Interest during construction period

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

09 May 2014 SIR,
A MANUFACTURING UNIT IS RUNNING FOR THE LAST SEVERAL YEARS.IT HAS INSTALLED A NEW PLANT AND MACHINERY IN THE SAME PREMISES.
THE PLANT AND MACHINERY IS ON LOAN FROM BANK.
INTEREST CHARGED BY THE BANK FROM THE DATE OF FINANCE TILL THE DATE OF PRODUCTION IS RS. 3.00 LAC
SIR, WHETHER THE AMOUNT OF INTEREST WILL BE CAPITALISED OR WILL BE DEBITED TO PROFIT AND LOSS ACCOUNT
SIR, PLEASE GUIDE ME

CA Jitender Sharma

CA Jitender Sharma (Expert)
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09 May 2014 As per As 16 you can capitalised the Interest portion in cost of Plant and machinery.

Querist : Anonymous

Querist : Anonymous (Querist)

09 May 2014 SIR,
WE CAN CAPITALISE BUT WHAT IS THE CORRECT RULE
PLEASE GUIDE ME

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Querist : Anonymous

Querist : Anonymous (Querist)

09 May 2014 SIR,
IF WE DEBIT THE INTEREST TO PROFIT AND LOSS ACCOUNT WHETHER IT WILL BE ALLOWED BY INCOME TAX AUTHORITIES

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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01 August 2024 For a manufacturing unit that has taken a loan to install new plant and machinery, the treatment of interest expense during the construction period is governed by specific accounting and tax principles.

### Treatment of Interest During Construction Period

1. **Capitalization of Interest**:
- **Accounting Standards**: According to Accounting Standard (AS) 16 on Borrowing Costs, and also Ind AS 23, borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset should be capitalized as part of the cost of that asset. A qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale.
- **Tax Treatment**: As per the Income Tax Act, 1961, interest on borrowed funds used for the acquisition of an asset for the period up to the date the asset is first put to use is required to be capitalized. This means the interest cost is added to the cost of the asset and not debited to the profit and loss account.

2. **Period for Capitalization**:
- The period for capitalization of interest starts from the date the borrowing costs are incurred and continues until the asset is ready for its intended use.

3. **Post-Construction Period**:
- Once the asset is ready for its intended use, any further interest on borrowings is charged to the profit and loss account.

### Application to Your Scenario

**Scenario**:
- Your manufacturing unit has installed a new plant and machinery, and the interest charged by the bank from the date of finance till the date of production is Rs. 3.00 lac.

**Action**:
- The interest expense of Rs. 3.00 lac incurred during the construction period should be capitalized. This means it should be added to the cost of the plant and machinery.
- This interest will not be debited to the profit and loss account during the construction period.

### Example Journal Entries

1. **During the Construction Period**:
- **Journal Entry for Interest Capitalization**:
```
Plant and Machinery Account Dr. 3,00,000
To Bank Loan Interest Account 3,00,000
(Being interest on loan capitalized for the construction period)
```

2. **Post-Construction Period**:
- Once the plant and machinery are ready for use, any further interest expense on the loan would be charged to the profit and loss account.
- **Journal Entry for Post-Construction Interest**:
```
Interest Expense Account Dr. X,XXX
To Bank Loan Interest Account X,XXX
(Being interest on loan charged to P&L post construction period)
```

### Conclusion
- The interest incurred during the construction period of the plant and machinery should be capitalized and added to the cost of the asset.
- It should not be debited to the profit and loss account.
- Ensure that the period for capitalization ends when the asset is ready for its intended use.

If you follow this treatment, it will be in compliance with both accounting standards and tax regulations. If you have any further questions or need assistance with the specific entries, feel free to ask!