Goods remain in a warehouse for nine months before sale, while the business continues paying financing costs. Does that financing become part of the goods' cost because they were held for a long time? Holding time alone is not the test. There is a fundamental difference between an asset that takes substantial time to become ready and finished goods waiting for a buyer.
IAS 23 links capitalisation to borrowing costs directly attributable to a qualifying asset; other borrowing costs are expensed. The discussion therefore starts with the asset and its preparation, not with selecting the account that improves reported margin. Adding a cost to an asset changes the timing of its effect on results. It does not remove the economic cost or return the cash paid.
A full warehouse or a lengthy production process?
A trader buys completed appliances that are ready for sale on receipt, but demand subsequently slows. Passing months do not turn those appliances into qualifying assets simply because their purchase loan remains outstanding. By contrast, a production process may necessarily take substantial time before an output becomes saleable. That situation requires assessment of the standard's conditions, scope and relevant exceptions rather than applying one conclusion to every inventory item in a factory.
A practical question for production management is what necessary work remains before readiness. “We are waiting for a better price” differs from “a required technical process remains incomplete.” Connect the explanation to production stages, specifications and completion records instead of relying on a general description in an accounting worksheet.
A simple calculation after eligibility is established
Assume an asset has been established as qualifying and a dedicated SAR 1 million loan carries a simplified annual rate of 6%. Assume the full amount funds the asset throughout six eligible months, with no temporary investment income, additional fees or relevant interruption. The illustrative calculation is SAR 1,000,000 × 6% × 6 ÷ 12, giving SAR 30,000.
The arithmetic is straightforward, but “six eligible months” contains much of the judgment. Drawing the loan six months ago is not enough: evidence must establish the qualifying period. Nor should the full million be used if the facts or financing structure require different treatment. For general borrowings, do not transplant this formula without analysing expenditures, the capitalisation rate and applicable limits.
If a bank statement includes financing costs for general working capital, do not place them all against the longest production order. Reconnect each amount to its funding agreement, purpose, period and calculation. Where dedicated borrowings were temporarily invested, examine the income's effect on eligible costs instead of ignoring it because payments and receipts passed through different accounts.
A timeline instead of an automatic monthly percentage
Maintain a timeline showing expenditure, borrowing costs, necessary preparation activities, interruptions and readiness evidence. It helps the reviewer assess commencement, suspension and cessation under the circumstances rather than allowing a monthly entry to continue until the loan is fully repaid.
- Distinguish funding drawdown from its use for qualifying expenditure.
- Explain interruptions: are they necessary to the process or disruptions requiring separate assessment?
- Reconcile approved costs to financing statements, recording excluded amounts and reasons.
- Review whether a completed part can operate or be sold independently instead of automatically waiting for the entire project.
Loan costs may continue after the asset is ready. An outstanding debt does not independently justify continuing capitalisation. Accounting therefore needs a readiness notification from operations, rather than discovering at the first sale that production finished two months earlier.
Present capitalised and expensed financing costs clearly in profitability discussions. A higher period profit caused by accounting timing is not a reduction in financing cost, nor proof that holding substantial inventory has become free. A good file lets a reviewer assess the decision before recalculating the amount: a precise percentage cannot repair an asset classified incorrectly from the outset.
Sources & further reading
Visit the original source to explore the concept and its wider context.
General educational content. Appropriate treatment depends on your business and accounting policies; consult your accounting professional when applying it to business records.
