How to Audit Borrowing Cost Capitalisation Under IAS 23

Why borrowing cost capitalisation keeps generating findings

IAS 23 is short. The core standard runs to 30 paragraphs plus application guidance. Auditors often assume that a short standard means a simple audit procedure. It doesn’t.

The capitalisation of borrowing costs requires meeting multiple conditions simultaneously. The asset must be a qualifying asset (IAS 23.5). Expenditures on that asset must have been incurred (IAS 23.17(a)). Borrowing costs must have been incurred (IAS 23.17(b)). Activities necessary to prepare the asset for its intended use or sale must be in progress (IAS 23.17(c)). If any one of those conditions drops away during the period, capitalisation must stop. When active development is suspended for an extended period, capitalisation is suspended (IAS 23.20). When substantially all activities are complete, capitalisation ceases entirely (IAS 23.22).

Most audit files test the first condition and skip the rest. The working paper confirms that a building is under construction (qualifying asset, yes) and that the client borrowed money (borrowing costs incurred, yes). But no one tested whether active construction was continuous throughout the capitalisation period. A six-week construction halt due to permit delays in Q3 should have triggered suspension under IAS 23.20. If it didn’t, the capitalised amount is overstated by six weeks of interest.

The FRC’s 2021-22 inspection findings on IAS 23 noted that audit files frequently lacked evidence of testing the commencement, suspension, and cessation conditions. The finding wasn’t that the client got the number wrong. It was that the auditor couldn’t demonstrate the number was right.

One more point for the planning stage: check whether IAS 23 even applies. The standard is mandatory for qualifying assets. But entities that don’t have qualifying assets don’t need IAS 23 procedures. A professional services firm with no construction projects, no long-term development work, and no inventory requiring a substantial preparation period can document that IAS 23 is not applicable and move on. Wasting time building an IAS 23 working paper for an entity that has no qualifying assets is audit inefficiency. Document the scoping decision, though. The reviewer will ask why IAS 23 procedures aren’t in the file, and “not applicable” needs a one-line rationale (no qualifying assets, no construction in progress, no long-term development expenditure).

What qualifies as a qualifying asset under IAS 23.5

IAS 23.5 defines a qualifying asset as one that necessarily takes a substantial period of time to get ready for its intended use or sale. The standard doesn’t define “substantial period.” In practice, this means judgment, and that judgment needs documentation.

Assets that clearly qualify: property under construction, manufacturing plants being built, power generation facilities, infrastructure projects, and inventories that require a substantial period to bring to a sellable condition (IAS 23.4 gives wine and aged spirits as examples). Assets that clearly don’t qualify: assets that are ready for use when acquired (office furniture, standard vehicles, off-the-shelf software). The distinction turns entirely on preparation time.

The grey area is narrower than most teams assume. A warehouse fit-out taking four months might qualify. Standard IT hardware installation taking two weeks doesn’t. The test isn’t whether the asset is expensive. It’s whether the preparation period is substantial. A €5M piece of equipment delivered and installed in a single day is not a qualifying asset. A €200K custom mould that takes eight months to fabricate is.

Two other boundaries matter. IAS 23.7 excludes financial assets and inventories manufactured or produced on a repetitive basis over a short period, even if they take time to sell. A car dealership holding vehicles in inventory for six months before sale does not capitalise borrowing costs on that inventory. The holding period is not a preparation period. And IAS 23.4 makes clear that qualifying assets can include inventories (wine, aged spirits, tobacco) where the production process itself is the substantial period.

For multi-component projects, assess each component separately. If an entity is constructing a production facility with a separately usable office wing, each component may have a different commencement and cessation date for capitalisation purposes (IAS 23.23). The office wing that’s finished in month six stops capitalising even though the production hall continues for another year.

Document the qualifying asset assessment as the first step in the working paper. Name the asset, state why it meets (or fails) IAS 23.5, estimate the preparation period, and record whether the client’s treatment is consistent with prior years. If the client capitalised borrowing costs on an asset that doesn’t qualify, every subsequent calculation is moot.

How to verify the capitalisation rate calculation

IAS 23 distinguishes between specific borrowings and general borrowings. The calculation method differs depending on which applies, and the segregation itself is the first audit judgment.

When the entity borrows specifically to obtain a qualifying asset, IAS 23.12 requires capitalisation of the actual borrowing costs incurred on that borrowing, less any investment income earned on the temporary investment of those funds. This is straightforward to audit: obtain the loan agreement, confirm the drawdown dates, calculate the interest for the capitalisation period, and subtract any income earned on unspent funds sitting in a deposit account. Confirm the loan purpose by reading the facility agreement’s purpose clause. If it restricts use to the qualifying asset, it’s a specific borrowing. If the agreement is silent on purpose, the entity’s internal accounting treatment and board minutes may provide supporting evidence.

General borrowings are more common in mid-tier engagements. When the entity funds a qualifying asset from its general borrowing pool, IAS 23.14 requires the auditor to verify a weighted-average capitalisation rate. The entity calculates this rate by dividing total borrowing costs for the period (excluding any borrowings made specifically for qualifying assets) by the weighted-average outstanding borrowings during the period (again excluding specific borrowings). That rate is then applied to the expenditures on the qualifying asset.

Two errors concentrate here. The denominator of the capitalisation rate must exclude specific borrowings entirely. If the entity has a €10M term loan specifically for the factory extension and a €25M revolving facility for general operations, only the revolving facility enters the general capitalisation rate calculation. Clients frequently include all borrowings in the denominator, which dilutes the rate and understates the capitalised amount.

The second common error: applying the capitalisation rate to the full qualifying asset cost rather than to the weighted-average expenditures incurred during the period. IAS 23.17(a) is explicit that expenditures must have been incurred. If the entity spent €2M in Q1 and €3M in Q3 on a qualifying asset, the weighted-average expenditure for the year is not €5M. It’s the time-weighted average of the drawdowns across the period. Applying the rate to €5M overstates capitalised borrowing costs. On a large project with uneven cash outflows, the difference between total expenditure and weighted-average expenditure can be material.

Use the ciferi Financial Ratio Calculator to benchmark the entity’s effective borrowing rate against the capitalisation rate applied. If the capitalisation rate is materially higher than the entity’s blended borrowing cost, the calculation warrants closer inspection.

IAS 23.14 also caps the capitalised amount: borrowing costs capitalised during a period cannot exceed total borrowing costs incurred during that period. This ceiling test is easy to perform and frequently omitted from audit files.

When capitalisation starts, suspends, and ceases

The timing rules in IAS 23.17 to IAS 23.25 determine the capitalisation window. Getting the dates wrong by even a few weeks can produce a material misstatement on large construction projects.

Capitalisation begins when three conditions are met simultaneously (IAS 23.17). The entity is incurring expenditures on the qualifying asset. Borrowing costs are being incurred. Activities necessary to prepare the asset for its intended use or sale are in progress. All three. If the entity signed the construction contract in March but the first payment wasn’t made until June, capitalisation cannot begin before June regardless of when construction started.

Suspension applies under IAS 23.20 when active development is interrupted for an extended period. The standard distinguishes between temporary delays that are a necessary part of the process (not triggering suspension) and extended periods during which active development stops (triggering suspension). A construction project halted for two months because of winter weather in a geography where winter shutdowns are standard practice does not trigger suspension (IAS 23.21). The same project halted for four months because of a contractual dispute with the builder does trigger it.

Document the distinction. The working paper should include a timeline of construction activity sourced from project management records, site visit logs, or progress certifications from the contractor. Cross-reference the timeline against the capitalisation period. Any gap that isn’t explained by routine seasonal or technical pauses needs assessment under IAS 23.20.

Cessation is governed by IAS 23.22: capitalisation stops when substantially all activities necessary to prepare the qualifying asset for its intended use or sale are complete. “Substantially all” requires judgment.

If the factory is operational and producing output but minor cosmetic work remains, capitalisation ceases when production begins. IAS 23.23 reinforces this: when construction is completed in parts and each part is capable of being used independently, capitalisation ceases for that part when substantially all activities for that part are complete. Waiting until the entire project completes to cease capitalisation overstates the capitalised amount for parts that entered use months earlier.

For the audit file, obtain the date the asset was brought into use (from the fixed asset register or commissioning certificate) and compare it to the date capitalisation ceased per the client’s calculation. If capitalisation continued beyond the commissioning date, the excess interest should be expensed.

A related point: IAS 23.25 addresses assets acquired over time in stages. When the entity completes a qualifying asset in phases and each phase can be used independently while construction continues on others, capitalisation for each completed phase ceases when substantially all activities for that phase are complete. A property developer finishing floor 1 of a five-storey building and leasing it out stops capitalising borrowing costs attributable to floor 1, even while floors 2 to 5 are still under construction. The working paper should track capitalisation windows separately for each independently usable component.

Worked example: Van Leeuwen Vastgoed B.V.

Client profile: Van Leeuwen Vastgoed B.V. is a Dutch property development company with €44M revenue, reporting under IFRS. The entity is constructing a mixed-use commercial building with an estimated total cost of €18M. Construction started in April of the prior year and is expected to complete in September of the current year. The entity has both a specific project loan and a general revolving credit facility.

1. Confirm the qualifying asset

The mixed-use building is under construction over an 18-month period. It clearly meets IAS 23.5: a substantial period of preparation. The fixed asset register shows the asset as “construction in progress” with a carrying amount of €12.4M at the start of the current year.

2. Calculate the specific borrowing component

Van Leeuwen has a €10M project-specific term loan at 4.2% drawn in April of the prior year. During the current year, the loan was fully drawn throughout. Gross interest on the specific borrowing: €420K. The entity earned €18K in interest on unspent project funds held in a short-term deposit during January and February (before the next construction milestone payment). Under IAS 23.12, capitalisable borrowing costs from the specific borrowing are €420K minus €18K, totalling €402K.

3. Calculate the general borrowing component

The entity also incurred qualifying asset expenditures in excess of the specific loan. Total expenditure on the building during the current year was €8.6M. The specific loan covered €10M (fully drawn from prior year), so the incremental expenditure funded from general borrowings needs calculation.

Weighted-average general expenditure for the current year (after deducting the portion funded by the specific loan): €2.1M.

Van Leeuwen’s general borrowing pool consists of a €15M revolving credit facility at 3.8% and a €5M overdraft facility at 5.1%. Weighted-average general borrowings outstanding during the year: €16.2M. Weighted-average capitalisation rate: ((€15M × 3.8%) + (€5M × 5.1%)) / €16.2M = 4.12%. Capitalisable borrowing costs from general borrowings: €2.1M × 4.12% = €87K.

4. Test for suspension

Construction progress reports from the contractor show a six-week halt in June and July due to a subcontractor insolvency. No work occurred on-site during this period. This is not a routine seasonal pause. IAS 23.20 requires suspension. The client’s capitalisation calculation does not reflect suspension. Overcapitalised interest for the six-week period: approximately €489K × (6/52) = €56K.

Practical checklist for your next engagement

1. Confirm the qualifying asset meets IAS 23.5 before testing any calculation. Document the asset, the preparation period, and why it qualifies. If it doesn’t qualify, stop here.
2. Obtain all loan agreements and identify which borrowings are specific to the qualifying asset and which form part of the general pool. The segregation drives the entire calculation.
3. For specific borrowings (IAS 23.12): calculate interest for the capitalisation period and subtract any temporary investment income on unspent funds.
4. For general borrowings (IAS 23.14): calculate the weighted-average capitalisation rate excluding specific borrowings from both the numerator and denominator. Apply the rate to weighted-average expenditures, not total expenditures.
5. Obtain construction progress reports, site visit logs, or contractor certifications. Map the activity timeline against the capitalisation period. Flag any halt exceeding two weeks for IAS 23.20 suspension assessment.
6. Verify the cessation date (IAS 23.22) against the commissioning or occupation date. If capitalisation continued after the asset entered use, the excess is an expense.

Common mistakes

• Including specific borrowings in the general capitalisation rate denominator (IAS 23.14). This dilutes the rate and understates capitalised costs. The PCAOB’s 2022 staff guidance on asset capitalisation noted that rate calculation errors were among the most frequent findings in construction-heavy industries.
• Failing to test the IAS 23.20 suspension conditions. Audit files confirm the qualifying asset and the rate but contain no evidence that construction activity was continuous. The FRC flagged this in its 2021-22 thematic review of capitalised costs, noting that working papers rarely included construction timelines or progress documentation.
• Applying the capitalisation rate to total qualifying asset expenditure rather than to weighted-average expenditures during the period. The difference can be material on projects with lumpy cash outflows.

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Further reading and source references

• IAS 23, Borrowing Costs: the source standard governing capitalisation of borrowing costs directly attributable to qualifying assets.
• IAS 16, Property, Plant and Equipment: governs the recognition and measurement of assets to which capitalised borrowing costs are added.
• IAS 2, Inventories: relevant for qualifying inventories that require a substantial preparation period.
• IFRS 15, Revenue from Contracts with Customers: relevant for construction contracts where IAS 23 capitalisation timelines intersect with revenue recognition.