CAF-1 · Chapter 2
IAS 23 Borrowing Costs MCQs with Answers
15 multiple-choice questions on IAS 23 Borrowing Costs for CAF-1 Financial Accounting and Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following assets would typically be classified as a 'qualifying asset' under IAS 23, allowing for the capitalization of borrowing costs?
- A) Inventories that are routinely manufactured in large quantities on a repetitive basis over a short period.
- B) A custom-built power plant that takes two years to construct.
- C) Manufacturing equipment purchased that is ready for its intended use upon delivery.
- D) Financial assets held for trading purposes.
Show answer & explanation
Answer: B) A custom-built power plant that takes two years to construct.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Routine inventories and assets ready for use upon purchase do not qualify.
Question 2
Under IAS 23, which of the following is NOT considered a borrowing cost?
- A) Interest expense calculated using the effective interest method.
- B) Exchange differences arising from foreign currency borrowings to the extent they are regarded as an adjustment to interest costs.
- C) Equity dividends declared and paid to ordinary shareholders.
- D) Finance charges in respect of finance leases.
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Answer: C) Equity dividends declared and paid to ordinary shareholders.
Borrowing costs are interest and other costs incurred in connection with the borrowing of funds. Dividends paid on equity are distributions of profit, not costs associated with borrowing funds.
Question 3
Delta Inc. borrowed Rs. 40 million specifically to construct a qualifying asset. Before the funds were needed for construction, Delta temporarily invested the unused portion and earned Rs. 1.5 million in interest income. How should this investment income be treated?
- A) Recognized as other income in the statement of profit or loss.
- B) Deducted from the total borrowing costs eligible for capitalization.
- C) Added to the overall cost of the qualifying asset.
- D) Credited directly to retained earnings.
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Answer: B) Deducted from the total borrowing costs eligible for capitalization.
IAS 23 dictates that the amount of borrowing costs eligible for capitalization on a specific borrowing must be reduced by any investment income earned on the temporary investment of those borrowed funds.
Question 4
Which of the following is typically excluded from being a 'qualifying asset' under IAS 23?
- A) Manufacturing plants.
- B) Custom-built power generation facilities.
- C) Financial assets and short-term manufactured inventories.
- D) Investment properties taking two years to develop.
Show answer & explanation
Answer: C) Financial assets and short-term manufactured inventories.
Financial assets and inventories manufactured over a short period are not qualifying assets.
Question 5
Which of the following costs is NOT considered a borrowing cost under IAS 23?
- A) Interest expense using the effective interest method.
- B) Exchange differences on foreign currency borrowings acting as interest adjustments.
- C) Dividends paid to equity holders.
- D) Finance charges related to specific loans.
Show answer & explanation
Answer: C) Dividends paid to equity holders.
Dividends paid to equity holders are distributions of profit, not borrowing costs under IAS 23.
Question 6
What is the condition for capitalizing borrowing costs regarding the probability of economic benefits?
- A) It is possible they will result in future economic benefits.
- B) It is probable they will result in future economic benefits and can be measured reliably.
- C) It is certain they will generate immediate cash flows.
- D) Borrowing costs are never capitalized.
Show answer & explanation
Answer: B) It is probable they will result in future economic benefits and can be measured reliably.
Borrowing costs are capitalized when it is probable that they will result in future economic benefits and the costs can be measured reliably.
Question 7
When does the capitalization of borrowing costs commence?
- A) When the loan agreement is signed.
- B) When the asset is physically completed.
- C) When expenditures and borrowing costs are incurred, and activities to prepare the asset have begun.
- D) When the first interest payment is made.
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Answer: C) When expenditures and borrowing costs are incurred, and activities to prepare the asset have begun.
Capitalization commences when expenditures and borrowing costs are incurred, and activities to prepare the asset for its intended use or sale are underway.
Question 8
During a major construction project, work is suspended for four months due to a prolonged labor strike. What should happen to the borrowing costs during this period?
- A) They should be capitalized as normal.
- B) Capitalization should be suspended, and the costs expensed.
- C) They should be added directly to equity.
- D) They should be deferred until the asset is sold.
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Answer: B) Capitalization should be suspended, and the costs expensed.
An entity shall suspend capitalization of borrowing costs during extended periods in which it suspends active development of a qualifying asset.
Question 9
If a temporary delay is a necessary part of getting an asset ready (e.g., waiting for high water levels to recede during bridge construction), how are borrowing costs treated?
- A) Capitalization is suspended.
- B) Capitalization continues during this necessary delay.
- C) They are expensed immediately.
- D) They are offset against future sales.
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Answer: B) Capitalization continues during this necessary delay.
Capitalization is not suspended when a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale.
Question 10
When are borrowing costs generally considered to cease being capitalized?
- A) When the final loan installment is paid off.
- B) When the asset is completely sold to a customer.
- C) When substantially all activities necessary to prepare the asset for its intended use or sale are complete.
- D) When the warranty period expires.
Show answer & explanation
Answer: C) When substantially all activities necessary to prepare the asset for its intended use or sale are complete.
Capitalization ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
Question 11
Omega Corp invests unused specific borrowed funds and earns Rs. 2 million in interest. How is this income treated under IAS 23?
- A) Added to the cost of the asset.
- B) Recognized as general business revenue.
- C) Deducted from the borrowing costs eligible for capitalization.
- D) Ignored for accounting purposes.
Show answer & explanation
Answer: C) Deducted from the borrowing costs eligible for capitalization.
The amount of borrowing costs eligible for capitalization on a specific borrowing is reduced by any investment income earned on the temporary investment of those funds.
Question 12
For funds borrowed generally, how is the amount of borrowing costs eligible for capitalization determined?
- A) By applying a capitalization rate based on the weighted average of general borrowings.
- B) By using the highest interest rate among all loans.
- C) By using the risk-free market rate.
- D) General borrowings cannot be capitalized.
Show answer & explanation
Answer: A) By applying a capitalization rate based on the weighted average of general borrowings.
For general borrowings, the eligible borrowing costs are calculated by multiplying expenditures by a capitalization rate, which is the weighted average of general borrowing costs.
Question 13
An entity completes a business park in stages, where each building can be used independently. What is the rule for ceasing capitalization?
- A) Cease capitalization only when the entire business park is finished.
- B) Cease capitalization for each building as its specific necessary activities are substantially completed.
- C) Continue capitalization until the park is fully occupied by tenants.
- D) Suspend capitalization until all buildings are painted.
Show answer & explanation
Answer: B) Cease capitalization for each building as its specific necessary activities are substantially completed.
If an asset is completed in parts and each part can be used independently, capitalization ceases for a specific part when its necessary activities are substantially complete.
Question 14
Which of the following must an entity disclose in its financial statements regarding borrowing costs?
- A) The names of the banks providing the loans.
- B) The amount of borrowing costs capitalized and the capitalization rate used.
- C) The personal credit score of the directors.
- D) The total expected future borrowing costs for the next ten years.
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Answer: B) The amount of borrowing costs capitalized and the capitalization rate used.
IAS 23 requires disclosure of the amount of borrowing costs capitalized during the period and the capitalization rate used.
Question 15
If an entity incurs minor modifications, such as decorating a property to a user's specification, does capitalization of borrowing costs continue?
- A) Yes, until the decoration is 100% finished.
- B) No, because substantially all core activities are considered complete.
- C) Yes, because decoration is a major structural change.
- D) No, capitalization must cease exactly one year after it starts.
Show answer & explanation
Answer: B) No, because substantially all core activities are considered complete.
If only minor modifications like decoration are outstanding, this indicates substantially all activities are complete and capitalization should cease.