In this comparison article, we will share the main differences in the accounting requirements for borrowing costs under MPSAS 5, MFRS 123 and Section 25 of MPERS. For this purpose, we will compare the requirements in MPSAS 5 and how are they different from MFRS 123 and Section 25 of MPERS. This comparison will help you to understand and be aware of the different accounting requirements between these standards, particularly helpful in the preparation of group financial statements as well as for entities planning to move from MPSAS to MFRS/MPERS framework and vice versa.
If you wish to refresh your understanding on determining which accounting framework an entity should be using, we have covered this in Financial reporting frameworks in Malaysia.
What is the definition of borrowing cost under MPSAS 5, MFRS 123 and Section 25 of MPERS?
MPSAS 5 defines borrowing cost as interest and other expenses incurred by an entity in relation to the funds borrowed. Borrowing cost includes the following type of costs:
- Interest on bank borrowings (both short term and long term) as well as bank overdrafts.
- Amortisation of discounts or premiums relating to borrowings.
- Amortisation of ancillary costs incurred in connection with the arrangement of borrowings.
- Finance charges in relation to finance leases and service concession arrangements.
- Exchange differences from foreign currency borrowings, to the extent that they are regards as an adjustment to interest costs.
Does the concept of borrowing costs different in MFRS 123 and Section 25 of MPERS? The definition of borrowing cost is the same between the three standards. However, there is a slight difference in the type of costs considered as borrowing cost. MFRS 123 has deleted the reference made to amortisation of discounts or premiums and amortisation of ancillary costs as compared to MPSAS 5. The same also applies to Section 25 as the section does not make any reference to the amortisation as borrowing costs.
What is the accounting treatment for borrowing costs under MPSAS 5, MFRS 123 and Section 25 of MPERS?
MPSAS 5 provides an option to public sector entities whether to capitalise the eligible borrowing costs or to expense them off in the period in which they are incurred. The method to expense off borrowing cost is called the “benchmark treatment” which generally used for simplification while the option to capitalise borrowing costs is called the “allowed alternative treatment” under MPSAS 5.
Under the allowed alternative treatment, borrowing costs are capitalised to the extent that they are eligible to be capitalised. Borrowing costs can be capitalised when they are directly attributable to the (i) acquisition, (ii) construction; or (iii) production of a qualifying asset. In such a situation, borrowing costs are capitalised as part of the costs of that asset when (i) it is probable that they will result in future economic benefits or service potential to the entity and (ii) the costs can be measured reliably. Those borrowing costs which are not eligible for capitalisation will be expensed off when incurred.
Under the capitalisation method, entities will need to exercise profession judgment to determine:
- whether there is a qualifying asset;
- whether the borrowing costs are considered as “directly attributable”;
- the amount of borrowing costs eligible to be capitalised using the method prescribed in the standard; and
- the commencement, suspension and cessation of capitalisation of borrowing costs.
We will explain these 4 areas in more detail in the subsequent sections of this article.
How about the accounting treatment for borrowing costs under MFRS 123 and Section 25 of MPERS? Are they the same as MPSAS 5? The answer is a no. For a high-level summary, MFRS 123 and Section 25 do not give an option to entities on the accounting treatment for borrowing costs. Both MFRS 123 and Section 25 of MPERS only allow one of the treatments stated in MPSAS 5. Under Section 25 of MPERS, all borrowing costs incurred need to be expensed off in profit or loss in the period in which they are incurred – similar to the “benchmark treatment” in MPSAS 5. Section 25 of MPERS does not allow for entities to capitalise on any borrowing costs. The treatment adopted in MPERS is to simplify the accounting requirements for borrowing costs by the private entities. Capitalisation of borrowing costs involves significant judgments in the 4 areas as stated above. MFRS 123 on the other hand, requires an entity to capitalise eligible borrowing costs, similar to the “allowed alternative treatment” in MPSAS 5. Borrowing costs which are not eligible for capitalisation will be expensed off in profit or loss in the period in which entities incur them. The treatment for an immediate recognition of borrowing costs as expense in MFRS 123 was deleted in March 2007.
Let us now discuss the 4 areas to be considered for the capitalisation of borrowing costs under MPSAS 5 and MFRS 123.
What is a qualifying asset under MPSAS 5 and MFRS 123?
Both MPSAS 5 and MFRS 123 define a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Both standards also provide examples of qualifying assets with examples given in MPSAS 5 are more relevant to the public sector entities. However, both MPSAS 5 and MFRS 123 did not define or provide further guidance on what does it mean by “substantial period of time”. In practice, some entities consider 6 months and above as a substantial period of time while some other entities consider anything more than 12 months as a substantial period of time. Because this area is left silent by the standards, entities are expected to develop their accounting policy and to apply the accounting policy chosen consistently. Take note that assets that are ready for their intended use or sale when acquired or obtained are not considered as qualifying assets.
How to determine if borrowing costs are “directly attributable”?
Another area of judgment for capitalisation of borrowing costs is in determining if the borrowing costs are directly attributable to the acquisition, construction, or production of a qualifying asset. What does it mean by “borrowing costs that are directly attributable”? Both MPSAS 5 and MFRS 123 refer them as borrowing costs that would have been avoided if the outlays or expenditure on the qualifying asset had not been made. Generally, if an entity borrowed fund to specifically fund for the acquisition or construction of a particular qualifying asset, borrowing costs that relate to the qualifying asset is directly and clearly identifiable. The tricky part is when there is no direct relationship between the borrowings obtained and a qualifying asset, for example when borrowings are obtained centrally for a group of entities.
How to determine if borrowing costs is eligible for capitalisation under MPSAS 5 and MFRS 123?
For borrowings obtained specifically for the purpose of obtaining the qualifying assets, the amount of borrowing costs eligible for capitalisation are the actual amount of borrowing costs incurred on those borrowings during the period. This amount should however, be deducted against any investment income on the temporary investment of those borrowings. It is common for entities to invest the borrowings obtained in short term investment like fixed deposits or money market to earn interest, pending their utilisation for obtaining the qualifying assets.
However, for general borrowings use to obtain qualifying assets, both MPSAS 5 and MFRS 123 require entities to determine the capitalisation rate to be applied to the outlays or expenditure on the assets. So how do we calculate this capitalisation rate? Both standards state that the capitalisation rate is determine as the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, excluding borrowings made specifically the purpose of obtaining qualifying assets (i.e., specific borrowings). It is however important to note that under MFRS 123, there was an amendment made to the standard through the Annual Improvement to MFRS Standards 2015 — 2017 Cycle. The amendment is to clarify that borrowing costs incurred for specific borrowing will be included or considered as general borrowing when substantially all the activities necessary to prepare that specific qualifying asset for intended use or sale are complete (i.e., such an asset is no longer a qualifying asset for the specific borrowing). This clarification however is not available in MPSAS 5. Nevertheless, we believe that the same principle should be applied for entities applying MPSAS 5 as this principle has been adopted at the international level in IPSAS 5 Borrowing Costs through the Improvements to IPSAS October 2018. Both MPSAS 5 and MFRS 123 further state that the amount of borrowing costs that an entity capitalises during the period should not exceed the amount of borrowing costs it incurred during the same period.
When is the commencement, suspension and cessation of capitalisation of borrowing costs?
Both MPSAS 5 and MFRS 123 have the same requirements with regard to the commencement, suspension and cessation of capitalisation of borrowing costs. Capitalisation of borrowing costs start when the entity meets all of the following criteria:
- It incurs outlays or expenditures for the asset;
- It incurs borrowing costs; and
- It undertakes activities that are necessary to prepare the asset for its intended use or sale (i.e., activities are in progress).
Both standards further state that the capitalisation of borrowing costs is suspended during extended period where active development of the asset is suspended or interrupted. Difficulty then arises in determining when the active development is considered suspended. Both standards clarify that capitalisation of borrowing costs continues during the period when entities carry out substantial technical and administrative works, not necessarily physical construction of the asset. The term ‘substantial technical and administrative works’ is however, left open for interpretation by preparers of the financial statements. MFRS 5 and MFRS 123 further state that the capitalisation of borrowing costs should also continue even if there is a temporary delay, if such delay is a necessary part of the process of getting the asset ready for its intended use or sale. Again, lots of judgment is required in interpreting the term “temporary delay” and hence justify the capitalisation of borrowing costs.
How about cessation? How does an entity know when it should stop capitalising the borrowing costs? Both standards state that the capitalisation of borrowing costs should stop when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. Generally, asset is ready for its intended use when the physical construction has completed although the administrative works or minor modification is still required for the asset. Again, this is another area where entities need to exercise their professional judgment to determine and interpret what is considered as “substantially completed”. Difficulty also arises when asset is completed in parts and each part is capable of being used while construction continues on the other parts. This is because borrowing costs can only be capitalised for the parts that are still on-going while capitalisation ceases for the completed parts. Lots of judgments are required to determine whether each part is “capable of being used individually” from other parts which are still under constructions.
What are the disclosures required for borrowing costs under MPSAS 5, MFRS 123 and Section 25 of MPERS?
Both MPSAS 5 and MFRS 123 require entities to disclose:
- The amount of borrowing costs capitalised during the period.
- The capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.
However, as MPSAS 5 gives the option for the two treatments (i.e., benchmark treatment vs allowed alternative treatment) on the accounting treatment for borrowing costs, the standard further requires entities to disclose the accounting policy adopted for borrowing costs.
For borrowing costs expensed off, there is required disclosure for entity to disclose finance costs and total interest expense in the financial statements. The full details of MPSAS 5, MFRS 123 and Section 25 of MPERS are available on the respective issuing bodies website for your reference.
We will continue to discussion other differences in our upcoming articles. Meanwhile, you can read other relevant articles in Financial Accounting section.