When a company borrows money to finance the construction of a long-term asset, the interest incurred during the construction period is not immediately expensed — it is added to the cost of the asset being built. This process is called capitalisation of borrowing costs. Under IAS 23 (Borrowing Costs), capitalisation is mandatory for qualifying assets, not optional. The rationale is straightforward: interest incurred during construction is as much a part of the cost of bringing the asset to its intended condition and location as the materials and labour used to build it.
Qualifying Assets
Not all assets qualify for borrowing cost capitalisation. A qualifying asset under IAS 23 is one that necessarily takes a substantial period of time to get ready for its intended use or sale. The standard does not define “substantial” in months — it requires judgment based on the nature of the asset and the construction process.
| Qualifying assets | Not qualifying assets |
|---|---|
| Buildings under construction | Assets purchased ready for use |
| Manufacturing facilities being built | Standard inventory produced over short periods |
| Power plants and utilities infrastructure | Financial assets (investments, receivables) |
| Internally developed intangible assets (where development takes substantial time) | Assets that are routinely manufactured in large quantities on a repetitive basis |
| Investment property under development | Land held for sale (unless being developed) |
The Capitalisation Period
Capitalisation of borrowing costs begins when all three of the following conditions are met simultaneously (IAS 23.17):
- 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
Capitalisation is suspended during extended periods when active development is interrupted (IAS 23.20). Routine, unavoidable delays in the construction process do not require suspension — only periods where no active work is occurring.
Capitalisation ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete (IAS 23.22). This is typically when construction is physically complete and the asset could be used, even if it has not yet been brought into use.
Specific vs General Borrowings — Calculating the Amount to Capitalise
The method for calculating the amount of borrowing costs eligible for capitalisation depends on whether the borrowings are specific to the qualifying asset or general.
Specific borrowings
Where funds are borrowed specifically to obtain a qualifying asset, the borrowing costs eligible for capitalisation are the actual costs incurred on that borrowing during the period, less any investment income earned by temporarily investing those borrowed funds before they are deployed on the asset.
Specific borrowing example A company borrows $5,000,000 specifically to construct a factory. Annual interest rate: 6%. Construction period: 18 months. In the first 3 months, $1,500,000 of the loan is not yet deployed and is temporarily invested at 2% per annum.
Year 1 (12 months):
Interest incurred: $5,000,000 × 6% = $300,000
Less: investment income on $1.5M for 3 months: $1,500,000 × 2% × 3/12 = $7,500
Borrowing costs eligible for capitalisation: $292,500
Year 2 (first 6 months to completion):
Interest incurred: $5,000,000 × 6% × 6/12 = $150,000
Total capitalised over 18 months: $292,500 + $150,000 = $442,500
General borrowings
Where funds are borrowed generally and used (in part) to obtain a qualifying asset, the amount eligible for capitalisation is determined by applying a capitalisation rate to the expenditures on the qualifying asset. The capitalisation rate is the weighted average of borrowing costs on the entity’s general borrowings outstanding during the period.
General borrowing example An entity has two loans outstanding:
Loan A: $3,000,000 at 5% per annum
Loan B: $2,000,000 at 7% per annum
Weighted average capitalisation rate = ($3M × 5% + $2M × 7%) / $5M = ($150,000 + $140,000) / $5,000,000 = 5.8%
Average expenditure on qualifying asset during the year: $2,000,000
Borrowing costs eligible for capitalisation: $2,000,000 × 5.8% = $116,000
This amount cannot exceed total borrowing costs incurred during the period ($290,000 in this case — so $116,000 is within the cap).
💡 The capitalisation cap: The amount of borrowing costs capitalised cannot exceed the total borrowing costs incurred during the period. This prevents a situation where capitalised interest exceeds the actual interest cost — which could arise in theory where the capitalisation rate is applied to large expenditures on a qualifying asset but only small borrowings are outstanding.
Journal Entries
During construction — capitalising borrowing costs each period
| Account | Debit | Credit |
|---|---|---|
| Asset Under Construction (PP&E) | $292,500 | |
| Interest Expense (P&L) | $292,500 |
The credit to interest expense means the P&L is not charged during the construction period — the cost is deferred into the asset. When construction is complete and the asset begins depreciation, the capitalised interest is included in the depreciable cost, spreading its impact over the asset’s useful life.
When construction is complete — transfer to PP&E in use
| Account | Debit | Credit |
|---|---|---|
| Property, Plant & Equipment (in use) | Cost incl. capitalised interest | |
| Asset Under Construction | Cost incl. capitalised interest |
IFRS vs US GAAP
Both frameworks require capitalisation of borrowing costs on qualifying assets, but differ in scope and application:
| IFRS (IAS 23) | US GAAP (ASC 835-20) | |
|---|---|---|
| Requirement | Mandatory for all qualifying assets | Required for self-constructed PP&E and certain other assets; not required for assets produced in routine manufacturing |
| Qualifying assets | Any asset taking substantial time to prepare | Assets constructed for own use, assets intended for sale or lease built as discrete projects, equity method investees when activities are related to principal operations |
| Capitalisation rate | Weighted average of general borrowing costs | Similar weighted average approach but with different hierarchy; specific borrowings first, then weighted average of other borrowings |
| Investment income offset | Deducted from specific borrowing costs before capitalisation | Not always required to be deducted (varies by specific borrowing) |
Consolidation Implications — Intercompany Loans Funding Qualifying Assets
A common group scenario: the parent lends funds to a subsidiary specifically to finance the construction of a qualifying asset in the subsidiary. The subsidiary capitalises the interest on this intercompany loan into its asset under construction. The parent records interest income on the intercompany loan.
At consolidation, the intercompany interest is eliminated — but the subsidiary has capitalised it into PP&E rather than expensing it. The elimination entry therefore reduces PP&E rather than reducing an interest expense line:
Consolidation elimination — intercompany capitalised interest
| Account | Debit | Credit |
|---|---|---|
| Interest Income (Parent) | $292,500 | |
| Asset Under Construction / PP&E (Subsidiary) | $292,500 |
From the group’s perspective, the subsidiary funded construction from within the group — no external borrowing cost was incurred for this asset. The consolidated asset is therefore carried at a lower cost than the subsidiary’s own balance sheet shows, and the consolidated depreciation charge is correspondingly lower. This is an ongoing adjustment in each period until the asset is fully depreciated.
For groups with qualifying assets under construction funded by intercompany borrowings, BrizoConsol provides the consolidation framework to track the capitalised interest elimination as an ongoing adjustment — ensuring the group’s PP&E balances and depreciation charges accurately reflect external borrowing costs only. Learn more or see it in action →