what is included in finance cost in the profit and loss account

Finance cost under Ind AS is a container rather than a single item. It commonly holds interest on borrowings, interest on lease liabilities, the unwinding of discount on long-dated provisions such as site restoration, and the amortisation of transaction costs under the effective interest method. Only the first of those is the price of borrowed money, and the finance cost note splits them out — which is why dividing the printed line by borrowings produces a rate no lender ever quoted.

how to calculate the implied cost of debt from an annual report

Take interest on borrowings from the finance cost note, add back the borrowing costs capitalised during the year, and divide by the average of opening and closing gross borrowings. The capitalised interest left the bank exactly as the expensed interest did; it was added to the cost of an asset under construction instead of charged against profit. Then compare the answer against the rates the borrowings note itself quotes and against the company’s credit rating band.

why is my calculated cost of debt higher than the rate in the borrowings note

Usually because the average of opening and closing borrowings understates the debt actually carried through the year — money drawn for most of the year and repaid shortly before the reporting date. Sometimes that is a genuine repayment from a receipt that landed in March, and sometimes the year-end figure has been arranged, since gross debt on the reporting date is among the easiest numbers in the accounts to manage. Interest accrues across all twelve months and cannot be arranged the same way, which is precisely why this reconciliation catches it.

does capitalised interest affect the interest coverage ratio

Yes, and in the company’s favour. Interest cover computed on the printed finance cost ignores the interest sitting inside capital work in progress, so a company midway through a large project shows better cover than the interest it is actually paying would support. When the asset is ready and capitalisation stops, the charge lands in the profit and loss account and cover falls mechanically, with borrowings unchanged.

What the debt actually costs, worked backwards

A company opened the year with ₹1,900 crore of borrowings and closed it with ₹2,500 crore, so it carried roughly ₹2,200 crore on average. The finance cost line in the profit and loss account reads ₹186 crore. Divide one by the other and the company appears to be borrowing at about 8.5% a year. It is rated several notches below the borrowers who actually pay that, its own borrowings note quotes rates in the low teens on most of its facilities, and no lender has given it a concession. Nothing in the accounts is wrong. The finance cost line is simply not the interest the company incurred, and the four lines that reconcile the two tell you something specific about what the company is doing.

Think of it like this

The electricity bill during the renovation

Your monthly bill halves for five months. Nobody negotiated a tariff and nothing became more efficient — the family was living at your mother’s while the flat was being done up, and the consumption moved somewhere else. When you move back it returns to what it was, and the fact that it was low for five months tells you about the renovation rather than about the tariff.

In the market

Interest incurred while an asset is being constructed is added to the cost of that asset instead of being charged against profit. The money leaves the bank either way. The profit and loss account simply does not carry it, and the finance cost line falls for a reason that has nothing to do with the rate.

Getting from the printed line to the rate actually paid

Four steps, all of them from disclosed figures

1
Start with the finance cost line, then read its note
Finance cost under Ind AS is a container, not a single item. It commonly includes interest on borrowings, interest on lease liabilities, the unwinding of discount on long-dated provisions such as site restoration, and the amortisation of transaction costs under the effective interest method. Only the first of those is the price of borrowed money, and the note splits them out.
2
Add back the borrowing costs capitalised
Interest directly attributable to acquiring or constructing an asset that necessarily takes a substantial period to get ready is added to the cost of that asset rather than expensed. The amount capitalised in the year is disclosed — usually in the borrowing-cost accounting policy, in the property, plant and equipment note or against capital work in progress.
3
Choose a denominator, and know that it is crude
Gross borrowings at the start plus gross borrowings at the end, divided by two. It is a rough proxy for the average balance carried through the year, and where it is a bad proxy the answer misbehaves in a way that is itself informative — which is the point of the next section.
4
Divide, then compare against two things
Against the interest rates the borrowings note actually states, and against the company’s credit rating band. A gap in either direction is a question, and the question usually has one of three answers.

Worked example

The 8.5% that is really 12%

A manufacturer midway through building a new plant

Finance cost, as printed in the profit and loss accountThe number every screener divides by, and the number that produced 8.5%₹186 cr

Less interest on lease liabilitiesFrom the leases note. Real interest, but not interest on borrowings — and the lease liability is not in the borrowings denominator either₹22 cr

Less unwinding of discount on provisionsA long-dated provision moving one year closer. No money changed hands and no lender is involved₹4 cr

Interest on borrowings actually expensed₹186 crore less ₹22 crore less ₹4 crore₹160 cr

Add borrowing costs capitalised during the yearAdded to the cost of the plant under construction. Paid in cash to lenders in exactly the same way as the ₹160 crore₹104 cr

Total interest incurred on borrowings₹160 crore expensed plus ₹104 crore capitalised₹264 cr

Average gross borrowings(₹1,900 crore opening + ₹2,500 crore closing) ÷ 2₹2,200 cr

Implied cost of borrowing₹264 crore ÷ ₹2,200 crore. The naive calculation of ₹186 crore ÷ ₹2,200 crore gave 8.5%12.0%

The company borrows at about 12%, which is consistent with its rating and with the rates printed in its own borrowings note, and it has never been offered 8.5% by anybody. The reconciliation also tells you what happens next, and that is the part worth holding on to. Capitalisation stops when the asset is ready for its intended use. From that date the interest on the money that built the plant is charged to the profit and loss account, so the finance cost line steps up sharply without the company borrowing an additional rupee — and interest cover computed on last year’s finance cost will have flattered a year that no longer exists. The ₹104 crore already inside the asset does not reappear as interest; it comes back as depreciation, spread across the life of a plant whose recorded cost includes it.

Three ways the answer comes out wrong, and what each one means

Too low, and the company is building something. Interest is being capitalised, and the size of the gap is roughly the size of the project. This is ordinary accounting, disclosed, and not a criticism. It becomes an analytical problem only when a reader compares this year’s margin and interest cover with a future year in which the plant is running and the interest is in the profit and loss account.
Too high, given the rate the borrowings note quotes. The average of opening and closing understates the debt actually carried through the year, which happens when borrowings were drawn for most of the year and repaid shortly before the reporting date. Sometimes that is a genuine repayment from a receipt that landed in March. Sometimes it is deliberate: gross debt on the reporting date is what gets published, and it is the easiest number in the accounts to arrange. The interest cost is not arrangeable in the same way, because it accrued over twelve months — which is precisely why this reconciliation catches it.
Too low, and nothing is being built. Part of the funding is not sitting in borrowings at all. Bills discounted or supplier finance arrangements presented within trade payables, interest-free or below-market loans from a promoter or a related party, or borrowings held inside a subsidiary when the figures being read are the standalone ones. Each of those is a different question, and each is answered in a note.

The same accounts, two readings

Reads the finance cost line

Divides ₹186 crore by ₹2,200 crore and records that the company borrows cheaply
Computes interest cover on the printed finance cost and calls it comfortable
Is surprised when the finance cost jumps in the year the plant commissions
Compares this company’s cost of debt with a peer that is not building anything
Treats a fall in year-end gross debt as deleveraging

Reads the finance cost against the borrowings

Strips out lease interest and discount unwinding, adds back capitalised interest, and gets 12%
Notes that cover will fall mechanically when capitalisation ceases, and estimates by how much
Has the commissioning date from the capital work in progress note and expects the step-up
Compares like with like by putting both companies on an incurred-interest basis
Checks whether the interest cost fell with the debt, and asks why if it did not

Check yourself

A company reports finance cost of ₹186 crore, which its note shows includes ₹22 crore of lease interest and ₹4 crore of discount unwinding. It capitalised ₹104 crore of borrowing costs into a plant under construction. Average gross borrowings were ₹2,200 crore. What is the implied cost of borrowing, and what happens when the plant is ready for use?

Simple bhasha mein

Renovation ke mahinon ka bijli bill

Flat ka kaam chal raha tha, ghar wale maa ke yahan shift the, aur bill aadha aaya. Tariff sasta nahi hua — kharcha jagah badal gaya. Company ka bhi wahi: finance cost ₹186 crore likha hai, par usme ₹22 crore lease ka aur ₹4 crore provision ka hai — hata do toh ₹160 crore bacha. Ab jo ₹104 crore ka byaaj naye plant ke khaate mein daal diya gaya woh jodo: ₹264 crore. Average karza ₹2,200 crore. Yaani asli rate 12%, na ki 8.5%. Aur plant chalu hote hi woh byaaj P&L mein dikhne lagega — bina ek rupya naya udhaar liye.

What to remember

Finance cost is a container: interest on borrowings, lease interest, discount unwinding and amortised transaction costs all sit in it.
Interest capitalised into an asset under construction never reaches the finance cost line, so the printed line understates what was paid.
Interest incurred divided by average gross borrowings gives an implied rate to test against the rates the borrowings note quotes.
A rate that comes out too high suggests the year-end debt figure is lower than the debt actually carried through the year.
When capitalisation ceases the finance cost steps up with no new borrowing, and the capitalised amount returns as depreciation, not interest.

You reached the endMark it done and keep your streak going.

Up nextBorrowing short to fund long Previous: The repayment calendar the ratio cannot show you

Finished this lesson?

Mark it done to track your progress through the curriculum.

Common questions

Short, direct answers to what people ask about this topic.

what is included in finance cost in the profit and loss account: Finance cost under Ind AS is a container rather than a single item. It commonly holds interest on borrowings, interest on lease liabilities, the unwinding of discount on long-dated provisions such as site restoration, and the amortisation of transaction costs under the effective interest method. Only the first of those is the price of borrowed money, and the finance cost note splits them out — which is why dividing the printed line by borrowings produces a rate no lender ever quoted.
how to calculate the implied cost of debt from an annual report: Take interest on borrowings from the finance cost note, add back the borrowing costs capitalised during the year, and divide by the average of opening and closing gross borrowings. The capitalised interest left the bank exactly as the expensed interest did; it was added to the cost of an asset under construction instead of charged against profit. Then compare the answer against the rates the borrowings note itself quotes and against the company’s credit rating band.
interest incurred while an asset is being constructed is: Capitalised — added to the cost of that asset rather than charged to the profit and loss account, where the asset necessarily takes a substantial period to get ready for its intended use. Capitalisation ceases when the asset is ready for use, so from that date the interest reaches the finance cost line and it steps up without a rupee of new borrowing. The amount already capitalised returns as depreciation over the asset’s life, not as a later interest charge.
why is my calculated cost of debt higher than the rate in the borrowings note: Usually because the average of opening and closing borrowings understates the debt actually carried through the year — money drawn for most of the year and repaid shortly before the reporting date. Sometimes that is a genuine repayment from a receipt that landed in March, and sometimes the year-end figure has been arranged, since gross debt on the reporting date is among the easiest numbers in the accounts to manage. Interest accrues across all twelve months and cannot be arranged the same way, which is precisely why this reconciliation catches it.
does capitalised interest affect the interest coverage ratio: Yes, and in the company’s favour. Interest cover computed on the printed finance cost ignores the interest sitting inside capital work in progress, so a company midway through a large project shows better cover than the interest it is actually paying would support. When the asset is ready and capitalisation stops, the charge lands in the profit and loss account and cover falls mechanically, with borrowings unchanged.