Borrowing Costs Capitalisation
Why the interest a company pays on a loan taken to build a new factory doesn't always show up as an 'interest expense' in the P&L — sometimes it quietly becomes part of the factory's cost instead.
In plain English
Imagine a company borrows ₹500 crore at 10% interest, specifically to build a new power plant that will take 3 years to construct before it generates any electricity or revenue at all. During those 3 years, the company is paying real interest — roughly ₹50 crore a year. Should that interest be treated as a normal finance cost, reducing profit every year even though the plant isn't operational? Or does it make more sense to think of that interest as part of the genuine, unavoidable cost of BUILDING the plant — much like cement, steel, and labour — and add it to the plant's own cost on the balance sheet? Borrowing Costs Capitalisation is the specific rule that answers this question.
Words you'll need first
An asset that necessarily takes a SUBSTANTIAL period of time to get ready for its intended use — typically a power plant under construction, a large real estate development, or a major manufacturing facility being built from scratch. Assets ready for use quickly don't qualify — the concept exists specifically for genuinely long-gestation projects, where a meaningful amount of interest cost would otherwise build up before the asset ever starts earning anything.
Adding a cost to the value of an asset on the balance sheet, instead of expensing it immediately in the P&L. Once capitalised, borrowing costs become part of the asset's total cost, and get charged to the P&L gradually later, through DEPRECIATION, spread over the asset's useful life once it's up and running — rather than as a large, immediate INTEREST expense during construction, before the asset generates any revenue to offset it against.
Interest on a normal loan vs interest during construction
Ordinary borrowing costs
Interest on general working capital loans, or on borrowings not specifically tied to constructing a long-gestation asset, is expensed in the P&L as it's incurred, in the period it relates to — the standard, default treatment for the vast majority of a typical company's borrowing costs.
Borrowing costs on a qualifying asset under construction
Interest specifically attributable to funds borrowed for constructing a qualifying asset is CAPITALISED — added to the cost of that asset on the balance sheet — for as long as active construction is genuinely underway. Once the asset is substantially complete and ready for use, capitalisation stops, and further interest on the same loan reverts to being expensed normally.
A worked example, with numbers
| Item | Value |
|---|---|
| Loan amount | ₹500 crore |
| Interest rate | 10% per year |
| Construction period | 3 years |
| Total interest paid during construction (capitalised) | ₹150 crore |
- None of the ₹150 crore of interest paid during the 3-year construction period hits the P&L as an 'interest expense' — instead, it's added directly to the power plant's cost on the balance sheet, alongside the cement, steel, turbines, and labour that physically built it.
- This means the company's REPORTED profit during the 3 construction years is HIGHER than it would be if this interest were expensed immediately — a genuinely important distinction when judging a capital-intensive company's profitability during a heavy capex phase.
- Once the plant is commissioned, that capitalised ₹150 crore becomes part of the asset's total depreciable cost, and gets charged to the P&L gradually, as depreciation, spread over the plant's useful life — a much slower, smoother charge than the concentrated 3-year interest expense would have been.
- From the moment the plant is commissioned onward, any FURTHER interest on that same loan reverts to being a normal, immediately-expensed interest cost, since capitalisation only applies during the genuine construction period.
What it does to the financial statements
Impact on the P&L
- Capitalised borrowing costs reduce reported interest expense, and so boost reported profit, during a company's active construction phase — a materially different profit picture than if the same interest were expensed as incurred.
- Once capitalisation stops at commissioning, the same underlying interest cost begins showing up in the P&L again for any continuing borrowing, while the ALREADY-capitalised amount instead flows through gradually as part of depreciation over many future years.
- A company undertaking a large, multi-year capex programme can show meaningfully different reported profit trajectories purely based on how much of its financing costs qualify for capitalisation versus ordinary expensing.
- Analysts examining capital-intensive, high-growth companies sometimes separately track total interest PAID (visible in the cash flow statement) against interest EXPENSED in the P&L, to get a fuller picture of true financing cost burden during a heavy construction phase.
Impact on the Balance Sheet
- Capitalised borrowing costs increase the carrying value of the qualifying asset, typically sitting within Capital Work in Progress until construction is complete, then moving into Property, Plant & Equipment upon commissioning.
- This larger asset base means correspondingly larger future depreciation charges once the asset is operational, spreading the true, all-in cost of building the asset across its operational life, rather than concentrating the financing cost entirely in the construction years.
- A company with a large ongoing capitalised-interest balance within its Capital Work in Progress is effectively deferring a real, already-incurred cash cost into future periods' depreciation charges.
- If a qualifying asset's construction is suspended for an extended period, capitalisation of borrowing costs is required to be paused during that suspension, reverting to normal expensing until active construction resumes.
Which standard covers this
In India this is governed by Ind AS 23 – Borrowing Costs, notified under the Companies (Indian Accounting Standards) Rules and applicable to companies that follow Ind AS, mandating capitalisation of borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset, for as long as construction is actively underway.
How it's recognised globally
Globally, the equivalent is IAS 23, and Ind AS 23 mirrors its core mandatory-capitalisation approach and qualifying-asset definition closely — this represents a genuine convergence point, since IAS 23 was itself revised specifically to eliminate an older, alternative 'expense immediately' option that international standards used to permit. Under US GAAP, equivalent guidance sits in ASC 835-20, sharing the same fundamental principle of capitalising interest during a qualifying asset's construction period, with broadly similar mechanics for calculating the capitalisation rate on general borrowings — one of the more closely aligned technical accounting areas globally.
Real example — Indian listed company
Large infrastructure and engineering companies like Larsen & Toubro, which routinely undertake multi-year construction projects — power plants, metro rail systems, large industrial facilities — financed partly through project-specific or general corporate borrowings, are natural real-world settings for borrowing cost capitalisation. For a company managing a portfolio of long-gestation projects simultaneously, the borrowing costs capitalisation rules mean a meaningful part of the interest cost associated with under-construction projects doesn't show up as a drag on reported profit during the construction years, but instead builds up within the projects' own capitalised cost, to be depreciated gradually once each project is commissioned. This is exactly why analysts covering large infrastructure and EPC companies pay close attention to the split between interest expensed and interest capitalised, disclosed in the notes, since a rising proportion of capitalised interest can signal a genuinely large, growing pipeline of under-construction projects — a leading indicator of future revenue and depreciation, not simply a footnote curiosity.
Where you'll see this
Related concepts
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Depreciation Methods
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Impairment of Property, Plant & Equipment
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