Chronology
IAS Plus Newsletter
Timetable
Background
This short-term convergence project is considering whether and how to converge IAS 23 Borrowing Costs and FAS 34 Capitalization of Interest Cost.
Discussion at the October 2005 IASB Meeting
Convergence Issues
The Board considered whether and how to amend IAS 23 Borrowing Costs. IAS 23 and FAS 34 Capitalization of Interest Cost, prescribe the accounting treatment for borrowing costs:
- IAS 23 permits two possible treatments, either the capitalisation of borrowing costs, to the extent that are directly attributable to the acquisition, construction or production of a qualifying asset (as defined), or alternatively, immediately expensing the borrowing costs.
- FAS 34 requires the capitalisation of borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset (as defined). Immediate expensing is not an option.
Not only is the fundamental approach different between IFRS and US GAAP, how the two sets of standards define a 'qualifying asset' is quite different.
The staff paper explored whether the Board should require capitalisation of interest on qualifying assets using what was termed an 'economic cost' model. In essence, this would result in an entity using the same discount rate as that used for testing for impairment in under the requirements of IAS 36 (a rate that reflects current market assessments of the risks specific to the asset being constructed). However, moving to this measurement approach would not result in convergence with US GAAP, unless the FASB agreed to adopt the same approach.
Some Board members welcomed the staff paper, saying that it was conceptually better than either IAS 23 or FAS 34. Others preferred expensing all interest costs as incurred, citing concerns about manipulation of profit or loss. A few Board members preferred an approach that would see constructed assets recognised on completion at fair value, with the gain or loss compared to costs of construction recognised (they did not say where, but probably in profit or loss).
The Board was reminded that this was a proposal related to a short-term convergence project and that such projects usually concentrated on eliminating alternatives. Some Board members noted that even eliminating the expensing option in IAS 23 would not achieve convergence with US GAAP because the definition of qualifying asset was different between the two sets of standards. One possibility would be to work on the capitalising approach based on economic cost, seeing whether there was any appetite on behalf of the FASB for change to their standard.
Conclusion
After a rather difficult debate, the Board agreed to proceed with a short-term convergence project on IAS 23 that would eliminate the alternative of immediate expense (as set out in IAS 23.7-9) (12 in favour; 2 opposed). It was noted that eliminating this alternative would not eliminate the SEC reconciling item for US registrants.
The staff was asked to return with an analysis of the definitions of 'qualifying assets' in IFRSs and US GAAP before the Board makes a decision on whether to seek convergence on this topic.
Discussion at the November 2005 IASB Meeting
The Board agreed with a staff proposal that the amendment to IAS 23 Borrowing Costs should eliminate the immediate expense alternative in the current standard but should not propose to use the capitalisation method in the US standard. The reason for this is that the method in US GAAP is not seen as 'a higher quality solution' than the current capitalisation method in IAS 23.
Discussion at the January 2006 IASB Meeting
At their meeting in November 2005, the Board had decided to address immediate expensing versus capitalising borrowing costs as a short term convergence project. For the January meeting, the staff prepared a paper setting out how the transitional provisions for only allowing capitalising should be addressed for existing IFRS users as well as for first time adopters.
The Board first considered the proposal as set out for existing IFRS users.
Some Board members questioned whether it should be mandatory to capitalise costs for projects started before the amendment was effected, but after the information necessary to apply the amendment was obtained. Some board members would like that to be an option, rather than a requirement, as they considered consistency in application to be more important.
The requirement for retrospective application as set out in the paper was defended by the staff. A choice for constituents could potentially delay implementation of these capitalisation requirements with several years on a lot of projects, as these are often long-term (building projects lasting several years).
The Board decided to issue an exposure draft proposing that:
- Existing IFRS users should apply the proposed amendments (required capitalisation) prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalisation is after the effective date - with an option to apply the capitalisation amendments starting at any date selected before the effective date.
- First-time adopters should have the same transition options as existing IFRS users (this will require amendment of IFRS 1).
The Board discussed whether the comment period on this exposure draft should be shorter than normal but decided the exposure period should be 120 days.
Discussion at the March 2006 IASB Meeting
The Board has decided to issue an exposure draft with an amendment to IAS 23 to remove the option to expense borrowing costs when they are incurred.
The Board agreed that this amendment should not be applied to borrowing costs directly attributable to the acquisition, construction or production of qualifying assets measured at fair value (such as biological assets). If this exception were not made, entities would be forced to capitalise interest costs on this assets, only to then write them back off again when remeasuring the assets to fair value.
Exposure Draft Issued May 2006
On 25 May 2006, the IASB published an Exposure Draft of proposed amendments to IAS 23. The Exposure Draft proposes to require an entity to capitalise borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. The option of immediately recognising those borrowing costs as an expense would be removed from IAS 23 Borrowing Costs. Click for Press Release (PDF 57k). Comment deadline is 29 September 2006.
Discussion at the November 2006 IASB Meeting
The Board discussed comments received on its Exposure Draft (ED) of proposed amendments to IAS 23 Borrowing Costs. The ED proposes to eliminate the option to expense immediately borrowing costs directly attributable to a qualifying asset.
A significant number of respondents expressed strong disagreement with the proposal in the ED to eliminate the option to expense as incurred. In light of comments received, the Board discussed whether it should proceed with the publication of a final amendment to IAS 23 or terminate the project.
The Board was split on how to proceed based on the comments received. Some Board members were persuaded by the quality of the comments from respondents and noted that they would support terminating the project. The proposal would eliminate the option to expense but there would still be significant differences as the requirements for capitalisation under US GAAP and IFRSs are different. Other Board members wanted to go forward with the project, noting that even if this was not convergence in detail it was still convergence in principle, and a better alternative than the current standard. Members also noted that the intention of this project was to improve the standard, not to come to the 'right answer'.
As this is one of the projects on the MOU, some Board members were concerned that it could jeopardise the MOU if the IASB dropped this project without at least discussing it with the FASB first. By 'jeopardise', Board members meant that the IASB could be seen not to take the MOU seriously by dropping projects when it met resistance from its constituents. Other Board members disagreed that this should stop them from dropping the project, if it was clear that continuing would result in a solution that is not helpful for constituents.
Due to the comments and the split view by Board members it decided that the staff should do further analysis on comments from respondents before the Board decides how to proceed.
Discussion at the December 2006 IASB Meeting
Whether to proceed with the amendments to IAS 23
The Board continued its redeliberations of planned amendments to IAS 23 Borrowing Costs. In particular, the Board discussed a staff recommendation that, notwithstanding the large-scale opposition from users, preparers, and other constituents, the Board should proceed with the amendments substantially as exposed and eliminate the option to expense interest as incurred, thereby mandating the capitalisation method.
The Chairman asked Board members whether any had changed their view on this essential question since the November meeting.
Ms O'Malley noted that she had changed he mind and now opposed continuing the project. She believed the ED had the correct answer and wanted to converge on the principle that capitalising interest was the correct approach, but she was concerned that the IASB had complicated the financial reporting of the very constituents it was trying to assist. Because it was not converging with US GAAP with respect to the definition of a 'qualifying asset' and measurement, it would force those IFRS entities filing in the US on Form 20F (or Form 18 for state-owned entities) to capitalise interest on two different bases and to reconcile material differences between them. This was unfair and unhelpful. She would vote for the amendment if the effective date is far enough in the future that this would not be an issue (that is, after the SEC's IFRS-US GAAP reconciliation is no longer required). Mr Cope and Mr Garnett noted that they still opposed the amendment, for various reasons.
Professor Barth was firmly in favour of the amendments: they removed an option in IAS 23, which would aid comparability, and moved IFRS closer to US GAAP in this area. Capitalising interest is consistent with the historical cost approach of measuring an asset at initial recognition at cost. She did not think that delaying the effective date would help. Mr McGregor thought the amendment would be an improvement, but was concerned about the disruption to IFRS preparers. However, if rejecting the staff's view would jeopardise the IASB's Memorandum of Understanding with the FASB, US Securities and Exchange Commission and the European Commission, he was prepared to vote in favour. Other Board members expressed this general view.
Senior staff suggested that it might be possible to ask the SEC whether they would require reconciliation of amounts of interest capitalised (at the moment, these amounts must be reconciled when material).
The Board voted by a majority of 10-4 to accept the staff recommendation and proceed with the amendments.
Amendments proposed by the staff
The Board considered two amendments proposed by the staff. The first was whether the revised IAS 23 should provide an exception from the general principle for certain inventories. The issue was raised by a constituent in the whisky and wine-making industry, who noted that while the effect on profit and loss was minimal, the effect on the balance sheet would be material because the inventories must mature for several years. Board members noted that it was exactly these types of inventories that should include interest cost in their carrying amount. However, having decided to converge in principle with US GAAP, the Board agreed to provide the same exception as in FAS 34 paragraph 10, such that 'interest cost shall not be capitalized for inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis'.
The Board also considered whether to amend the scope of the revised IAS 23 to include assets that are carried at fair value (except those within the scope of IAS 41 Agriculture). The issue concerns 'geography' within the statement of profit and loss and how the fair value adjustment is recorded: as the total change in fair value from period to period or the change between items (such as interest) included in the historical cost carrying amount and the fair value. After debating this issue at some length, the Board confirmed the position exposed in the ED (paragraph 3A) that there would be a scope exception for all assets measured at fair value, including biological assets.
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