1.34 Query: Accounting treatment of replacement of conveyor belts.
1. A company is in the business of iron ore extraction from various mechanised/semi-mechanised iron ore mines in India. The company has three iron ore mines at Kirandul, Bacheli and Donimalal. Its annual production capacity is 15 million tonnes. For the year 1995-96, the production of iron ore was 13.77 million tonnes. The total cost of plant and machinery, when it was installed, was Rs. 67.91 crores. The cost of conveyor belts capitalised alongwith the cost of plant was Rs. 5. 91 crores. Subsequent cost of replacement of conveyor belts was charged off to profit and loss account upto 31.3.1979 and from 1.4.1979 till date the actual cost of replacement was adjusted against provision made towards replacement of conveyor belts based on life and length of converyor belts.
2. The querist has stated that the cost of plant and machinery has been fully depreciated in respect of its mines at Kirandul and, in respect of other units, the cost of plant and machinery would be fully depreciated by 1997-98. The initial mining lease period granted by the respective State Governments has already expired in respect of the above units.
3. The conveyor system is an integral part of plant and machinery and a conveyor belt is a part of the conveyor system. The conveyor belts carry the iron ore from the ore crushing plant to screening and loading plants. The conveyor belts are replaced regularly either in part or in full length depending upon its wear and tear. The conveyor belts used by the company are of different lengths ranging from 200 mtrs. to 5000 mtrs. and above. The conveyor belts are classified based on its usage into different life spans, viz., below 5 years, above 5 years and below 8 years, above 8 years and below 10 years and 10 years and above, based on technical assessment. The replacement of belts on account of wear and tear is regular, although not in its total length but in parts.
4. The querist has stated that the cost of conveyor belts together with the cost of the plant when initially erected was capitalised and depreciated alongwith the plant in the normal course. The conveyor belts replaced were treated as spare parts and its cost was charged off in the year in which it was issued. This treatment was adopted upto 31.3.1979. According to the querist, the cost of a conveyor belt was a major item of cost and whenever a conveyor belt was replaced, the charge to profit and loss account affected the profitability. To overcome the situation, the matter was referred to the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI) for its expert opinion. The querist has submitted the opinion for the perusal of the Committee.
5. The querist has stated that based on the opinion of the Expert Advisory Committee, the company has, from the year 1979-80, adopted a method by which the charge towards replacement of conveyor belts was made uniformly by creating a provision based on the estimated life of different sizes of belts. By this method, the charge to profit and loss account on account of replacement of conveyor belts was uniform.
6. The querist has stated that in the year 1989-90, the company further reviewed the life of the conveyor belts. Based on the technical appraisal, the life of the belts has been reassessed as referred in para 5 above. The provision for replacement of conveyor belts for which a policy as listed in Annexure I was incorporated in the Statement of Accounting Policies forming part of Annual Accounts. On review of the above procedure, it was found that the provision made for replacement of conveyor belts, taking into account its estimated life and current cost of replacement in each year, has resulted in excess provision when compared to actual cost of replacement made from 1979-80 to 1988-89 onwards, the year in which the second review of the life of the belts was made. The querist has enclosed a statement indicating the year-wise provision, actual replacement cost and excess provision resulting thereon as Annexure II for the perusal of the Committee. In this background, the company has decided to review the accounting treatment of conveyor belts which was hitherto followed by the company as indicated above for the following reasons: -
(a) The cost of conveyor belts is no more a major element of cost in the plant as a spare as there are other more valuable spares and components which when issued are charged to profit and loss account.
(b) The conveyor belt, as thought of earlier, is not replaced in its full length and presently being replaced in parts due to technological improvements in its usage.
(c) The conveyor belt is a spare of the plant and replacement of such spare should be charged to profit and loss account in the year in which it is replaced.
(d) Though the provision towards cost of replacement of conveyor belts is made to equalise the charge to profit and loss account, when the actual cost of replacement of conveyor belt takes place, it always remains low, at any point of time of review, resulting in excess provision (as shown in Annexure-2) due to life obtained being more than what was anticipated, lesser wear and tear, improved maintenance of belts and better performance guarantee obtained from suppliers.
7. Thequerist has desired the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the company can change the existing procedure of making provision for replacement of conveyor belt by charging off the cost of conveyor belt in the year in which it is replaced as it was done upto 31.3.1979.
(ii) If the answer to (i) above is “yes”, whether the unutilised provision existing in books of account as on 31-3-1996 can be treated as reserve as per interpretation in clause 7(2)(b) of Part III of Schedule VI to the Companies Act, 1956?
(iii) In case the unutilised provision is treated as reserve as per clause 7(2)(b) of Part III of Schedule VI to the Companies Act, 1956, whether it can be transferred to General Reserve without routing through profit and loss account?
(iv) If the answer to (iii) above is ‘no’, whether it can be shown in profit and loss account below the line, i.e., after provision for taxation?
(v) Whether the present system of making provision could be continued with certain modifications considered necessary in the life of the belts determined based on technical assessment so as to ensure that the provision made annually would be reasonable compared to the current replacement cost?
(vi) If the answer to (v) above is ‘yes’, while continuing the existing method of making provision, the unutilised provision as on 31.3.1996 (the unutilised provision found on periodical review = total provision made upto the date of review minus actual replacement cost charged during the period to the provision) be treated as reserve and adjusted accordingly as per (iv) and (v) above?
Opinion February 17, 1997
1. The Committee notes that its earlier opinion was given on 11th March, 1980, on the same subject. The Committee also notes the changed factual position as stated by the querist and also the subsequent developments in accounting, e.g., issuance of mandatory Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’.
2. The Committee also notes para 23 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which states as below:
“23. Subsequent expenditure related to an item of fixed asset should be added to its book value only if they increase the future benefits from the existing asset beyond its previously assessed standard of performance.”
3. The Committee notes from the facts of the query that it appears that the expenditure incurred on replacement of conveyor belts only results in maintaining the previously estimated standard of performance. It does not, therefore, appear to improve the previously assessed standard of performance. Accordingly, the expenditure on replacement of conveyor belts should be charged off to the profit and loss account in the year of replacement. In view of this, the provision for replacement of conveyor belts presently appearing in the accounts is no longer required.
4. In this context, the Committee notes clause 3(ix)(B) of Part II of Schedule VI to the Companies Act, 1956, which provides that the profit and loss account shall disclose in respect of the period covered by the account, the aggregate, if material, of the amounts withdrawn from such provision, as no longer required.
5. Since the treatment suggested in Para 3 above would amount to a change in accounting policy, the same should be disclosed as per para 12 of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, as below:
“Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicted. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”
6. Based on the above the committee is of the following opinion for the issues raised at para 7 of the query:
(i) Yes, the company should change the existing procedure of making provision for replacement of conveyor belts. If such replacement does not increase the future benefits beyond the previously assessed standard of performance, it should charge off the cost of conveyor belt in the year in which it is replaced. The amount of provision which is already existing should be written back in the profit and loss account. Such a change of method is a change in accounting policy and it should be disclosed as per para 5 above.
(ii) No.
(iii) Since the answer to (ii) above is in the negative, this question does not arise.
(iv) No, the amount of provision written back cannot be shown below the line.
(v) No.
(vi) Since the answer to (v) is in the negative this question does not arise.
ANNEXURE - I ACCOUNTING POLICY
9.5 Provision for replacement of Conveyor Belts:
Provision is made on estimated basis towards replacement cost of conveyor belts measuring more than 500 metres and having an anticipated running period of 5 years and above as indicated below which constitutes major portion of the consumption of conveyor belts:
In each year, we are making a provision towards replacement cost of conveyor belts measuring more than 500metres classified into different running period as stated in (a), (b) and (c) above. We take the cost of belt, if held in stock as on 31st March or in case it not held in stock, its estimated purchase cost as on 31st March is ascertained. Provision equivalent to 1/5th and 1/10th as the case may be of the cost (if held in stock) or estimated cost of each belt is provided in each year. This provision is made in each year even if no replacement of belt has taken place. Whenever actual replacement of belt is made, the actual cost is debited to provision for replacement cost of conveyor belt.
ANNEXURE – I
PROVISION FOR CONVEYOR BELTS
(Rs. in Lacs)
___________________________
|
||||||||||||||||||||||||||||