Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 10

Subject: Accounting treatment of special tools, jigs and fixtures.[1]

A. Facts of the Case

 

1. An industrial engineering company is engaged in the manufacture of earthmoving equipment for supply to various sectors of the economy. The query relates to accounting for special tools, jigs and fixtures used by the company in its manufacturing process.

 

2. As per the querist, jig is a super structure designed to carry out repetitive jobs accurately in a pre-determined manner. Usually, the jig is attached to the fixture. While the fixture secures the material firmly, the jig guides the performance of the required job. The jigs can be put to alternative uses. For example, the company manufactures bulldozers ranging from a small capacity to a large capacity. The jig used for producing the smallest bulldozer can also be used for producing the next higher capacity with certain major modifications.

 

3. While special tools are procured by the company totally from outside sources, jigs and fixtures are produced in-house as well as bought from indigenous and overseas sources. While jigs and fixtures are produced/bought to suit the requirements of manufacturing a particular model of earthmoving equipment, they can be modified to suit other models also. They are scrapped only when it is identified that they cannot be put to any alternative use.

 

4. Special tools are use-and-throw type and their life span is generally less than 12 months. The jigs and fixtures, on the other hand, are designed to last long enough for producing a particular batch of earthmoving equipment. Their life span varies from 18 to 36 months. The jigs and fixtures put to use in a particular batch of production can be considered as 95% used up in producing that batch. However, they are modified for being put to alternative use or for production of another batch. Normally, the modification cost ranges from 75% to 95% of the original cost. After such modification, the jigs and fixtures generally lose their original form and identity. After modification, the life of the jigs and fixtures is similar to that of a new jig/fixture.

 

5. The special tools, jigs and fixtures are shown by the company under the head ‘Other Current Assets’ in the balance sheet, ‘net’ of amortisation. The accounting policy followed in respect of special tools, jigs and fixtures right from the inception of the company is as below:

 

“The cost of special tools and jigs is amortised over production based on technical assessment. The value is net as per books.”

 

6. The cost of purchase of indigenous items as well as imported items is debited to a separate account called ‘Special tools, jigs and fixtures - (Asset a/c)’. The Tool Engineering Department determines the extent of their usage in production during the year and fixes the rate of amortisation. Such rate of amortisation is applied in respect of each batch of equipment produced and credited to a separate account called ‘Amortisation a/c - special tools, jigs and fixtures’. The net amount of the above two accounts (i.e., balance in the aforesaid asset account minus the balance in the aforesaid Amortisation account) is shown in the balance sheet under the head ‘Other Current Assets’.

 

7. The jigs and fixtures are modified to suit the specific requirements of production. The cost of modifications, viz., material, labour and overheads, is charged to profit and loss account under the head ‘Consumable Tools etc’. As already stated, the jigs and fixtures are scrapped when it is identified that they are of no further use. When modifications are carried out, jigs undergo a physical change depending on the job to be performed. According to the querist, due to change in physical form, physical verification of jigs is a stupendous task and is normally not carried out. As per the querist, the company categorises jigs as a current asset rather than a fixed asset mainly due to this reason.

 

8. During the course of audit of accounts of the company for the year 1996-97, the statutory auditors expressed the opinion that these items should be exhibited as a part of fixed assets and depreciation charged thereon at the rate applicable to general plant and machinery as per Schedule XIV to the Companies Act, 1956.

 

9. According to the querist, the company has taken into account three main criteria in accounting for special tools, jigs and fixtures. They are:

 

(i)      location of the assets;

 

(ii)     utility; and

 

(iii)    requirements of the law.

 

As per the querist, so far as the first criterion is concerned, the asset (i.e. special tools, jigs and fixtures) is not akin to any other fixed asset. Because of continuous change in the form of jigs, it is not feasible to identify their location and thus it is not feasible to carry out their physical verification. Further, this expenditure is not treated as fixed asset as this is not included in the capital expenditure budget. As regards the second criterion, the company being a heavy earthmoving equipment manufacturing entity, the special tools, jigs and fixtures are meant for specific jobs and their life cycle is more akin to that of a current asset rather than to machinery. As regards the third criterion, the querist has contended that Schedule VI to the Companies Act, 1956 contains specific requirements regarding disclosure of fixed assets. According to the querist, Schedule VI requires items to be exhibited like land, buildings, plant and machinery and vehicles, and nowhere are the items in the nature of special tools, jigs and fixtures included in fixed assets. The querist has further stated that Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, is silent on this aspect. According to the querist, the nature of special tools, jigs and fixtures is similar to that of machinery spares and as per AS 10, the expenditure on machinery spares can be either charged off to revenue on their issue to production or amortised if the expenditure is substantial. According to the querist, on the above grounds, the disclosure of this asset by the company as ‘Other Current Assets’ is in order.

 

10. According to the querist, the above method of accounting has been accepted by the government auditors and the statutory auditors in the past.

 

B.  Queries

 

11. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(a)     Whether the accounting treatment followed by the company consistently over several years would meet the requirements of the Companies Act, 1956.

 

(b)     Whether the statutory auditors’ contention regarding treatment of the relevant items as fixed assets and charging depreciation thereon is the only correct accounting method to be followed.

 

C.  Points Considered by the Committee

 

12. The Committee notes the following definitions of the expressions ‘assets’ and ‘current assets’ as given in the ‘Guidance Note on Terms used in Financial Statements’ and of the term ‘Fixed Assets’ as given in AS 10.

 

“Assets – Tangible objects or intangible rights owned by an enterprise and carrying probable future benefits.”

 

“Current Assets – Cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.”

 

“Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.”

 

13. The Committee also notes paragraphs 3.1 and 3.2 of Accounting Standard (AS) 6, ‘Depreciation Accounting’, which state as under:

 

“3.1  Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined.”

 

“3.2   Depreciable assets are assets which

 

               (i)   are expected to be used during more than one accounting period; and

 

               (ii)  have a limited useful life; and

 

               (iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.”

 

14. The Committee observes that special tools, jigs and fixtures, referred to by the querist, are assets as these objects carry probable future benefits. The special tools are consumed in the process of production over a relatively short period. As such, they are of the nature of ‘current assets’. The jigs and fixtures, on the other hand, are not consumed in the production of goods, their life span varies from 18 months to 36 months, and they can be modified for alternative use. Thus, they are meant for use in the production process over a longer period and are, therefore, of the nature of ‘fixed assets’. The Committee also observes that jigs and fixtures of the nature specified by the querist fulfill all the criteria for qualifying as depreciable assets and, therefore, need to be depreciated over their useful life. Similarly, special tools that are expected to be used during more than one accounting period also need to be amortised to take cognisance of their consumption in the production process.

 

15. The Committee further notes paragraphs 20 and 23 of AS 10 which state as under:

 

“20. The cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use....”

 

“23. Subsequent expenditures 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.”

 

16. As regards the expenditure incurred on modifying the jigs and fixtures for alternative use or for use in production of a fresh batch of earthmoving equipment, the Committee observes that after such modification, the jigs and fixtures again have a life of 18-36 months as in the case of the original jigs and fixtures. Thus, due to modification, there is an increase in the useful life of the jigs and fixtures as compared to the original estimate of such life. Therefore, in accordance with paragraph 23 of AS 10, the expenditure incurred on such modification should be capitalised. After such capitalisation, the jigs and fixtures would appear in the books at an amount equal to the residual book value (stated at 5% by the querist) plus the modification costs.

 

17. The Committee notes the company’s arguments for not accounting for jigs and fixtures as fixed assets as stated in paragraph 9 above. The Committee is of the view that the contention of the company that jigs and fixtures cannot be physically verified and also that the expenditure on special tools, jigs and fixtures is not included in the capital expenditure budget do not by themselves provide sufficient justification for excluding these items from the head ‘fixed assets’.

 

18. The Committee also notes the following requirements of Part I of Schedule VI to the Companies Act, 1956, regarding disclosure of fixed assets:

 

“Fixed Assets

 

Distinguishing as far as possible between expenditure upon (a) goodwill, (b) land, (c) buildings, (d) leasehold, (e) railway sidings, (f) plant and machinery, (g) furniture and fittings, (h) development of property, (i) patents, trade marks and designs, (j) livestock, and (k) vehicles, etc.”

 

19. The Committee notes that the definition of the word ‘machinery’ as given in the Concise Oxford Dictionary (9th edition) includes “.... components of a machine ....”. The Committee further notes that Schedule XIV to the Companies Act, 1956, classifies moulds, patterns, dies and templates, and wooden lasts used in the manufacture of shoes as items of plant and machinery. On this basis, the Committee is of the view that jigs and fixtures fall within the head ‘plant and machinery’ under Schedule VI to the Companies Act, 1956.

 

20. The querist has contended that special tools, jigs and fixtures are in the nature of machinery spares. In this regard, the Committee notes the meaning of the word ‘spare’ as given in the Concise Oxford Dictionary, namely, ‘reserved for emergency or occasional use’. The Committee is of the view that special tools, jigs and fixtures, dealt with in the query, are meant not for emergent or occasional use but for regular use in production. Therefore, they are not in the nature of spares.

 

21. Paragraph 13 of Accounting Standard (AS) 6, ‘Depreciation Accounting’, states as under:

 

“13. The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with requirements of the statute.”

It follows from paragraph 13 of AS 6 that depreciation on jigs and fixtures should be provided on the basis of their expected useful life subject to consideration of any minimum depreciation rate(s) provided in Schedule XIV to the Companies Act, 1956, for the relevant items.

 

D. Opinion

 

22. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 11:

 

(a)     The following accounting treatment of special tools, jigs and fixtures would be in consonance with the requirements of the Companies Act, 1956:

 

(i)   The special tools should be treated as current assets and their cost should be charged off over the relevant accounting period(s) with reference to their usage.

 

(ii)  Jigs and fixtures, being of the nature of fixed assets, should be capitalised at cost (including modification costs) and depreciated over their useful life, subject to consideration of any minimum depreciation rate(s) provided in Schedule XIV to the Companies Act, 1956, for the relevant items.

 

(b)     Refer to (a) above.

 

[1]Opinion finalised by the Committee on 24.12.1998.