1.30 Query: Accounting treatment of inventory of capital/insurance spares.
1. A multi-unit Cooperative Society is registered under the Delhi Cooperative Societies Act, 1972, and is governed by the rules and regulations of the Multi-State Cooperative Societies Act, 1984 (MSCS Act) and the rules framed thereunder.
2. The society was incorporated in April 1980 as a national level cooperative society to manufacture and distribute chemical fertilisers. The society is having its Plant at Hazira near Surat in Gujarat. It has two phases of ammonia plant of 1350 MTPD capacity each and two phases of urea plant of 2200 MTPD capacity each. Each phase of urea plant consists of two streams of 1100 MTPD, with an annual capacity to produce 14.52 lakh MT of urea. The society commenced its commercial production from March 1986.
3. The society produces urea which is covered under the Fertiliser (Control) Order, 1985 and the Essential Commodities Act, 1985. It is getting Retention Price Subsidy from Fertiliser Industry Coordination Committee (FICC), Government of India, under the administered price system.
4. During the construction period, the society placed orders on vendors for supply of two years operational spares as well as insurance spares alongwith the main equipments. On commissioning of the plant in February 1986, these spares were codified and taken in the inventory and kept under the custody of stores department. As on date, the value of such spares comes to around Rs. 15.45 crores.
5. According to the querist, the society has adopted the following procedure for accounting of issues out of these items:
(i) If the issues/spares are of small value and are consumable in nature, the cost of such items is charged off to profit & loss account under the head “Repairs & Maintenance- Plant & Machinery.”
(ii) If the issues are of high value and are used as replacement of plant & machinery items, such items are capitalised on either of the following basis:
(a) The new item is captialised as additional item if the old one/replaced item can be repaired and reused and is kept as standby for future use. In this case the replaced item which is kept as standby after repairs is not decaptialised and is being put to use whenever the need arises.
(b) If the old item has already become scrap, then the new item is capitalised after decapitalising the old item by charging off the written down value of the old item under the head “Loss on Retirement of Asset.”
6. According to the querist, the above accounting procedure is followed for items of capital/insurance/standby nature being procured during the operation period also and the society has been consistently following this accounting procedure since beginning. No specific guidelines have been prescribed under the MSCS Act and Rules in this regard.
7. The querist has stated the statutory audit of the society is being conducted by the firms of chartered accountants appointed by the Central Registrar of Cooperative Societies. While conducting the audit of the society for the year 1996-97, the statutory auditors expressed the view that since these items are of capital nature, they should not form part of current assets as inventory and hence should be capitalised from the date of their purchase as an addition to fixed assets. The statutory auditors further observed that the depreciation should also be charged on such spares from the date of purchase. This issue was deliberated and discussed at length with statutory auditors and, finally, it was felt proper to seek the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India.
8. The querist has drawn the attention of the Committee to the following:
(i) Opinion expressed in reply to query no. 1.16 in Compendium of Opinions, Vol. II of the Expert Advisory Committee of ICAI which states:
“as soon as an item of plant and machinery is installed and is fit for use, depreciation should be provided. However, since the items under question were not installed and were thus not ready for being put to use, it was not necessary to provide depreciation on them.”
(ii) Depreciation on assets purchased but not used during a particular period, in ‘Contemporary Auditing’ by Shri Kamal Gupta, it has been opined that
“as soon as an item of plant and machinery is installed and is fit for use, depreciation should be provided. The Company Law Department has concurred with the view that depreciation arises also out of efflux of time. However, if a plant and machinery has not been installed and is, thus, not ready for being put to use in a particular year, it is not necessary to provide depreciation thereon.”
9. The querist has enclosed the relevant extracts from both the documents referred to above for ready reference of the Committee.
10. The querist has sought the opinion of the Expert Advisory Committee on the accounting treatment in regard to the capital/insurance/stand-by spares procured alongwith the procurement of main equipments as well as purchases made during operational period, on the following points:
(i) Whether the society may continue to follow the accounting treatment as is being followed at present as stated herein above?
(ii) In case the Committee is of the view that the society should capitalise the insurance spares procured initially/prior to capitalisation/prior to commencement of commercial production then:
(a) Whether the depreciation will be charged from their original date of procurement?
(b) Whether the depreciation shall be charged from the year in which capitalisation of such spares is resorted to (in case of spares lying in stores as inventory) at the applicable rates?
(c) Whether the depreciation should be charged with reference to the remaining useful life of the machinery in which these spares are used?
(iii) What should be the accounting treatment for insurance spares procured subsequent to commencement of commercial production/during operational period?
Opinion March 17, 1998
1. The Committee notes para 8.2 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which states as below:
“8.2 Stand-by equipment and servicing equipment are normally capitalised. Machinery spares are usually charged to the profit and loss statement as and when consumed. However, if such spares can be used only in connection with an item of fixed asset and their use is expected to be irregular, it may be appropriate to allocate the total cost on a systematic basis over a period not exceeding the useful life of the principal item.”
2. The Committee notes that the spares often termed as capital spares/insurance spares normally consist of stand-by equipment and machinery spares. The factors normally considered in classification of spares into the aforesaid types include the purpose for which the spares are kept, separate identification as an item of plant and machinery, and their value. A stand-by equipment is kept for the purpose of using in the manufacturing process when the original unit breaks down, has a high value in relation to the cost of plant and machinery, and is capable of being separately identified. Machinery spares are those spares which do not fulfill the aforesaid criteria. The Committee is of the view that whether the spares are purchased along with the concerned plant and machinery or subsequently, is irrelevant from the point of view of accounting treatment thereof. The Committee is further of the view that similar would be the treatment in case of spares acquired prior to or subsequent to commencement of commercial production.
3. On the basis of the above, the Committee is of the view that capital spares/insurance spares of the nature of stand-by equipment should be capitalised. Depreciation on such spares should be charged from the date they are ready for use even though kept in stores since as stand-by spares, their ‘use’ is to await their turn in the production process in the event of breakdown. On the other hand, machinery spares should be charged to profit and loss account as and when consumed. However, where such spares could be used only in connection with an item of fixed asset and their use is expected to be irregular, then it would be appropriate to allocate the total cost of the spares on a systematic basis over a period not exceeding the useful life of the asset from the date of acquisition.
4. Based on the above, the Committee is of the following opinion on issues raised in para 10 of the query:
(i) The accounting treatment followed by the querist is not correct. For correct accounting treatment, please refer to para 3 of the opinion.
(ii) Please refer to para 3 of the opinion.
(iii) Pleases refer to para 3 of the opinion.
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