Borrowing costs, government grants and inventory measurement at Northbridge Components Ltd
Northbridge Components Ltd, a private manufacturer with a 31 December year end, began constructing a new assembly line on 1 March 2024. It borrowed $8 million specifically for the project at 6% annual interest and had $12 million of general borrowings outstanding all year at 5%. Construction expenditure was $3 million on 1 March, $5 million on 1 July and $4 million on 1 October. The line was physically complete on 31 December 2024 but required essential testing before it could be used, which finished on 15 January 2025. Unused specific loan monies earned $60,000 of temporary investment income. Separately, on 1 April 2024 the company received a $1.2 million government grant toward equipment costing $4 million; the equipment was ready for use that day, has an eight-year life and a condition that it be retained for five years. Northbridge presents grants as deferred income. Inventory includes finished goods costing $1.5 million, expected to sell for $1.6 million with $250,000 selling costs, and raw materials costing $900,000 with net realisable value $870,000; the materials will be used in a profitable product line.
1. Calculate the borrowing costs capitalisable for the assembly line for the year ended 31 December 2024. Explain the capitalisation period and how the specific and general borrowings are treated.
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Capitalisation begins on 1 March 2024 when expenditure and borrowing activity start. It does not stop at 31 December 2024 because the asset is not ready for its intended use until essential testing finishes on 15 January 2025. Therefore 2024 includes ten months of capitalisation.
Specific borrowing:
- Actual interest: $8m x 6% x 10/12 = $400,000.
- Less temporary investment income on unused funds: $60,000.
- Net specific borrowing cost: $340,000.
General borrowings:
- Cumulative expenditure is $3m on 1 March, $8m on 1 July and $12m on 1 October.
- The $8m specific loan covers cumulative expenditure up to 1 July. Only the $4m spent on 1 October is funded by general borrowings, and it is outstanding for three months.
- Weighted average general-funded expenditure: $4m x 3/12 = $1m.
- Capitalisation rate on general borrowings: 5% because the only general borrowings carry 5%.
- Capitalisable general borrowing cost: $1m x 5% = $50,000.
Total borrowing cost capitalised in 2024 = $340,000 + $50,000 = $390,000. The remaining borrowing costs are expensed. No borrowing cost is capitalised in 2025 because the asset is ready for use on 15 January 2025.
2. Show how the government grant and related equipment affect the 2024 statement of profit or loss and statement of financial position, assuming no breach of conditions. State the amounts.
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The equipment is ready for use on 1 April 2024, so 2024 depreciation covers nine months: $4m / 8 years x 9/12 = $375,000.
Because Northbridge presents grants as deferred income, the grant is not deducted from the asset. The grant is recognised in profit or loss over the periods in which the related depreciation expense is recognised. With an eight-year asset life, 2024 grant income is $1.2m / 8 years x 9/12 = $112,500.
2024 profit or loss:
- Depreciation expense: $375,000.
- Grant income: $112,500.
- Net expense: $262,500.
31 December 2024 statement of financial position:
- Equipment carrying amount: $4,000,000 - $375,000 = $3,625,000.
- Deferred income: $1,200,000 - $112,500 = $1,087,500.
- Net carrying amount: $3,625,000 - $1,087,500 = $2,537,500, which equals the net presentation of a $2.8m grant-adjusted asset depreciated for nine months.
No breach has occurred. If a breach became probable, the repayment obligation would be assessed and a liability recognised rather than continuing to amortise the grant without adjustment.
3. Determine the carrying amount of inventory at 31 December 2024 and explain the treatment of the raw materials.
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Finished goods are measured at the lower of cost and net realisable value. NRV is $1.6m - $250,000 = $1.35m. Cost is $1.5m, so a write-down of $150,000 is required. Carrying amount: $1.35m.
Raw materials cost $900,000 and their standalone NRV is $870,000. However, they are held for use in production, not for direct sale. Under IAS 2, materials held for use are not written down merely because their replacement cost or NRV is below cost if the finished products into which they will be incorporated are expected to be sold at or above cost. The facts state the product line is profitable, so the raw materials remain at $900,000.
Total inventory carrying amount = $1.35m + $900,000 = $2.25m. The $150,000 write-down is recognised as an expense in 2024.