Borrowing Costs on a Delayed Solar Project
Meridian Infra Ltd is constructing a 40 MW captive solar plant for its own factory. It borrowed ₹240 crore at 10% per annum. Construction began on 1 April 2023 and was expected to be ready for use by 31 March 2024. Because a state transmission licence was delayed, active construction stopped from 1 August 2023 to 30 November 2023; limited security and site maintenance continued. Interest of ₹24 crore was incurred for FY 2023-24, of which ₹8 crore relates to the four-month stoppage. The company temporarily invested ₹30 crore of unutilised loan funds in fixed deposits and earned ₹1.2 crore interest. The CFO has capitalised the full ₹24 crore as borrowing cost and separately recognised the ₹1.2 crore as other income, arguing that the plant is a qualifying asset. The audit committee wants the correct accounting treatment under Ind AS 23 and the effect on profit before tax. The project is still not complete on 31 March 2024.
1. Compute the amount of borrowing cost to be capitalised for FY 2023-24 and the amount to be expensed, with reasoning under Ind AS 23.
Read the worked answer
Ind AS 23 requires borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset to be capitalised. The solar plant is a qualifying asset. However, capitalisation must be suspended during an extended period in which active development is interrupted, unless the interruption is a necessary part of getting the asset ready. A four-month stoppage caused by a delayed transmission licence is not necessary for construction; site security and maintenance do not amount to active development. Therefore, the ₹8 crore of interest relating to the stoppage is expensed.
Income from the temporary investment of borrowed funds pending expenditure on the qualifying asset is deducted from the borrowing costs eligible for capitalisation. The ₹1.2 crore fixed-deposit interest must therefore reduce the capitalised amount, not be recognised separately as other income.
Computation:
- Total interest: ₹24.00 crore
- Less: interest during suspension: ₹8.00 crore
- Less: temporary investment income: ₹1.20 crore
- Capitalised borrowing cost: ₹14.80 crore
- Expensed borrowing cost: ₹8.00 crore + ₹1.20 crore = ₹9.20 crore
The CFO’s treatment of capitalising ₹24 crore and showing ₹1.2 crore as income is not correct under Ind AS 23.
2. What is the effect on profit before tax and on the loan covenant EBITDA if the CFO’s treatment is retained? Explain the quality-of-earnings concern.
Read the worked answer
Under the CFO’s treatment, profit before tax is higher by ₹10.4 crore: ₹9.2 crore of borrowing cost is not expensed and ₹1.2 crore of investment income is added. Correctly, the company expenses ₹9.2 crore and recognises no separate investment income. Therefore, PBT is overstated by ₹10.4 crore.
The EBITDA effect is smaller because interest expense is added back in EBITDA. Under the correct treatment, the ₹1.2 crore is not other income; under the CFO’s treatment it is included in EBITDA. Assuming the loan covenant defines EBITDA to include other income, EBITDA is overstated by ₹1.2 crore. The ₹9.2 crore finance cost is added back under both treatments. The covenant test should be checked against the actual definition; if EBITDA excludes other income, the covenant effect may be nil.
The quality-of-earnings concern is that capitalising interest during a construction stoppage and treating investment income as operating other income flatters both PBT and the debt covenant. It shifts current costs into future depreciation and hides the cost of the delay. The audit committee should require correction and disclosure of the accounting policy and the suspension period.
3. At year-end, costs incurred on the project are ₹210 crore and the recoverable amount is estimated at ₹180 crore. How should the company account for this, and can it avoid impairment by capitalising more interest?
Read the worked answer
The project must be tested for impairment under Ind AS 36 because there is an indication that the carrying amount may not be recoverable: the transmission licence delay and the project’s unfinished status. The carrying amount is ₹210 crore and the recoverable amount is ₹180 crore, so an impairment loss of ₹30 crore should be recognised in profit or loss. The loss should be allocated to the project asset, and the revised carrying amount should be depreciated once the asset is ready for use.
The company cannot avoid impairment by capitalising more interest. Ind AS 23 limits capitalisation to borrowing costs directly attributable to the qualifying asset and requires suspension during an extended interruption. Capitalising costs that do not meet the standard would increase the carrying amount further and worsen the impairment. The correct response is to record the impairment, disclose the judgement and assumptions, and reassess the project’s expected recoverable amount and completion timetable.