Ind AS 23 | Accounting Treatment for Interest on Project-Specific Loans and Adjustment of Investment Income

1. Facts

Metro Link Infrastructure Limited, hereinafter referred to as “the Company,” is engaged in the business of development and construction of a metro rail network. The project is fully funded by the Government of India (GoI) through interest-free subordinate debt specifically earmarked for project execution.

During the year, the Company received substantial subordinate debt from the Government to meet capital expenditure requirements of the metro system, which is currently under construction. The Company applies the principles of Ind AS 109, Financial Instruments, for financial reporting purposes. Accordingly, the subordinate debt is measured at fair value on initial recognition, and the difference between the amount received and the fair value is treated as a government grant. Further, for subsequent measurement, the company applies the Effective Interest Rate (EIR) method, resulting in recognition of a notional interest expense over the tenure of the debt.

As per the company’s accounting policy, the borrowing costs that are directly attributable to the construction of a qualifying asset are capitalised in accordance with Ind AS 23, Borrowing Costs. Therefore, the interest expense arising from fair valuation of the subordinate debt determined under the effective interest method has been charged to Capital Work-in-Progress (CWIP), as it relates specifically to the ongoing construction of the metro infrastructure.

Furthermore, the Company has temporarily deployed a portion of the unutilised subordinate debt proceeds in short-term investments. The investments generated interest income, which the Company has recognised in the Statement of Profit and Loss considering it as an incidental income earned during the construction phase.

State whether the accounting treatment for interest on subordinate debt is appropriate. Further, analyse whether the interest income earned from temporary deployment of project specific subordinate debt funds should be adjusted against the cost of the qualifying asset or should continue to be recognised in profit or loss?

2. Relevant Provision

Ind AS 109 – Financial Instruments

Para 4.2.1 of Ind AS 109

An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:

(a) financial liabilities at fair value through profit or loss.

(b) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies.

(c) financial guarantee contracts …………….

Amortised cost of a financial asset or financial liability

The amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance.

Effective Interest Method

The method that is used in the calculation of the amortised cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period.

Effective Interest Rate

The rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a financial liability.

Ind AS 23 – Borrowing Costs

Para 8 of Ind AS 23

An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognise other borrowing costs as an expense in the period in which it incurs them.

Para 12 of Ind AS 23

To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.

Para 13 of Ind AS 23

The financing arrangements for a qualifying asset may result in an entity obtaining borrowed funds and incurring associated borrowing costs before some or all of the funds are used for expenditures on the qualifying asset. In such circumstances, the funds are often temporarily invested pending their expenditure on the qualifying asset. In determining the amount of borrowing costs eligible for capitalisation during a period, any investment income earned on such funds is deducted from the borrowing costs incurred.