Difference Between IAS 23 Under Going Concern and IAS 23 Under Liquidation

Introduction

IAS 23, “Borrowing Costs,” outlines the accounting treatment for borrowing costs. It specifies how to capitalize borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset. This report explores the key differences in applying IAS 23 under a going concern assumption and during liquidation.

IAS 23 Under Going Concern

Core Principle

Under IAS 23, the core principle is that borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset must be capitalized as part of the cost of that asset. Other borrowing costs are recognized as an expense in the period in which they are incurred.

Definition of 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. Examples include inventories that require a long production period, manufacturing plants, and investment properties.

Example: A company constructs a new manufacturing plant that takes two years to complete. The plant qualifies as a qualifying asset under IAS 23.

Capitalization of Borrowing Costs

Borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset are capitalized. This includes interest expense on loans specifically for the project and, under certain conditions, interest on general borrowings.

Example: A company borrows R10,000,000 specifically to construct a manufacturing plant. The interest expense on this loan during the construction period is capitalized as part of the cost of the plant.

Recognition of Borrowing Costs

Borrowing costs are capitalized as part of the cost of a qualifying asset when:

• Expenditures for the asset are being incurred.

• Borrowing costs are being incurred.

• Activities necessary to prepare the asset for its intended use or sale are in progress.

Example: A company begins construction of a plant on January 1. Borrowing costs incurred from January 1 onwards, while construction activities are in progress, are capitalized.

Cessation of Capitalization

Capitalization of borrowing costs ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. If construction is completed in parts and each part is capable of being used while construction continues on other parts, capitalization ceases for each part as it is completed.

Example: A company completes the main structure of a plant but continues to work on auxiliary buildings. Capitalization of borrowing costs ceases for the main structure once it is ready for use.

Disclosures

Entities must disclose:

• The amount of borrowing costs capitalized during the period.

• The capitalization rate used to determine the amount of borrowing costs eligible for capitalization.

Example: A company discloses that it capitalized R500,000 of borrowing costs during the period, using a capitalization rate of 5%.

IAS 23 Under Liquidation

Core Principle

During liquidation, the focus shifts from the capitalization of borrowing costs to the immediate settlement of liabilities and realization of assets. The urgency to liquidate assets and settle debts means that borrowing costs are generally expensed as incurred rather than capitalized.

Definition of Qualifying Asset

The concept of a qualifying asset remains the same, but the relevance of capitalizing borrowing costs diminishes as the entity focuses on liquidation. The emphasis is on the immediate realization of assets rather than their long-term construction or production.

Example: A company in liquidation has ongoing construction projects. The priority shifts to selling these projects, and borrowing costs are no longer capitalized.

Capitalization of Borrowing Costs

During liquidation, the capitalization of borrowing costs typically ceases. Borrowing costs incurred are recognized as expenses in the period they are incurred, reflecting the urgency to manage cash flows and settle debts quickly.

Example: A company in liquidation incurs interest expenses on a loan for an unfinished plant. These costs are recognized as expenses rather than being capitalized.

Recognition of Borrowing Costs

Borrowing costs incurred during liquidation are expensed immediately. The focus is on managing cash flow and reducing liabilities rather than capitalizing costs for long-term asset creation.

Example: Interest on loans taken to finance construction projects is expensed in the period incurred, rather than capitalized, during liquidation.

Cessation of Capitalization

Capitalization of borrowing costs ceases entirely during liquidation. All borrowing costs are recognized as expenses to reflect the financial urgency and liquidation process.

Example: A company ceases all capitalization of borrowing costs as it enters liquidation, recognizing all future interest expenses as period costs.

Disclosures

Disclosures during liquidation should reflect the change in treatment of borrowing costs and provide information about the immediate recognition of these costs as expenses. The goal is to provide transparency about the financial impact of liquidation on borrowing costs.

Example: A company discloses that it has ceased capitalizing borrowing costs and now recognizes all such costs as expenses, providing details about the amounts and impact on financial statements.

Immediate Realization and Settlement

The focus during liquidation is on the immediate realization of assets and settlement of liabilities. This urgency affects how borrowing costs are treated, with a shift from capitalization to immediate expensing.

Example: A company in liquidation sells its unfinished construction projects and recognizes the interest expenses on related loans as period costs.

Loss of Future Economic Benefits

As the liquidation process progresses, the entity no longer considers the future economic benefits of capitalized assets, focusing instead on their immediate liquidation value and related borrowing costs as expenses.

Example: A company in liquidation no longer capitalizes borrowing costs for a long-term project, recognizing all incurred costs as immediate expenses.

Conclusion

The application of IAS 23 under a going concern assumption and during liquidation involves the same fundamental principles but different practical considerations. Under going concern, the focus is on capitalizing borrowing costs for qualifying assets, reflecting the future economic benefits and systematic preparation for asset use. In contrast, during liquidation, the emphasis shifts to the immediate recognition of borrowing costs as expenses, reflecting the urgency to manage cash flows and settle liabilities. Entities must carefully reassess their treatment of borrowing costs and make necessary adjustments to ensure accurate and transparent financial reporting during liquidation. This adjustment ensures that stakeholders receive a true and fair view of the entity’s financial position and performance during the liquidation process.

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