Capitalisation of borrowing costs

What it means

Capitalisation of borrowing costs means that interest on a loan used to acquire an asset is not expensed immediately but included in the asset's acquisition cost. It then reaches the income statement gradually through depreciation over the asset's useful life.

It covers interest for the period from the start of acquisition until the asset is put into use, for example while a hall financed by an investment loan is being built. Once the asset is in use, further interest is charged to finance costs in the normal way, since the asset is now generating benefit.

Slovak accounting procedures allow such interest to be included in the measurement of fixed assets. Under IFRS, in IAS 23, capitalisation is mandatory for qualifying assets, meaning those that take a substantial period of time to get ready for their intended use.

How it works in practice

During construction, costs including interest accumulate in the account for assets under construction. When the asset is brought into use, the whole amount is transferred to fixed assets and depreciation begins. The company's internal accounting policies should state whether and how it capitalises interest.

If a loan finances several things at once, interest must be allocated according to the portion of the loan used for the asset being acquired. With general working capital financing, capitalisation is debatable, so for larger investments a separate purpose-specific loan makes things simpler.

For tax purposes, capitalised interest increases the input price and is deducted through tax depreciation, which for buildings means over decades. The company loses an immediate tax deduction, but in the early years it reports higher accounting profit, which can help when a bank assesses it.

What to watch out for

Capitalisation does not get around the thin capitalisation rules. Interest paid to related parties above the limit set by the Income Tax Act is not tax deductible, whether it is expensed or added to the cost of the asset.

If construction is suspended for an extended period, interest for that period should not be capitalised because it does not relate to active preparation of the asset. Changing the approach between years is a change in accounting policy that must be justified and disclosed in the notes.