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Plain‑English explainer of HKAS 23 / IAS 23 for students, junior accountants and non‑specialists who find official standards too dense to read.
This article is based on Hong Kong Accounting Standards (HKAS / HKFRS), which are fully aligned with IAS / IFRS except for minor local tweaks, so the same principles generally apply under IAS / IFRS unless noted otherwise. The goal is to unpack HKAS 23 Borrowing Costs (equivalent to IAS 23) using plain English and practical, real‑life examples instead of technical jargon. It is written for students, junior accountants, audit juniors and finance professionals who want to understand not just “what the standard says” but how to actually read and prepare financial statements in line with it.
When you see “the company” or “the entity” below, you can think of any entity that prepares general purpose financial statements under HKFRS / IFRS.
Why can’t we always expense interest?
Imagine you work in a property development company, helping to review the numbers for a large office building project. The company has taken out a big bank loan to finance construction. Each month, interest on that loan accumulates—should all that interest go straight to profit or loss as an expense, or should some of it be added to the cost of the building?
Many beginners instinctively think “interest = expense, always”. HKAS 23 Borrowing Costs (equivalent to IAS 23) tells us the story is not that simple: it sets out when borrowing costs should be capitalised (included in the cost of an asset) and when they should be expensed (taken directly to profit or loss). This choice affects reported profit and also how comparable and fair the financial statements are to users.
What You Should Be Able To Do After Reading?
By the end, you should be able to:
- Understand the purpose and basic principles of HKAS 23 / IAS 23.
- Identify which items qualify as “borrowing costs” under the standard.
- Explain what a “qualifying asset” is and apply the key tests.
- Recognise common items that are scoped out of HKAS 23.
- Grasp the idea of “directly attributable” borrowing costs and why it is a judgment area.
1. The core aim and principle of HKAS 23 / IAS 23
HKAS 23 / IAS 23 aims to create a consistent method to decide which borrowing costs should be capitalised as part of the cost of certain assets. The whole standard can be summarised in one key sentence:
Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset must be capitalised; all other borrowing costs are expensed.
Capitalising means you treat interest and related borrowing costs as part of the asset’s cost and initially present them on the statement of financial position. The effect of those costs on profit only appears later through depreciation, amortisation or when the asset is sold. Expensing, on the other hand, means you recognise the borrowing costs immediately in the statement of profit or loss in the period they are incurred.
Why does this principle matter? When an asset takes a long time to get ready for use or sale, the related borrowing costs are part of what the company had to sacrifice to bring that asset to its working condition. For example, if a property development project takes three years to complete, the interest incurred during construction is clearly part of the economic investment into that building. If all that interest is expensed immediately, the reported cost of the project may look artificially low compared with the future income it generates.
2. What counts as “borrowing costs”?
Under HKAS 23 / IAS 23, borrowing costs is a fairly broad term. It is not limited to simple bank interest. Instead, it includes various costs that arise from borrowing funds, such as:
- Interest expense calculated using the effective interest method, including the amortisation of any premium or discount on borrowings.
- Amortisation of fees, transaction costs and other costs incurred when arranging borrowings.
- Certain finance costs on lease liabilities (for example under HKFRS / IFRS 16), which are treated as interest on borrowed funds.
- Exchange differences on foreign‑currency borrowings, but only to the extent that the standard allows them to be treated as an adjustment to interest costs.
Compared with US GAAP, which tends to focus more narrowly on actual interest paid, HKAS 23 / IAS 23 takes a more economic view of “financing cost”. If a cost arises because the entity raised debt finance, it is likely to fall into borrowing costs.
A simple example: a company issues bonds specifically to finance the construction of a factory and pays arrangement and issuance fees on that bond issue. Under HKAS 23 / IAS 23, those fees, when amortised using the effective interest method, form part of borrowing costs and may be capitalised if they are directly attributable to a qualifying asset. In contrast, if the company funds a project purely using retained earnings, distributions such as dividends are not borrowing costs and can never be capitalised under this standard.
In practice, clearly defining which costs are borrowing costs is the first step before you even think about capitalisation. This helps avoid mistakenly capitalising items that do not relate to financing at all.
3. What is a “qualifying asset”?
HKAS 23 / IAS 23 defines a qualifying asset as:
An asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
The key idea is time—not every asset qualifies. Buying a fully functioning machine that you can start using immediately is not a qualifying asset under this definition. The standard is aimed at assets that require a significant construction or development period.
Typical examples of qualifying assets include:
- Buildings and production facilities such as property developments and factories that require design and construction over an extended period.
- Intangible assets in development, for example, internally developed software or patents that are still being created.
- Large infrastructure, power plants, shipbuilding or similar long‑term construction projects.
- Certain inventories that take a long time to produce or mature, such as ageing wine or long‑term agricultural crops.
- Investment properties that are still under construction.
- Bearer plants, such as tea trees or fruit trees, that require several years before they start to bear produce.
On the other hand, the following are usually not qualifying assets:
- Inventories that are produced in a normal, short production cycle.
- Investments that are ready for use or sale immediately, including trading securities.
- Properties that are already complete and simply sitting vacant.
- Assets that are already in use and are only undergoing later refurbishment or upgrades.
A practical way to think about it:
If the asset goes through a clearly substantial period from start of construction or development to being ready for use or sale, and the company actually incurs borrowing costs during that period, then it probably is a qualifying asset.
For example, suppose a food manufacturer builds a new production line over 18 months and finances it using a specific bank loan. During those 18 months, interest is incurred mainly because of this project. That production line is a strong candidate for being a qualifying asset and its related borrowing costs may need to be capitalised.
But if the same manufacturer buys raw materials that are processed and sold within a few weeks, those inventories do not qualify—even if the company uses an overdraft or a short‑term facility to help manage working capital.
4. Items outside the scope of HKAS 23 / IAS 23
HKAS 23 / IAS 23 also tells us some costs and assets are deliberately excluded from the capitalisation rules. The reasons are usually that capitalisation would not be meaningful or would fail a cost‑benefit test.
Examples include:
- Equity costs – Returns to shareholders, such as dividends on ordinary shares, are not borrowing costs because shareholders are not creditors and their capital is not a borrowing.
- Assets measured at fair value, including some biological assets – Where assets are carried at fair value, with regular remeasurement through profit or loss, including borrowing costs in the carrying amount would add complexity without improving the information users receive.
- Inventories manufactured or produced over a short period – For products made quickly on a continuous basis, such as drinks or consumer electronics, trying to trace small portions of interest into each batch rarely adds value and may create significant administrative burden.
- Assets that are already ready for use or sale – Once an asset is ready for its intended use or sale, borrowing costs incurred afterwards can no longer be capitalised. For instance, interest expense related to a completed building during a vacant period must be expensed.
These exclusions reflect an important spirit of HKAS 23 / IAS 23: capitalisation should have a logical basis and should not make financial reporting more complicated without real benefit to users.
5. “Directly attributable”: the judgment hotspot
After identifying which costs are borrowing costs and which assets are qualifying assets, the final key question is:
Are the borrowing costs directly attributable to the acquisition, construction or production of that qualifying asset?
Under HKAS 23 / IAS 23, borrowing costs are directly attributable if they would not have been incurred had the expenditure on the qualifying asset not been made.
In straightforward cases, this is easy. For example:
- The company takes out a specific borrowing to finance a new factory.
- The loan agreement clearly states the funds are for that project.
- The company actually uses the borrowed funds to pay for construction costs.
In such cases, the interest on that specific borrowing is normally treated as directly attributable and is therefore eligible for capitalisation while the factory is under construction.
However, things become more complex in these situations:
- The company uses general borrowings (multiple loans or facilities) to finance many different projects at the same time.
- A group treasury raises funds centrally at the parent level and then allocates money around the group.
- Projects are completed in phases, and some borrowed funds sit idle or are temporarily invested before being used.
In those more complex scenarios, the company often has to use a weighted average capitalisation rate on general borrowings to determine how much of the interest can reasonably be linked to qualifying assets. That detailed calculation, and when to start or suspend capitalisation, is usually part of a more advanced discussion and will be covered in a follow‑up article.
For now, the key takeaway is that “directly attributable” is not just a mechanical rule. It involves judgment about whether, without the qualifying asset, those borrowing costs would still have been incurred. This is where exam questions and practical reviews of working papers often focus their testing.
6. Looking at borrowing costs from the top down
Understanding HKAS 23 / IAS 23 becomes easier if you see it as a three‑step filter:
- What is the nature of the cost? Is it genuinely a borrowing cost (interest, amortised fees, certain exchange differences on borrowings, etc.)?
- What type of asset are we dealing with? Does it meet the definition of a qualifying asset, i.e. does it require a substantial period of time to get ready for use or sale?
- How strong is the link between the borrowing and the asset? Would the borrowing costs have been incurred if the company had not spent money on that qualifying asset? If not, they are directly attributable and may need to be capitalised.
These three questions drive the final decision: capitalise or expense. For students and junior accountants, it is more important to internalise this framework than to memorise every detailed rule or formula. Once the logic is clear, applying the mechanics becomes much easier.
A good way to practise is to review notes to the financial statements that disclose borrowing costs, particularly for companies with large construction or development projects. Look at which borrowing costs are capitalised, which are expensed, and then ask yourself if that aligns with the three‑step framework above.
Key Takeaways for Students and Junior Accountants
- When you see interest in a trial balance or in working papers, pause and ask: is there any qualifying asset in the background that might justify capitalisation under HKAS 23 / IAS 23?
- For exam questions, quickly run through the three filters: (1) is it a borrowing cost, (2) is there a qualifying asset, and (3) is the borrowing cost directly attributable? This helps you avoid jumping straight to “expense everything”.
- Be careful with assets measured at fair value and short‑term inventories—these are classic traps where candidates mistakenly attempt to capitalise interest.
- When reviewing contracts or loan agreements, note which borrowings are clearly specific to a project and which form part of general borrowing pools; this will drive how much interest can be capitalised.
- In working papers, clearly document your reasoning for why certain borrowing costs are directly attributable to a qualifying asset (or why they are not); this is exactly what reviewers and auditors will look for.
- If you are unsure in practice, start from the conservative position (expense) and only move to capitalisation when all three conditions—borrowing cost, qualifying asset, direct attribution—are clearly satisfied.
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