Borrowing cost

From CEOpedia | Management online

Borrowing cost - "Include interest and other costs incurred by an entity in relation to borrowing of funds." (Abbas A. Mirza, Magnus Orrell, Graham Holt, 2008, p. 170).

In general, borrowing costs include interest costs. However, these are not only the costs of interest on short-term borrowings, such as hank overdrafts and obligated bills of exchange, or long-term borrowings, such as term loans and mortgages (Abbas A. Mirza, Magnus Orrell, Graham Holt, 2008, p. 171).

Components of the total borrowing costs

The components of the total cost of the loan include (D. W. Adams and G. I. Nehman, 1979, p. 166):

  • interest rate
  • fee for considering the application
  • interest
  • preparation fee
  • commission
  • payment for establishing a security
  • expenses for insurance on loan repayment
  • administrative fee
  • time and travel expenses involved in the loan transaction

Other related costs with borrowing cost

Borrowing costs are interest and other costs incurred in borrowing funds. Financing costs may include (Abbas A. Mirza, Magnus Orrell, Graham Holt, 2008, p. 171):

  • Interest on overdraft facilities and interest on short-term and long-term loans and credits
  • "Amortization of discounts or premiums relating to borrowing
  • Amortization of ancillary costs incurred in connection with the arrangement or borrowings
  • Exchange differences arising from foreign currency borrowings to the extent they are regarded as an adjustment to interest costs
  • Finance charges in respect of finance leases".

Borrowing costs eligible for capitalization

Borrowing costs that are directly related to the construction, acquisition or production will qualifying to such an asset that requires a significant amount of time to prepare it for its intended use or sale, then such borrowing costs eligible for capitalization. They contain the actual borrowing costs incurred, less income on the momentary investment from these borrowings. The application of the capitalization rate to the expenditures incurred on this asset will determine the altitude of borrowing costs eligible for capitalization (PKF International Limited, 2015, p. 189).

The capitalization rate This is the initial return expected by the purchaser of the property, expressed as a percentage of the purchase price of the property fully covered by cash.

To be able to capitalize on interest, the necessary conditions should be met:

  • the construction of assets has already started (the necessary actions have been taken that constitute the planning phase)
  • some expenses have already been made,
  • interest costs are incurred.

Capitalization of acquisition costs or manufacturing costs ends when the asset is adjusted to the place and conditions needed to start operating as intended by management, i.e. the asset is ready for use.

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Author: Weronika Chudzik