1. A public limited company incorporated under the Companies Act, 1956, is in the business of manufacture of newsprint and writing paper. As the major portion of the plant and machinery is imported, the company is constrained to carry inventory of critical spares to ensure uninterrupted manufacturing operations.

2. The company is procuring spares from the suppliers of machinery at the time of purchase of machinery and also subsequently. The machinery spares that have been purchased along with the equipments and machineries have been capitalised in the books of account of the company. The machinery spares purchased subsequently for smooth operation have been shown under the head ‘Inventories’ and held as insurance spares. Such spares when put to use on the machine are either capitalised or charged to repairs and maintenance in the year of consumption, depending upon their usage.

3. The querist has stated that this treatment is based on paragraph 8.2 of Accounting Standard (AS) 10, ‘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."

4. In the year 2002, Accounting Standards Interpretation (ASI) 2, ‘Accounting for Machinery Spares’, was issued by the Institute of Chartered Accountants of India, wherein at paragraph 4, it has been stated that capital spares and insurance spares shall be capitalised at the time of their purchase whether procured along with the equipment or subsequently. According to the querist, paragraph 8.2 of AS 10 provides for a treatment only at the point of consumption, whereas, ASI 2 provides for a treatment at the point of purchase itself. It is not clear as per the querist, as to how to treat the insurance spares which are held in closing stock as ASI 2 has not expressly spelt out a procedure in this regard.

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

7. The Committee notes paragraph 8.2 of AS 10 as reproduced above and paragraphs 3 and 4 of Accounting Standards Interpretation (ASI) 2,‘Accounting for Machinery Spares’, issued by the Institute of Chartered Accountants of India, which state as below:

"3. Whether to capitalise a machinery spare under AS 10 or not will depend on the facts and circumstances of each case. However, the machinery spares of the following types should be capitalised being of the nature of capital spares/insurance spares –

(i) Machinery spares which are specific to a particular item of fixed asset, i.e., they can be used only in connection with a particular item of the fixed asset, and

          (ii) their use is expected to be irregular.

4. Machinery spares of the nature of capital spares/insurance spares should be capitalised separately at the time of their purchase whether procured at the time of purchase of the fixed asset concerned or subsequently. The total cost of such capital spares/insurance spares should be allocated on a systematic basis over a period not exceeding the useful life of the principal item, i.e., the fixed asset to which they relate."

8. The Committee notes that paragraph 8.2 of AS 10 and paragraphs 3 and 4 of ASI 2 lay down the same principles. Machinery spares which are not specific to a particular item of fixed asset but can be used generally for various items of fixed asset should be charged to profit and loss account as and when issued for consumption. Machinery spares which are specific to a particular item of fixed asset and their use is expected to be irregular, are in the nature of capital spares or insurance spares. They should be capitalised separately at the time of their purchase whether procured at the time of the purchase of the fixed asset concerned or subsequently. Such spares should be depreciated on a systematic basis over a period not exceeding the useful life of the fixed asset to which they relate.

9. The Committee notes the definition of ‘Prior-period items’ and paragraph 15 of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, which state as follows:

11. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:

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