Practice Questions: IAS 23 (Borrowing Costs)

Example # 1

ADAMs has arranged a loan with Swedbank, to enable him to build a football stadium in Vilnius. He will be allowed to borrow up to $300,000,000 to be used in such amounts and at such times as he requires the funds. The bank charges interest at the rate of 7% per annum and ADAMs is able to invest any surplus funds at the rate of 5% per annum.

He borrowed $100,000,000 on 1 January 2008 and immediately invested $50,000,000. On 28 Feb he withdrew $30,000,000 from the funds invested. On 1 April, he borrowed a further $120,000,000 of which he invested $70,000,000. On 31 May he spent $60,000,000 out of the funds invested. On 31 August he borrowed a further $80,000,000, spent $20,000,000 immediately and invested the remainder. On 1 November work was stopped because of a strike by the workforce. The work recommenced on 1 January 2009 and ADAMs closed all investment accounts and  spent the rest of the loan in completing the project which was ready for final inspection by 29 February. The Local authority finally gave their approval of the stadium on 1 April and paid ADAMs the full contract price of $350,000,000.

Required: Calculate the carrying amount of the Football Stadium in ADAMs financial statements immediately before the sale transaction

Example # 2

A socially responsible multinational corporation (MNC) decided to construct a tunnel that will link two sides of the village that were separated by a natural disaster years ago. Realizing its role as a good corporate citizen, the MNC has been in this village for a couple of years exploring oil and gas in the nearby offshore area. The tunnel would take two years to build and the total capital outlay needed for the construction would be not less than $20 million. To allow itself a margin of safety, the MNC borrowed $22 million from three sources and used the extra $2 million for its working capital purposes.

Financing was arranged in this way:

·        Bank term loans: $5 million at 7% per annum

·        Institutional borrowings: $7 million at 8% per annum

·        Corporate bonds: $10 million at 9% per annum

 In the first phase of the construction of the tunnel, there were idle funds of $10 million, which the MNC invested for a period of six months. Income from this investment was $500,000.

REQUIRED: If the MNC decided to opt for the “allowed alternative treatment” under IAS 23, how would it treat the borrowing costs? How would it capitalize the borrowing costs, and what would it do with the investment income?