Illustrative example – Group situations
- Parent Co has no operating activities of its own but performs management functions for its subsidiaries.
- Financing activities and cash management in the group are coordinated centrally.
- Finance Co is a vehicle used by the group solely for raising finance.
- All entities in the group prepare IFRS financial statements.
The following information is relevant for the current reporting period:
Real Estate Co:
- External general borrowings of C1,000,000 with an interest rate of 7% pa.
- Expenditures on qualifying assets during the period amounted to C1,540,000.
- All construction works were performed by Construction Co. Amounts invoiced to Real Estate Co included 10% profit margin.
- No borrowings during the period.
- Financed C1,000,000 of expenditures on qualifying assets using its own cash resources.
- Raised C2,000,000 at 7% pa externally and issued a loan to Parent Co for general corporate purposes at the rate of 8%.
- Used loan from Finance Co to acquire a new subsidiary.
- No qualifying assets apart from those in Real Estate Co and Construction Co.
- Parent Co did not issue any loans to other entities during the period.
Question: What is the amount of borrowing costs eligible for capitalisation in the financial statements of each of the four entities for the current reporting period?
No expenditure on qualifying assets have been incurred, so Finance Co cannot capitalise anything.
Real Estate Co:
Total interest costs in the financial statements of Real Estate Co equal C70,000. Expenditures on qualifying assets exceed total borrowings, so the total amount of interest can be capitalised.
No interest expense has been incurred, so Construction Co cannot capitalise anything.
Consolidated financial statements of Parent Co:
Total general borrowings of the group:
C1,000,000 (Real Estate Co) + C2,000,000 (Finance Co) = C3,000,000.
Although Parent Co used proceeds from its loan to acquire a subsidiary, this loan cannot be excluded from the pool of general borrowings.
Total interest expenditures for the group = C3,000,000 x 7% = C210,000.
Total expenditures on qualifying assets for the group are added up. Profit margin charged by Construction Co to Real Estate Co is eliminated:
Real Estate Co – C1,540,000/1.1 = C1,400,000.
Construction Co – C1,000,000.
Total consolidated expenditures on qualifying assets: C(1,400,000 + 1,000,000) = C2,400,000.
Capitalisation rate = 7%.
Borrowing costs eligible for capitalisation = C2,400,000 x 7% = C168,000.
Total interest expenditures of the group are higher than borrowing costs eligible for capitalisation calculated based on the actual expenditures incurred on the qualifying assets.
Therefore, only C168,000 can be capitalised.