AS 16, Borrowing Costs, is often misunderstood as a rule that lets every interest cost connected with a project be added to the asset. The standard is narrower. Borrowing costs are capitalised only when they are directly attributable to the acquisition, construction or production of a qualifying asset; other borrowing costs are recognised as an expense. The practical task is to identify the qualifying asset, determine the attributable borrowings, and apply the commencement, suspension and cessation rules correctly.
ICAI's official AS 16 text contains the recognition and measurement rules, while the ICAI AS 16 publication page provides the dedicated professional-reference publication. This guide is for entities applying Accounting Standards rather than Ind AS.
What counts as borrowing costs?
Borrowing costs are interest and other costs incurred in connection with borrowing funds. AS 16 says they may include interest and commitment charges, amortisation of borrowing discounts or premiums and ancillary borrowing-arrangement costs, finance charges under finance leases or similar arrangements, and certain foreign-currency exchange differences to the extent treated as an adjustment to interest costs.
What is a qualifying asset?
A qualifying asset necessarily takes a substantial period of time to get ready for its intended use or sale. AS 16 says what is substantial depends on the facts and circumstances, although ordinarily twelve months is considered substantial unless a shorter or longer period can be justified.
Examples in the standard include manufacturing plants, power-generation facilities, inventories requiring a substantial period to become saleable, and investment properties. Assets ready for intended use or sale when acquired, and inventories routinely produced in large quantities over a short period, are not qualifying assets.
Specific borrowings: actual cost less temporary investment income
Where funds are borrowed specifically for a qualifying asset, the amount eligible for capitalisation is the actual borrowing cost incurred on that borrowing during the relevant period, less income earned from temporarily investing those borrowings. Finance teams should retain the loan account, drawdown dates, interest calculations, temporary-investment income and project-expenditure trail together.
General borrowings: apply a capitalisation rate
Where general borrowings are used to obtain a qualifying asset, AS 16 requires a capitalisation rate to be applied to expenditure on that asset. The rate is the weighted average of borrowing costs on borrowings outstanding during the period, excluding borrowings made specifically for a qualifying asset. Total borrowing costs capitalised for a period cannot exceed borrowing costs incurred during that period.
The working paper should therefore identify the general borrowings in the weighted-average rate, exclude specific project borrowings, show the qualifying expenditure base and apply the overall borrowing-cost cap.
When does capitalisation start?
Capitalisation begins only when all three conditions are satisfied at the same time:
- expenditure on the qualifying asset is being incurred;
- borrowing costs are being incurred; and
- activities necessary to prepare the asset for its intended use or sale are in progress.
The third condition is broader than physical construction. Necessary technical and administrative work before construction, such as obtaining permits, may qualify. Merely holding land without development activity that changes its condition does not.
When must capitalisation be suspended?
Capitalisation is suspended during extended periods in which active development is interrupted. Borrowing costs during such an interruption are costs of holding a partially completed asset rather than costs of preparing it for use or sale.
Not every delay causes suspension. Capitalisation is not normally suspended while substantial technical or administrative work continues, or when a temporary delay is a necessary part of getting the asset ready. The file should explain the nature and duration of an interruption rather than treating every pause in physical work alike.
When does capitalisation stop?
Capitalisation ceases when substantially all activities necessary to prepare the qualifying asset for its intended use or sale are complete. Routine administrative work or minor modifications do not ordinarily justify continuing capitalisation after the asset is substantially ready.
If a project is completed in parts and a completed part can be used independently, capitalisation for that part stops when substantially all activities necessary for that part are complete. AS 16 gives a business park with independently usable buildings as an example.
Worked illustration
Assume a company takes a specific ₹10 crore construction loan at 9% per year on 1 May. Project expenditure and necessary development activities begin on 1 June, so all three commencement conditions are first met on 1 June. Active development runs from June through November. Work is then completely interrupted for an abnormal extended period during December and January, with no substantial technical or administrative activity. Development resumes on 1 February and the asset is substantially ready on 31 March.
Assuming simple interest, no temporary-investment income and no other fact affecting eligibility, the active capitalisation periods are June to November and February to March: eight months. Illustrative borrowing cost eligible for capitalisation is ₹10 crore × 9% × 8/12 = ₹60 lakh. Interest for May is before commencement, while December and January fall within the extended interruption. The example shows why the loan date alone does not determine the capitalisation period.
Year-end AS 16 checklist
- Document why each asset meets the qualifying-asset definition.
- Separate specific borrowings from general borrowings.
- For specific borrowings, reconcile actual borrowing costs and temporary-investment income.
- For general borrowings, retain the weighted-average capitalisation-rate calculation and qualifying expenditure base.
- Evidence the date on which all three commencement conditions were met.
- Identify extended interruptions and document whether meaningful preparation activities continued.
- Record when each asset, or independently usable part, became substantially ready.
- Confirm capitalised borrowing costs do not exceed borrowing costs incurred for the period.
- Support disclosure of the borrowing-cost accounting policy and amount capitalised during the period.
Common mistakes
- Capitalising project interest merely because a loan exists.
- Treating every capital asset as a qualifying asset.
- Starting capitalisation on the borrowing date before expenditure or preparation activity begins.
- Failing to deduct temporary-investment income from specific-borrowing costs.
- Using a selected rate instead of the required weighted-average rate for general borrowings.
- Continuing capitalisation through an extended abnormal shutdown with no active development.
- Continuing capitalisation after the asset is substantially ready because minor work remains.
Practical takeaway
AS 16 is best applied as a timeline-and-attribution exercise. Prove the asset is qualifying, separate specific and general borrowings, calculate only the borrowing cost attributable to qualifying expenditure, start only when all three commencement conditions are met, suspend for extended inactive development periods, and stop when the asset is substantially ready. A project timeline tied to loan and expenditure records usually prevents the most common year-end errors.
