|
Query No. 10
Subject :
Accounting
for spares and conveyor belts.1
A. Facts of the
Case
1. A company
capitalises the original procurement of conveyor belts alongwith the asset. The
subsequent replacements of belts are treated as
deferred revenue expenditure and charged off over a period of 2 to 6
years depending upon the life of the belt assessed by the company. The
company’s accounting policy in respect of deferred revenue expenditure is as below:
Deferred Revenue Expenditure:
| Description |
Period of charge |
| Fabric belting in conveyors of different categories |
2/3 years |
Steel cord belting in conveyors
-2400m
-Others |
4 years
6 years |
| Spares and Unit assemblies costing Rs. 50 lakh and above. |
5 years/Technical assessment whichever is lower. |
| Repair expenditure on costly spares |
Fully charged in the year in which put to use. |
| Bond issue initial placement expenditure |
Amortised in equal instalments over the debt period |
| Others |
Technical assessment |
2. The joint
statutory auditors in
their audit report
have commented
upon the non-compliance of Accounting Standard (AS) 10,
‘Accounting for Fixed Assets’, with regard to the first three items as follows:
“As required by AS
10, the cost
of spares as
and when issued
to production are charged
off to revenue,
whereas as per
company’s policy, spares costing more than Rs. 50 lakh are treated as
deferred expenditure and written
off over the
period as specified
in the accounting policy.”
3. As per
the querist, while
certifying the true
and fair view
of the profit of
the company, the
auditors have qualified
for all the
items of deferred revenue
expenditures stating that
they had relied
upon the management representation for
the useful life
of various types
of expenditures for their amortisation.
4. As per AS
10, the machinery spares are
usually charged to profit and loss account as and when consumed.
According to the querist, the use of the word ‘usually’ leaves room for
deferment of expenditures. The expenditures under consideration are of enduring
benefits which extend beyond the year
of incurrence of
such expenditures. Accordingly,
the company is charging the expenditure to the profit and loss account
to the extent of consumption,
and is deferring
the remaining portion
to subsequent years.
5. The company
is having approximately
75 kms. of
conveyors and over 150 kms. of
conveyor belts. The charge off period of the different kinds of belts is based
on the average life of the belts. For example, if the fabric belt is used in
the over burden removal system it is charged over 2 years as its useful life is
estimated to be 2 years. However, if it is used in the lignite system, its life
is estimated as 3 years and hence the period of charge is 3 years. Likewise, in
the case of the steel cord belts of 2400 mm
width, the useful
life is estimated
as 4 years,
and for 2000
mm width, the useful life is estimated as 6 years, and the charge off is
made accordingly. If the belts are used in the machine, their life is one year,
and so the value is charged off in the year in which they are put into the
machine. In case of premature failure, the remaining value of the belt is being
charged off fully in the year of premature failure. Similarly, in the case of
spares and unit
assemblies costing Rs.
50 lakh and
above, the useful life is based
on the technical assessment subject to a maximum of
5 years. As
per the querist,
the company is consistently following this accounting policy
for spares costing more than Rs. 50 lakh and conveyor belts for the past several
years.
B. Query
6. The querist
has sought the opinion of the Expert Advisory Committee
as to whether
the treatment of
spares and belts
as deferred revenue expenditure on
the basis of
their life as
per the company’s
accounting policy is a non-compliance of AS 10.
C. Points
considered by the Committee
7. The
Committee notes that the issues raised by the querist relate to the accounting
for spares and
conveyor belts only.
Therefore, the Committee has not
examined any other accounting issue contained in the facts of the case.
8. The Committee
notes that the
treatment of deferred
revenue
expenditure has been dealt with in the ‘Guidance Note on Audit of Miscellaneous Expenditure Shown in the
Balance Sheet’, issued by the Institute of Chartered Accountants of India,
which states in paragraph 3
as below:
“3.
‘Miscellaneous expenditure’ shown
in the balance
sheet of
companies (or shown under this or some other appropriate
heading in the balance sheet of other enterprises) embraces within its
fold a variety of items
of expenditure which
are not entirely
charged to income in the year in
which they are incurred, but are carried forward in the balance sheet to be written-off in subsequent
periods. Unless some benefit from the expenditure can reasonably be expected to
be received in future and unless the amount of such benefit is reasonably
determinable, there is no justification
for carrying forward
the expenditure for being
written-off in subsequent
periods. Also, the amount of
expenditure to be carried forward should not exceed the expected future
revenue/other benefits related to the expenditure”.
9. The
Committee further notes that the Guidance Note provides, inter alia, in
paragraph 6 that the items of expenditure included under the head ‘miscellaneous expenditure’ do not represent any tangible
asset.
10. From the
above, the Committee
notes that a
deferred revenue expenditure
should not be represented by a tangible asset. Accordingly, since the conveyor
belts and spares are tangible assets, their treatment as deferred revenue
expenditure is not appropriate.
11. The Committee
notes paragraph 23
of Accounting Standard
(AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute
of Chartered Accountants of India, which states as below:
“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.”
12. The Committee
notes from the facts of the case 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.
13. The Committee
also notes that the accounting for spares is governed by Accounting Standard
(AS) 2, ‘Valuation of Inventories’ and Accounting Standard (AS) 10, ‘Accounting
for Fixed Assets’. Relevant paragraphs of both the Standards are reproduced below:
AS 2
“4. Inventories encompass
goods purchased and
held for resale, for example, merchandise purchased by
a retailer and held for resale,
computer software held
for resale, or
land and other property held for resale. Inventories
also encompass finished goods produced, or work in progress being produced, by
the enterprise and include
materials, maintenance supplies, consumables and
loose tools awaiting
use in the
production process.
Inventories do not
include machinery spares
which can be used only in connection with an item of fixed asset and
whose use is expected to be irregular; such machinery spares are accounted
for in accordance
with Accounting Standard(AS) 10, Accounting for Fixed Assets.”
AS 10
“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.”
14. From the above,
the Committee is of the view that the accounting treatment of
spares depends on
their nature. The
Committee is of the
view that the machinery spares referred to in paragraph 8.2 of AS 10 can be
used only in connection with a particular item of fixed asset and their use is
expected to be irregular. Such spares are often termed as capital spares (also
called insurance spares). The cost of such a spare is written- off over the
useful life of the principal asset unless the useful life of the spare is
shorter than the useful life of the principal asset. However, the machinery
spares that can be used in connection with more than one item fixed asset
are of the
nature of maintenance
spares and not
of the nature of
capital spares. Such
machinery spares should
be treated as inventory
items and expensed
when put to
use. Factors normally
considered in classification of spares include the purpose
for which the spares are kept, separate identification as an item of plant and
machinery and their value.
D. Opinion
15. On the basis of
the above, the Committee is of the opinion that the accounting treatment
followed by the
company in respect
of conveyor belts and spares is
not appropriate. The accounting treatment of conveyor belts and
spares should be in accordance
with paragraphs 12 and 14 above.
1Opinion finalised
by the Committee on 14.4.2001.
|