Key Points
- Capitalisation is mandatory, not optional, for borrowing costs directly attributable to a qualifying asset.
- Capitalisation begins when the entity incurs expenditures, incurs borrowing costs, and undertakes activities to prepare the asset for use or sale.
- The capitalisation rate for general borrowings is calculated as the weighted average of borrowing costs outstanding during the period, excluding any specific-purpose facilities.
- Capitalisation stops when substantially all activities necessary to prepare the asset for its intended use or sale are complete.
What is Borrowing Costs (IAS 23)?
IAS 23.8 requires an entity to capitalise borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset. A qualifying asset is one that necessarily takes a substantial period to get ready for its intended use or sale (IAS 23.5). The standard does not define "substantial period" numerically, so entities apply judgment. In practice, most preparers treat any construction or development phase exceeding 12 months as qualifying.
Borrowing costs eligible for capitalisation include interest calculated using the effective interest rate method, finance charges on leases recognised under IFRS 16, and exchange differences arising from foreign currency borrowings to the extent they adjust interest cost (IAS 23.6). When the entity borrows specifically for the qualifying asset, the capitalised amount is the actual borrowing cost minus any investment income earned on temporary deployment of those funds (IAS 23.12). When the entity draws on general borrowings, the capitalised amount is determined by applying a capitalisation rate to the expenditures on the asset, where that rate is the weighted average of borrowing costs applicable to the general pool (IAS 23.14).
The auditor's role under ISA 540.13(a) centres on evaluating whether the entity's method for determining the capitalisation rate is appropriate and whether the allocation between specific and general borrowings reflects the actual funding structure.
Worked example
Client: Italian infrastructure company, FY2025, revenue EUR 48M, IFRS reporter. Bonetti is constructing a toll-road bridge under a 30-month government contract. Construction began on 1 March 2025. By 31 December 2025, Bonetti has spent EUR 14M on the project.
Bonetti has two borrowing facilities. A specific project loan of EUR 10M drawn on 1 March 2025 at 4.5% per annum. A general revolving credit facility of EUR 20M at 3.8% per annum, from which EUR 4M of the bridge expenditure was funded. Bonetti invested EUR 2M of the undrawn specific loan proceeds in a short-term deposit earning 2.9% for two months before deploying the funds.
Step 1 — Identify the qualifying asset
The bridge requires 30 months of construction. This exceeds any reasonable interpretation of "substantial period." The asset qualifies under IAS 23.5.
Documentation note: record the construction start date, the expected completion date (August 2027), and the basis for concluding the asset meets the qualifying asset definition under IAS 23.5.
Step 2 — Calculate specific borrowing costs
Interest on the EUR 10M project loan for 10 months (March to December) is EUR 375,000 (EUR 10M multiplied by 4.5%, multiplied by 10/12). Investment income on the temporarily invested EUR 2M for two months is EUR 9,667 (EUR 2M multiplied by 2.9%, multiplied by 2/12). Net specific borrowing cost eligible for capitalisation is EUR 365,333 (IAS 23.12).
Documentation note: record the loan agreement terms, the deposit confirmation, and the net calculation per IAS 23.12. Cross-reference the interest expense to the bank statement and the investment income to the deposit maturity advice.
Step 3 — Calculate general borrowing costs
The expenditure funded from general borrowings is EUR 4M. The capitalisation rate is 3.8% (the weighted average of the general pool, which here consists of a single facility). General borrowing costs eligible for capitalisation for the relevant period are EUR 126,667 (EUR 4M multiplied by 3.8%, multiplied by 10/12, assuming the EUR 4M was drawn evenly from March). IAS 23.14 caps the capitalised amount at the actual borrowing costs incurred on the general facility during the period.
Documentation note: record the weighted average calculation, the expenditure draw-down schedule, and the cap test per IAS 23.14. If multiple general borrowings existed, the weighted average would blend all of them.
Step 4 — Total capitalised and year-end position
Total borrowing costs capitalised to the bridge asset for FY2025 are EUR 491,999 (EUR 365,333 plus EUR 126,667). The carrying amount of the asset under construction at 31 December 2025 is EUR 14,491,999 (EUR 14M expenditure plus EUR 491,999 capitalised borrowing costs). Remaining borrowing costs on the general facility that do not relate to the qualifying asset are expensed in profit or loss.
Documentation note: record the total capitalised amount, the carrying amount of the asset under construction, and the reconciliation to the trial balance. Confirm that capitalisation commenced when all three IAS 23.17 conditions were first met simultaneously.
Conclusion: the EUR 492,000 of capitalised borrowing costs is defensible because the qualifying asset determination, the split between specific and general borrowings, the offset of temporary investment income, and the capitalisation rate are each traceable to underlying loan agreements and expenditure records.
Why it matters in practice
Teams frequently capitalise borrowing costs during periods when active development is suspended. IAS 23.20 requires the entity to suspend capitalisation during extended periods in which it suspends active development of the qualifying asset. Construction delays caused by permitting or weather are common triggers. If the auditor does not compare the construction progress reports to the capitalisation period, overstated asset costs go undetected.
The capitalisation rate for general borrowings is often calculated including specific-purpose facilities that should be excluded. IAS 23.14 explicitly requires the weighted average to exclude borrowings made specifically to obtain a qualifying asset. Including the specific loan in the general pool distorts the rate and double-counts interest already capitalised under IAS 23.12.
Borrowing costs vs. finance costs in the income statement
| Dimension | Capitalised borrowing costs (IAS 23) | Finance costs expensed (IAS 23 / IAS 1) |
|---|---|---|
| Where they go | Added to the carrying amount of the qualifying asset on the balance sheet | Recognised in profit or loss as incurred |
| When they apply | Only during the period the qualifying asset is being acquired, constructed, or produced | All other periods, plus any borrowing costs not attributable to a qualifying asset |
| Effect on profit | Deferred; hit profit later through depreciation or amortisation of the completed asset | Immediate reduction in profit for the period |
| Audit focus | Verify the qualifying asset determination, the capitalisation start and stop dates, and the rate calculation | Verify completeness of finance cost disclosures under IAS 1.82(b) and the consistency of the capitalisation policy |
The distinction matters during construction phases. If the entity expenses borrowing costs that should be capitalised, it understates the asset and overstates the current-period loss. If it capitalises costs beyond the point when the asset is substantially ready, it overstates the asset and understates finance costs.
Related terms
Frequently asked questions
When do I stop capitalising borrowing costs?
IAS 23.22 requires capitalisation to cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. "Substantially all" means the asset is ready for its purpose, even if minor modifications or administrative work continue. If only a section of an asset is complete and usable independently, capitalisation stops for that section under IAS 23.24.
Do borrowing costs apply to inventory?
IAS 23.7 identifies inventory that takes a substantial period to manufacture or produce as a qualifying asset. Wine, spirits, aged cheese, and large-scale construction projects held as inventory all qualify. Routine inventory produced in large quantities on a repetitive basis does not qualify, even if the production cycle spans several months (IAS 23.4).
How do I audit the capitalisation rate for general borrowings?
Obtain the entity's schedule of all outstanding borrowings, identify which are specific-purpose and which are general, and recalculate the weighted average rate excluding specific facilities. ISA 540.18 requires the auditor to evaluate whether the inputs to the rate (principal amounts, interest rates, draw-down dates) are supported by loan agreements and bank confirmations. Compare the entity's rate to your independent recalculation and investigate differences exceeding a few basis points.