Borrowing costs on construction projects

Contractors vs developers: who capitalises borrowing costs on construction projects?

A contractor building for a client recognises revenue over time, so what it carries are receivables and contract assets, plus any work in progress the client already controls. The IFRS Interpretations Committee concluded in 2019 that, for a developer recognising revenue over time, the receivable, the contract asset and even work in progress on unsold units are not qualifying assets, because the units are ready for sale in their current condition. Interest is expensed. A developer selling only on completion, by contrast, holds inventory that takes years to get ready for sale, a qualifying asset.

A developer's borrowing costs: an example

A developer builds an apartment block whose units will be sold on completion, so revenue is recognised at a point in time. It takes a specific construction loan of CU 10 million at 8%, and temporarily invests the undrawn funds, earning 0.2 million. It also funds 4 million of average spending in the year from its general borrowings, whose weighted average rate is 6%.

The 0.84 million becomes part of the cost of the apartments and reaches profit through cost of sales when they are sold. The amount capitalised from general borrowings cannot exceed the borrowing costs actually incurred in the period.

How is the general borrowings rate set?

As the weighted average of borrowing costs on all borrowings outstanding in the period, excluding borrowings made specifically for a qualifying asset until substantially all the work on that asset is complete. Since a 2019 amendment, a specific loan still outstanding after its asset is ready joins the general pool.

When does capitalisation start, pause and stop?

• Start: when the developer incurs spending on the asset, incurs borrowing costs, and starts the activities to prepare it, which include planning and permits, not just physical construction.
• Pause: during extended periods when active development is suspended, such as a project halted for a year by a funding shortfall, but not for normal delays such as weather.
• Stop: when substantially all the activities needed to prepare the asset are complete, even if minor fitting-out continues.

What about assets built for the company's own use?

A contractor building its own head office, or a developer building investment property it will hold at cost, has a qualifying asset and capitalises borrowing costs. Investment property measured at fair value is outside the requirement, though capitalisation may still be applied as a policy. A new mine is another qualifying asset; see mine development costs.

What is disclosed about borrowing costs?

IAS 23 requires the amount of borrowing costs capitalised in the period and the capitalisation rate used for general borrowings. Developers often also show capitalised interest within inventory or investment property movements, so readers can see how much of the carrying amount is financing. In the cash flow statement, IAS 7 requires the total interest paid to be disclosed, whether it was expensed or capitalised, and classified consistently from period to period. Under the amendments made by IFRS 18, from 2027 most companies outside banking and investing will classify interest paid in financing activities; see IFRS 18 cash flow statement changes.

How does US GAAP differ?

ASC 835-20 has similar rules but does not reduce capitalised interest by income on temporarily invested funds, except in limited cases such as tax-exempt borrowings. See property development revenue, construction revenue over time and construction accounting.

This guide is general information. It is not tax or legal advice for your situation.