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Cases Study for Discussion

Case-I: Magnificent PLc.


(a) Magnificent Inc. engaged a consulting firm to advise it on many projects that it had been
planning to undertake in order to diversify its operations and enhance its public image and
ratings. With this mandate, considering the booming demand for electric power in the
region Magnificent Plc. is operating, the consulting firm start to prepare a feasibility study
for the construction of an electric power generating plant at one of the largest irrigation
dams that were used for irrigation of Magnificent Plc.s sugar plantations. This would make
Magnificent Plc. the first private electric power generator in the country. Magnificent
contacted Chinese Development Bank in China to raise 70% of the capital required for
implementation of the project. The power generation unit will be completed in three
phases such that in the first phase (requiring 14 months) the construction of two tunnels
carrying the water from the dam to the nearby mountainous area where the power unit is
located will be done. In the second phase of the project (which starts 6 months after the
commencement of the first phase) Magnificent builds the main power unit that is
estimated to take 9 months. The final phase of the project contains the construction of
power accumulation and distribution grid including the construction of electric wires to
target market area. It is estimated that the third phase requires 10 months of construction
time and it can be performed 4 months after the introduction of second phase. The Bank
insisted Magnificent to start the first phase the project and it will then finance the second
and third phases of the project only after looking at the progress of the first phase.
(b) The consulting firm also set out to prepare a feasibility study for the construction of a
shopping mall that would house anchor tenants such as world-class international designers
and well-known global retail chains. The consulting firm advised Magnificent Inc. that this
kind of a project would do wonders to its corporate image. This shopping mall had certain
distinguishing features that were unique in many respects, and it could easily win the
coveted title of the most popular commercial complex in the country. Based on this advice,
Magnificent Inc. began construction of the shopping mall on a huge plot of land in the heart
of the city. Substantial amounts were spent on its construction. Architects from around the
globe competed for the project, and the construction was entrusted to the best
construction firm in the country. The construction took over two years from the date the
project was launched. The total cost of construction was financed by a term loan from an
international bank.
(c) The consulting firm also advised Magnificent Inc. to launch a car dealership that deals only
in world-renowned, expensive brand names, such as Rolls-Royce and Alfa Romeo.
According to the research study undertaken by the consulting firm, this would be yet
another business to diversify and invest in order to enhance the corporate image of
Magnificent Inc. with people who matter, as such an exclusive car dealership would cater
only to the needs of the top management of multinational corporations (MNCs) operating in
the country. Magnificent Inc. invested in this business by borrowing funds from major local
banks. Besides the corporate guarantees Magnificent Inc. gave to the banks, they also
insisted on depositing with the banks title deeds of the cars as security for the loans until
the entire loan amounts remain unpaid.
Required
I.

II.

Would the power generation plant construction in three phases be considered as qualifying
asset under IAS 23, thereby making it possible for Magnificent Inc. to capitalize the
borrowing costs for Chinese Development Bank? If yes when should the capitalization of
borrowing costs start?
Would the shopping mall be considered a qualifying asset under the Standard? Would the
interest expense on the term loan borrowed for the construction of the shopping mall
qualify as eligible borrowing costs?

III.

Would the expensive cars purchased by the car dealership be considered qualifying assets
under the Standard, thereby making it possible for Magnificent Inc. to capitalize the
borrowing costs, which are substantial compared to the costs of the cars? Would borrowing
costs include guarantee commission paid to banks for arranging corporate guarantees in
addition to interest expense on bank loans?

Case-II: MNC Co.


A socially responsible multinational corporation (MNC) decided to construct a tunnel
that will link two sides of the village that were separated by a natural disaster years
ago. Realizing its role as a good corporate citizen, the MNC has been in this village for
a couple of years exploring oil and gas in the nearby offshore area. The tunnel would
take two years to build and the total capital outlay needed for the construction would
be not less than ETB20 million. To allow itself a margin of safety, the MNC borrowed
ETB22 million from three sources and used the extra ETB2 million for its working
capital purposes.
Financing was arranged in this way:
Bank term loans: ETB5 million at 7% per annum
Institutional borrowings: ETB7 million at 8% per annum
Corporate bonds: ETB10 million at 9% per annum
In the first phase of the construction of the tunnel, there were idle funds of ETB10
million, which the MNC invested for a period of six months. Income from this
investment was ETB 500,000.
Required : If the MNC applies IAS 23:
A. How would it treat the borrowing costs?
B. How would it capitalize the borrowing costs, and
C. what would it do with the investment income?

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