Convergence generally involves standard setters working together to achieve a standard that is superior to either of their existing standards. As a practical matter, in the short term, most changes have resulted in either the IASB or FASB modifying their standard to more closely conform to the standard of the other body. In the long term, where both boards’ standards on a given topic are perceived to need significant improvement, joint projects will result in entirely new standards.
Recently, the IASB has revised its guidance for interest capitalization in IAS 23, Borrowing Costs, to more closely conform to the U.S. standard, FASB Statement no. 34, Capitalization of Interest Cost. Previously, IAS 23 mirrored the U.S. GAAP standard in many ways but rejected mandatory capitalization, instead allowing both a “benchmark” and an “allowed alternative” method. The former immediately expensed all interest costs (called “borrowing costs” under IFRS), while the latter employed deferred expense recognition via capitalization.
IAS 23 as revised in 2007 (IAS 23R) requires capitalization of borrowing costs associated with qualifying assets (defined as those taking a substantial period of time to prepare for intended use or sale). Qualifying assets can be inventories, plant and equipment, intangibles and investment properties, unless the assets are accounted for at fair value (since adding borrowing costs would cause carrying amounts to exceed fair value, which is prohibited). Inventories that are routinely manufactured, or otherwise produced in large quantities on a repetitive basis, are outside the scope of IAS 23R.
Borrowing costs include interest as well as ancillary costs such as amortization of financing fees or charges and premium or discount on the borrowings. The basic principle is that avoidable borrowing costs incurred due to the acquisition, construction or production of qualifying assets are to be capitalized. When multiple, non-specific borrowings are incurred, the entity’s weighted average borrowing cost is the basis for capitalization. Also included in the definition of borrowing costs are exchange differences arising from foreign currency borrowings (to the extent they are regarded as an adjustment to interest costs), and finance charges associated with leases that are capitalized under IAS 17.
Borrowing cost capitalization under IAS 23R begins when the reporting entity first incurs expenditures for the asset; incurs borrowing costs; and undertakes activities that are necessary to prepare the asset for its intended use or sale. Expenditures are payments of cash or transfers of other assets, or incurrence of interest-bearing liabilities. Activities are broadly defined to include physical construction and also pre-construction technical and administrative work.
Borrowing cost capitalization does not take place, however, during periods when activities have ceased or have yet to begin, such as when land is held for future development. When substantially all necessary activities are completed, capitalization terminates.
The effective date of IAS 23R is Jan. 1, 2009, with earlier adoption encouraged. The amendments are to be applied prospectively; comparatives will not need to be restated, so if immediate expensing was previously employed and a long-lived asset is under construction at the adoption date, it will not be necessary to capitalize previously expensed borrowing costs.
While the latest revision to IAS 23 results from convergence efforts, differences with U.S. GAAP remain. These include the definition of borrowing costs, which is broader than interest cost under U.S. GAAP; the exclusion from qualifying assets under IAS 23R of investments accounted for by the equity method; and the treatment of exchange differences, which are included under IAS 23R but excluded under FASB Statement no. 34. These remaining differences are notable to U.S. CPAs, since if the United States ultimately adopts IFRS in place of U.S. GAAP, these will likely be the final differences.
By Barry Jay Epstein, CPA, Ph.D., a partner at Chicago-based Russell Novak & Co. LLP, and Eva Jermakowicz, CPA, Ph.D., a professor of accounting at Tennessee State University. Their e-mail addresses are firstname.lastname@example.org and email@example.com, respectively.
In 2002, FASB and the IASB published a joint memorandum of understanding that has come to be known as “The Norwalk Agreement.” This agreement outlined the commitment of the two standard-setting bodies to remove differences between U.S. GAAP and International Financial Reporting Standards (IFRS). This is the first column in a series that will examine the progress of joint projects between FASB and the IASB.