Key takeaways
- Borrowing costs directly attributable to a qualifying asset must be capitalised. This is not optional.
- For a project-specific loan, use the actual interest less income earned on temporary investment of the funds. For general borrowings, apply a capitalisation rate to the weighted average expenditure.
- Commencement, suspension and cessation depend on the actual state of development and supporting documents.
- IDC shifts the timing of the expense. It does not change the total over the life of the asset, and it does not change the cash interest burden.
Why interest is a project cost
Hotel, resort, condominium and infrastructure projects require substantial borrowing. Thai Accounting Standard No. 23, Borrowing Costs, which is consistent with IAS 23, requires borrowing costs directly attributable to a qualifying asset to be included in the cost of that asset. In finance, this concept is known as IDC, or interest during construction.
1. Key definitions
1.1 Borrowing costs
Borrowing costs are interest and other costs incurred in connection with borrowing, such as interest under the effective interest method, fees that form part of the effective interest rate, interest on lease liabilities, and exchange differences to the extent they are regarded as an adjustment to interest cost. Hedging costs must be analysed according to the hedging relationship and the accounting policy.
Dividends paid to shareholders are not borrowing costs. For legal advisory fees or valuation fees, consider whether they relate directly to raising the debt or to acquiring the asset.
1.2 Qualifying Asset
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. The standard does not set a fixed number of months, but in practice many entities use 12 months as a starting point for assessment.
Examples that qualify
- A hotel or resort under construction
- Condominiums and housing estates under development, depending on the facts of the project
- A factory or warehouse under construction
- Investment property under development
- Large-scale infrastructure
Examples that do not qualify
- Assets bought that are ready for use immediately
- Inventories manufactured repetitively in large quantities over a short period
- Assets already in normal use
- Land held idle with no development activity
2. The core rule
Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset must be capitalised. Other borrowing costs are expensed in the period.
3. Calculation principles by type of borrowing
3.1 Project-specific loans
Capitalise the actual interest incurred in the period, less income earned from the temporary investment of the unused portion of the loan.
3.2 General borrowings
Capitalisation rate = interest on general borrowings in the period ÷ average general borrowings
Interest capitalised = capitalisation rate × weighted average expenditure
The amount capitalised must not exceed the borrowing costs actually incurred in the period. When calculating the rate, exclude project-specific loans until substantially all the activities of that qualifying asset are complete.
4. The capitalisation period
- Commencement: expenditure is being incurred, borrowing costs are being incurred, and activities necessary to prepare the asset are under way, such as design, obtaining permits, site preparation or construction.
- Suspension: when active development is suspended for an extended period.
- Cessation: when substantially all the activities necessary are complete, not the date sales begin or commercial operation starts.
Awaiting EIA approval: if the wait is part of the normal process and technical work or design revisions are continuing, it may still count as development activity. If the project is halted for an abnormally long time with no necessary activity, capitalisation must stop and the interest must be expensed. Supporting documentation of progress is required.
Interruptions that are a normal part of the construction process, such as waiting for concrete to set or expected weather stoppages, do not prevent capitalisation from continuing. For a project completed in phases, capitalisation must cease separately for each phase that is ready for use or sale.
5. Practical examples
Case 1: a project-specific loan for a hotel
Borrowing of THB 300 million at 6%, with an average of THB 100 million of unused funds deposited at 1%. In the first year, interest paid is THB 18.0 million, less interest received of THB 1.0 million, leaving THB 17.0 million to capitalise. If the original hotel cost is THB 200 million, it rises to THB 217 million.
Case 2: general borrowings of a condo developer
| Borrowing | Balance (THB m) | Rate | Interest (THB m) |
|---|---|---|---|
| Term Loan | 200 | 5% | 10 |
| Bonds | 300 | 6% | 18 |
| OD | 100 | 7% | 7 |
| Total | 600 | 5.83% | 35 |
If the weighted average expenditure is THB 110 million, the cost that can be capitalised is 110 × 35 ÷ 600 = THB 6.42 million, which does not exceed total interest of THB 35 million.
Case 3: specific and general borrowings
A project costing THB 500 million has a specific loan of THB 300 million at 5%, assumed to be drawn for the full year. Weighted average expenditure is THB 350 million, with the remainder funded by general borrowings at 6%. The amount capitalised is therefore 300 × 5% = THB 15 million plus 50 × 6% = THB 3 million, a total of THB 18 million.
Case 4: a condo as inventory
Construction takes about 30 months. Cumulative construction cost is THB 600 million and IDC is THB 50 million, so inventory is THB 650 million. When units are transferred, IDC is recognised through COGS in proportion to the units transferred.
6. Foreign currency borrowings
Exchange differences can be included in borrowing costs only to the extent that they are regarded as an adjustment to interest cost. For example, a USD loan carries 4% interest, whereas a THB loan would cost 6%. The exchange loss to be capitalised is generally limited to the 2% interest saving, using a defined method applied consistently. Any excess is recognised in profit or loss. Confirm the calculation method with the auditor.
7. Effects on the entity
7.1 Financial statements
In the construction years, capitalisation results in higher net profit and asset value than expensing immediately. Later, depreciation or COGS is higher, and the total over the life is the same. TAS 23 therefore changes the timing of recognition, not the total.
7.2 Ratios
EBITDA during construction is unaffected because interest sits below EBITDA. However, when IDC is recognised through the COGS of inventory, EBITDA in the transfer year will be lower than if the interest had been shown as interest expense. Debt ÷ EBITDA during construction therefore does not improve as a result of capitalisation, while net profit margin and interest coverage as reported may look higher. Banks and investors should also look at interest paid in cash.
7.3 Cash flow statement
Interest capitalised into PP&E is usually shown under investing activities. If it is capitalised into inventory, consider the policy and consistency with how cash paid for inventory is presented, which is generally within operating activities. The entity should disclose its policy clearly.
8. Tax issues
Accounting and tax treatment may not be consistent. Check them against the nature of the loan and the facts of the project. If the tax base differs from the accounting base, a temporary difference arises and deferred tax must be considered.
Mechanical example: if the accounts capitalise IDC of THB 50 million and depreciate it at THB 1 million a year over 50 years, but for tax purposes it is assumed to be deductible in full in the year incurred, the entity has a deferred tax liability (DTL) of THB 10 million at a 20% rate. Before applying this in practice, confirm the tax treatment with the auditor and tax adviser.
9. Disclosure
- The amount of borrowing costs capitalised in the period
- The capitalisation rate used
- Relevant accounting policies in accordance with the presentation requirements
10. Full example: a hotel with a THB 500 million budget before IDC
The investment budget comprises land of THB 100 million, construction of THB 350 million and FF&E of THB 50 million. The specific loan is THB 350 million at 6%, and shareholders' equity is THB 150 million. The construction period is 24 months. This example assumes that IDC of THB 34.5 million is funded by additional equity from shareholders, because the THB 500 million of debt and equity covers only the budget before IDC.
| Year | Expenditure | Average loan balance | IDC 6% | CIP at year-end |
|---|---|---|---|---|
| 0 Land and design start | 100 | 50 | 3.0 | 103.0 |
| 1 Construction | 200 | 200 | 12.0 | 315.0 |
| 2 Fit-out and FF&E | 200 | 325 | 19.5 | 534.5 |
| Total | 500 | — | 34.5 | 534.5 |
In year 3 the hotel opens, and CIP of THB 534.5 million is transferred to PP&E. Interest of 350 × 6% = THB 21 million is expensed. Excluding land of THB 100 million and depreciating the remainder as a single lump over 30 years, depreciation is about THB 14.5 million a year. If the full IDC of THB 34.5 million is included in the depreciable amount, it is spread at about THB 1.15 million a year.
11. Common mistakes
- Expensing IDC immediately even though the asset qualifies
- Continuing to capitalise after the asset is ready for use or sale
- Not deducting income from temporary investment of specific loans
- Including specific loans in the capitalisation rate calculation for general borrowings
- Not stopping capitalisation when the project is halted for an abnormally long time
- Not preparing a reconciliation between tax and accounting
- Capitalising on assets that do not qualify
12. Checklist for the CFO
- There is a written capitalisation policy
- Identify the entity's qualifying assets
- Separate specific and general borrowings
- Calculate the capitalisation rate regularly
- Track the start, suspension and end dates for each project
- Keep loan agreements, drawdown schedules and progress reports
- Deduct income from temporary investments
- Review tax differences and deferred tax
Conclusion
TAS 23 requires borrowing costs directly attributable to a qualifying asset to be capitalised, but only within a clear timeframe and using a defined calculation method. Good figures in the financial statements during construction do not reduce the cash burden, so management must look at both the accounting result and the interest actually payable.