Query No. 33
Subject: Depreciation on capital spares.1 A. Facts of the Case
1. A company is a Government of India undertaking incorporated in 1975 under the Companies Act, 1956. One of the objectives of the company is to set up thermal power plants at various geographical locations in the country and to supply bulk power to the various state electricity boards/succession entities.
2. The company is registered under the Companies Act, 1956, and being an electricity generating company, is governed by the provisions of the Electricity Act, 2003. According to the querist, as the Government has not prescribed any format of statement of accounts for the central undertakings engaged in generation of electricity, the company is preparing its accounts in the format prescribed as per Schedule VI to the Companies Act, 1956. These accounting formats have been adopted since inception of the company and have been accepted by various audit agencies.
3. The company has 13 coal based generating stations and 7 gas based generating stations located all over the country. Besides, the company is also setting up a hydro generation plant.
4. According to the querist, in line with the provisions of Accounting Standard (AS) 2, ‘Valuation of Inventories’ (revised 1999), and Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, the company has identified spares, which can be used only in connection with an item of fixed asset and whose use is expected to be irregular. These spares are classified as ‘capital spares’ and spares other than capital spares are classified as ‘inventories’. Capital spares identified by the company are capitalised at the time of their purchase along with the principal item of fixed asset or at the time of subsequent procurement. Depreciation on capital spares purchased along with the item of fixed asset is provided on a systematic basis over the period not exceeding the useful life of the concerned item of fixed asset. The depreciation on the capital spares identified/purchased subsequent to the capitalisation of the concerned items of fixed asset is provided systematically over the balance life of the concerned item of fixed asset. In both the situations, capital spares are amortised to the extent of 95% as required by section 205 and section 350 of the Companies Act, 1956.
5. The querist has stated that a view has been expressed by the government auditor that the capital spares identified by the company and capitalised along with the concerned item of fixed asset should be amortised to the extent of 100% and not to the extent of 95%. The view is based on the provisions of paragraph 8.2 of AS 10 which, inter alia, provides that "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" (emphasis supplied by the querist).
6. The company has supported its view based on the provisions of section 205 and section 350 of the Companies Act, 1956. According to the querist, section 205 of the Companies Act, 1956, provides that depreciation shall be provided to the extent specified in section 350 or for any such amount as is arrived at by dividing 95% of the original cost of the asset. Accordingly, the company has been charging depreciation to the extent of 95% in respect of assets including capital spares.
B . Query
7. The querist has sought the opinion of the Expert Advisory Committee as to whether as per paragraph 8.2 of AS 10, ‘capital spares’ identified by the company, keeping in view the provisions of AS 2 (revised 1999) and AS 10, are to be depreciated to the extent of 100% over the balance useful life of the concerned item of fixed asset or to the extent of 95% as required by section 205 and section 350 of the Companies Act, 1956.
C. Points considered by the Committee
8. The Committee notes paragraph 8.2 of AS 10 as below:
9. The Committee notes that a spare that is capitalised (hereinafter referred to as ‘capital spare’) in accordance with the above requirements of AS 10, does not have a useful life of its own as its useful life is linked to the useful life of the principal item. Thus, in the view of the Committee,a capital spare does not depreciate as an independent item of ‘plant and machinery’ in terms of its own wear and tear. For instance, an item of capital spare may be totally new at the time when the principal item is discarded. Yet, it would have to be written off in view of the fact that its useful life is linked to the useful life of the principal item of the asset which is nil, having the same been discarded. In other words, the capital spare does not have any residual value. The Committee is, accordingly, of the view that the requirement in paragraph 8.2 to allocate the total cost on a systematic basis for a period not exceeding the useful life of the principal item is appropriate (emphasis supplied by the Committee).
10. With regard to whether allocating the total cost of the capital spare over the useful life of the principal item of asset, is in accordance with the requirements of the Companies Act, 1956, the Committee is of the view that the requirement under the Companies Act, 1956, is to provide for as depreciation, at least 95% of the original cost of the asset, in view of sub- section (5) (a) of section 205 of the Companies Act, 1956, which prescribes computation of depreciation for the purposes of section 205 and section 350 of the Act. The said sub-section is reproduced below:
(Emphasis supplied by the Committee.) Thus, a company can provide for more than 95% of the original cost of the asset by way of depreciation. Accordingly, allocating the total cost of the capital spare over the useful life of the principal item is not in contravention of the requirements of the Companies Act, 1956.
D. Opinion
11. On the basis of the above, the Committee is of the opinion that as per paragraph 8.2 of AS 10, capital spares identified by the company, keeping in view the provisions of AS 2 and AS 10, should be depreciated to the extent of 100% over the balance useful life of the concerned item of fixed asset and that this is in accordance with the requirements of section 205 and section 350 of the Companies Act, 1956.
1 Opinion finalised by the Committee on 28.1.2005 |