activi
ties are complete. When the construction of a qualifying asset is completed in parts
and a completed part is capable of being used while construction continues for the
other parts, capitalisation of borrowing costs in relation to a part should cease when
substantially all the activities necessary to prepare that part for its intended use or
sale are complete.

PAST EXAM QUESTIONS

MAY 19
Q. First Ltd. began construction of a new factory building on 1st April, 2017. It
obtained 2,00,000 as a special loan to finance the construction of the factory
building on 1st April, 2017 at an interest rate of 8% per annum. Further, expenditure
on construction of the factory building was financed through other non-specific loans.
Details of other outstanding non-specific loans were:

Amount (`) Rate of Interest per

annum
4,00,000 9%
5,00,000 12
%
3,00,000 14
%
The expenditures that were made on the factory building construction were as follows:
 Date Amount (`)
1st April, 2017 3,00,000
31st May, 2017 2,40,000
1st August, 2017 4,00,000
31st December, 3,60,000
2017
The construction of factory building was completed by 31st March, 2018. As
per the provisions of AS 16, you are required to:
(1) Calculate the amount of interest to be capitalized.
(2) Pass Journal entry for capitalizing the cost and borrowing cost in respect
of the factory building.
A.
(a) (i) Computation of average accumulated expenses

`
` 3,00,000 x 12 / 12 = 3,00,000
` 2,40,000 x 10 / 12 = 2,00,000
` 4,00,000 x 8 / 12 = 2,66,667
` 3,60,000 x 3 / 12 = 90,000
8,56,667
(ii) Calculation of average interest rate other than for specific borrowings

Amount of loan (`) Rate of Amount of

interest interest
(`)
4,00,000 9% = 36,000
5,00,000 12% = 60,000
3,00,000 14% =

42,000

1,38,000
 Weighted average rate of interest = 11.5%
 1,38,000  
12,00,000100
 
(iii) Amount of interest to be capitalized

`
Interest on average accumulated
expenses: 16,00
Specific borrowings (` 2,00,000 x 8%) = 0

Non-specific borrowings (` 6,56,667 x = 75,517

11.5%)
Amount of interest to be capitalised = 91,517
(ii) Total expenses to be capitalised for building

`
Cost of building ` (3,00,000 + 2,40,000 + 4,00,000 + 13,00,000
3,60,000)
Add: Amount of interest to be capitalized 91,517
13,91,517
(iii) Journal Entry

Date Particulars Dr. Cr. (`)

(`)
31.3.201 Building A/c Dr. 13,91,5
8 To Building WIP  A/c 17 13,00,00
0
To Borrowing costs A/c 91,517
(Being amount of cost of
building and borrowing cost
thereon capitalised)