Borrowing Cost PDF

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Topic 3: Borrowing CostsQuestion 1 Borrowing costs are: a. interest and other costs that an entity incurs in connection with the borrowing of funds. b. interest expense calculated using the effective interest method only. c. finance charges in respect of finance leases only. d. none of the above. AN...

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Topic 3: Borrowing Costs Question 1 Borrowing costs are: a. interest and other costs that an entity incurs in connection with the borrowing of funds. b. interest expense calculated using the effective interest method only. c. finance charges in respect of finance leases only. d. none of the above. ANSWER: A Question 2 Borrowing costs do not include: a. interest incurred on bank overdrafts. b. incremental administrative fees incurred in connection with raising loans. c. finance charges in respect of finance leases. d. dividends declared to equity holders. ANSWER: D Question 3 An entity must: a. recognize all borrowing costs as an expense in profit or loss in the period in which they are incurred. b. recognize all borrowing costs as an expense in profit or loss in the period in which they are incurred, except to the extent that borrowing costs that are directly attributable to the acquisition, construction or production of an asset that necessarily takes a substantial period of time to get ready for its intended use or sale are capitalized as part of the cost of that asset. c. choose either (a) or (b) above as its accounting policy for borrowing costs and apply the chosen policy consistently to all of its borrowing costs. ANSWER: C Question 4 Fun Company was constructing an asset that qualified for interest capitalization. The entity had outstanding notes payable during the entire year of construction comprising P6,000,000 8% interest and P9,000,000 9% interest. None of the borrowings were specified for the construction of the qualified asset. What interest rate should be used to calculate capitalized interest on the construction? a. 9.00% b. 8.50% c. 8.00% d. 8.60% ANSWER: D Question 5 The third year of a construction project of Villain Company began with a P3,000,000 balance in construction in progress. Included in that figure is P600,000 of interest capitalized in the first two years. Construction expenditures during the third year were P8,000,000 which were incurred evenly throughout the entire year. The entity had P30,000,000 in interest-bearing debt outstanding in the third year at an interest rate of 9%. 1. What amount of interest for the third year is capitalized? a. 360,000 b. 630,000 c. 936,000 d. 990,000 ANSWER: B

Balance- 1st and 2nd year Construction expenditures- 3rd year (8m/2) Total

3,000,000 4,000,000 7,000,000

Capitalized Interest (7m x 9%)

630,000

2. What amount should be reported as interest expense for the third year? a. 2,700,000 b. 2,070,000 c. 1,980,000 d. 1,350,000 ANSWER: B Actual borrowing cost (30M x 9%) Capitalize Borrowing cost Interest Expense

2,700,000 (630,000) 2,070,000

FEEDBACK/ASSESSMENT Test your knowledge of the requirements for accounting for borrowing costs by answering the questions below. Choose the most correct statement/answer. Question 1 Jambeh Company started construction on a building at the beginning of current year and completed construction at year-end. The entity had only two interest notes outstanding during the year and both of these notes were outstanding for all 12 months of the year. The following information is available: Average accumulated expenditures Ending balance in construction in progress before capitalization of interest 6% note incurred specifically for the project 9% long-term note

2,500,000 3,600,000 1,500,000 5,000,000

What is the cost of the building? a. 3,780,000 b. 2,680,000 c. 3,750,000 d. 3,825,000 ANSWER: A Question 2 During 2016, Josa Company constructed asset costing P5,000,000. The weighted average expenditures totaled P3,000,000. To help pay for construction, P2,200,000 was borrowed at 10% on January 1, 2016. Funds not needed for construction were temporarily invested in short term securities yielding P45,000 in interest revenue. Other than the construction funds borrowed, the only other debt outstanding during the year was a P2,500,000, 10year, 9% note payable dated January 1, 2015.

1. What amount of interest should be capitalized during 2016? a. 300,000 b. 150,000 c. 247,000 d. 472,000 ANSWER: C

2. What amount should be reported as interest expense for 2016? a. 225,000 b. 178,000 c. 153,000 d. 0 ANSWER: A Question 3 During 2016, Elsa Company constructed a new facility at a cost of P30,000,000. The expenditures for the building, which was finished late in 2016 were incurred evenly during the year. The entity had the following loans outstanding on December 31 2016: • 10% note to finance specifically the construction, dated January 1, 2016, P10,000,000. This note is unpaid on December 31, 2016. Investments were made on the proceeds from this loan and income of P100,000 was realized in 2016. • 12% 20-year bonds issued at face amount on April 30, 2015, P30,000,000. • 8% 5-year note payable, dated March 1, 2015, P10,000,000. What amount of interest is capitalized as cost of the new building? a. 1,550,000 b. 1,450,000 c. 1,400,000 d. 1,500,000 ANSWER: B Question 4 Which of the following is a disclosure requirement in relation to borrowing cost? I. Amount of borrowing cost capitalized during the period. II. Segregation of assets that are "qualifying assets" from other assets in the statement of financial position or as a disclosure in the notes to financial statements. III. Capitalization rate used to determine the amount of borrowing cost eligible for capitalization. a. I, II and III b. I and II only ANSWER: C

c. I and III only

d. I only

Question 5 An asset is being constructed for an entity's own use. The asset has been financed with a specific new borrowing. The interest cost incurred during the construction period as a result of expenditures for the asset is a. b. c. d.

Interest expense in the construction period A prepaid asset to be written off over the estimated useful life of the asset A part of the historical cost of acquiring the asset to be allocated over the estimated useful life of the asset A part of the historical cost of acquiring the asset to be allocated over the term of the borrowing used to finance the construction of the asset ANSWER: C

Question 6 When computing the amount of interest cost to be capitalized, the concept of "avoidable interest” refers to

a. The total interest cost actually incurred. b. A cost of capital. c. That portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made. d. That portion of average accumulated expenditures on which no interest cost was incurred. ANSWER: A Question 7 Which of the following assets could be treated as qualifying asset for purposes of capitalizing borrowing cost? a. Investment property b. Investment in financial instrument c. Inventory that is manufactured or produced in large quantity on a repetitive basis and takes a substantial period of time to get ready for use or sale d. Biological asset ANSWER: C Question 8 Which of the following statements about the capitalization of borrowing cost as part of the cost of a qualifying asset is true? a. If funds come from general borrowings, the amount to be capitalized is based on the weighted average amount of expenditures. b. Capitalization always continues until the asset is brought into use. c. Capitalization always commences as soon as expenditure of the asset is incurred. d. Capitalization always commences as soon as interest on relevant borrowings is being incurred. ANSWER: C Question 9 Which of the following is required for borrowing cost incurred that is directly attributable to the construction of a qualifying asset? I. Recognize as an expense in the period incurred. II. Capitalize as part of the cost of the asset. a. I only b. II only ANSWER: C

c. Either I or II

d. Neither I nor II

Question 10 An entity is commencing a new construction project which is to be financed by borrowing. The key dates for the current year are as follows: May 15 Loan interest relating to the project starts to be incurred. June 15 Technical site planning commences. June 30 Expenditures on the project start to be incurred. July 15 Construction work commences. The entity can commence the capitalization of borrowing cost from what date? a. May 15 b. June 15 c. June 30 d. July 15 ANSWER: C...