|
A. Facts of the Case
1. A company is a Government of India undertaking incorporated
in the year 1975 under the Companies Act, 1956. One of the
objectives of the company is to set up power plants in various
geographical locations in the country and to supply bulk power to
the various state electricity boards. The company, being an
electricity generating company, is also governed by the provisions
of the Electricity Act, 2003. As per the querist, since the Government
has not prescribed any statement of accounts for the central
undertakings engaged in generation of electricity, the company is
preparing its financial statements in the format prescribed in
Schedule VI to the Companies Act, 1956.
2. The querist has stated that in line with the provisions of
Accounting Standard (AS) 2 ‘Valuation of Inventories’ (revised 1999)
and Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’,
the company has identified certain 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
are capitalised alongwith the related plant and machinery and their
total cost is amortised over the useful life of the related plant and machinery. Other spares are classified as ‘machinery spares’ and
are included in inventories. According to the querist, ‘capital spares’
identified by the company are capitalised alongwith the value of
related principal items of fixed assets whether procured alongwith
the related principal item or subsequently. The total cost of the
capital spares, whether purchased alongwith the related plant and
machinery or subsequently, is amortised on a systematic basis
over a period not exceeding the useful life (remaining useful life in
case of subsequent procurement) of the related plant and
machinery.
3. The querist has further stated that when the capital spare is
issued for consumption, i.e., replaces the worn out spare in the
fixed asset, the following accounting treatment is carried out in the
accounts:
● In case the taken out spare is irrepairable:
– the gross block and accumulated depreciation of
the spare taken out is de-capitalised.
● In case the taken out spare is repairable:
– the gross block and accumulated depreciation of
the spare taken out and repaired is kept in the
books of account; and
– the repair charges are debited to the profit and loss
account.
4. The querist has referred to the opinion of the Expert Advisory
Committee on Query No. 40 contained in the ‘Compendium of
Opinions – Volume XXI’ wherein the Committee has, inter alia,
opined:
Paragraph 14 of the Opinion
“Machinery spares of the nature of capital spares/insurance
spares are capitalised separately at the time of their purchase
whether procured at the time of the purchase of the fixed
asset concerned or subsequently. Depreciation on capital
spares purchased along with the fixed assets is charged on a systematic basis over a period not exceeding the useful life of
the fixed asset to which they relate. When the capital spare/
insurance spare is actually used, i.e., it replaces the worn out
spare in the fixed assets, the written down value of the capital
spare, on the date it is put to use, should be immediately
expensed. This is because the replacement of the spare does
not increase the future benefits from the existing asset beyond
its previously assessed standard of performance. The capital
spare/machinery spare purchased subsequent to the purchase
of the machine is capitalised and depreciated on a systematic
basis over a period not exceeding the remaining useful life of
the related fixed asset and when replaced should be treated
in the manner explained above.”
Paragraph 18 (d) of the Opinion
“An item of capital/insurance spares should be charged to
revenue, if the year of purchase and consumption is the same.”
The view is based on the provisions of paragraph 23 of AS 10
which provides “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.”
5. In the view of the querist, the opinion of the Expert Advisory
Committee regarding capital/revenue spares to be charged to
revenue in case the year of purchase and consumption is same
may need review considering the following:
(i) Normally, the items of capital spares in a company are
identified much before their procurement by a group of
technical experts considering the provisions of AS 2
and AS 10, viz., usage with an item of fixed asset and
expected irregular use. Based on this, capital spares
are identified and capitalised alongwith the related plant
and machinery.
(ii) The cost of spares both fitted in the main plant and the
other spare (whether procured alongwith the related main
plant or subsequently) kept in stores as capital spare is included in the cost of related plant and machinery even
though there was no increase in the future benefits
from the existing assets beyond its previously assessed
standard of performance from the spare kept in store.
(iii) Paragraph 14 of the aforesaid opinion suggests the
accounting treatment of capital spares based on the
accounting periods and not on the principles laid down
in AS 2 and AS 10 regarding usage with an item of
fixed asset and expected irregular use.
(iv) The accounting of the capital spares should be based
on the nature of items, i.e., usage with an item of fixed
asset and expected irregular use as defined in AS 2
and AS 10 and should not be on the basis of purchase/
issue of the spares, i.e., a capital spare purchased on
31st March, 2007, i.e., at the balance sheet date and it
replaces the taken out spare on 1st April, 2007, i.e., 1st
day of the following accounting year is to be capitalised.
But in case the capital spare is purchased on 1st April
2007, i.e., at beginning of the balance sheet date and it
replaces the taken out spare on 31st March 2008, i.e.,
last day of the accounting year, it is to be charged to
revenue.
(v) The taken out spare can be repairable and the repair
cost is charged to revenue. The repaired spare can be
used again for replacing the taken out spare.
In the view of the querist, capital spares should be charged to
revenue only in those cases where the taken out spares are
irrepairable and of no future use.
B. Query
6. Based on the above, the querist has requested the Expert
Advisory Committee to review its earlier opinion published as Query
No. 40 of ‘Compendium of Opinions – Volume XXI with respect to
the issues reproduced in paragraph 4 above.
C. Points considered by the Committee
7. The Committee notes that the basic issue raised in the query
relates to the accounting treatment for replacement of worn-out
part in the fixed asset with the spare and particularly, when the
year of purchase and consumption of the spare is the same. The
Committee, has therefore, considered only these issues and has
not touched upon any other issue arising from the ‘Facts of the
Case’, such as, appropriateness of the identification of the spares
as capital spares, etc.
8. In the context of replacement of spares, the Committee notes
paragraph 23 of AS 10, which states as follows:
“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.”
On the basis of the above, the Committee is of the view that at the
time of subsequent expenditure, in order to determine accounting
treatment thereof, it should be evaluated as to whether the
subsequent expenditure increases the future benefits arising from
the asset beyond its previously assessed standard of performance
in terms of its useful life, or its production capacity, or in terms of
decreased operational costs, etc. Applying the above principles,
the Committee notes that since the replacement of a part of the
fixed asset with its spare does not increase the future benefits
arising from the fixed asset beyond its previously assessed standard
of performance, the cost of replacement should be charged to
revenue and should not be added in the value of fixed asset.
When the worn-out part of the fixed asset is replaced by a previously
capitalised capital spare, the written down value of the capital
spare should be charged off to the profit and loss account. It
would be appropriate to write off the written down value of the part
taken out from the fixed asset only if the said part was capitalised
separately when the fixed asset was purchased applying the
principles contained in paragraph 8.3 of AS 10.
9. As far as the accounting treatment of replacement of spares
when the year of purchase and consumption thereof is same is concerned, extending the above principles, the Committee is of
the view that the cost of replacement in the present case is the
cost of new spares and accordingly, the same should be charged
off to the revenue account at the time of replacement. In case, it is
not consumed in the same year and is replaced in a subsequent
year, the depreciated amount in respect thereof is expensed. Thus,
the principle is the same whether the spare is replaced in the year
of purchase or in a subsequent year. At best, the entity may
charge pro-rata depreciation in the year of purchase till it is
consumed, but the total effect will remain the same whether the
full amount of replaced spare is expensed or it is expensed as
depreciation for part of the year. The Committee notes that the
same accounting treatment has been prescribed in the earlier
opinion referred by the querist in paragraph 4 above.
10. As regards the arguments of the querist in paragraph 5 above,
the Committee is of the following view:
(i) Identification of capital spares with an item of fixed asset
does not allow the capital spares to be capitalised as a
part of the fixed asset concerned. A capital spare
procured subsequent to the purchase of the fixed asset
should be capitalised separately.
(ii) The capital spare, whether procured along with the fixed
asset or subsequently, is capitalised because it has future
economic value of being put to use when the part of the
fixed asset needs replacement. Upon actual replacement,
the capital spare kept in store looses its identity and
becomes a part of the fixed asset when the worn-out
part is taken out. Therefore, applying the principles of
paragraph 23 of AS 10, the written down value of the
capital spare kept in store is charged to the profit and
loss account.
(iii) The suggested accounting treatment is in line with the
principles of AS 2 and AS 10. In accordance with the
principles of AS 2, an item of capital spares is not
considered as an inventory rather the same is capitalised
as per the provisions of AS 10 at the time of purchase and the total cost thereof is also allocated over the
useful life of the fixed asset. However, upon replacement
of a part of the fixed asset by its spare when the year of
purchase and year of consumption of the spare is same,
in view of the principles of paragraph 23 of AS 10, the
cost of the spare purchased should be charged to
revenue as it does not increase the level of performance
of the fixed asset. This has been discussed in paragraph
9 above in detail.
(iv) The accounting treatment prescribed above is based on
the nature of the item, viz., replacement expenditure
incurred. As per the provisions of paragraph 23 of AS
10, it requires evaluation as to whether the expenditure
increases the future benefits arising from the fixed asset
beyond its previously assessed standard of performance.
If not, the expenditure is considered of the nature of
revenue and accordingly, charged off to revenue and if
yes, it is of capital nature and accordingly, it is capitalised.
Accordingly, a capital spare when purchased is
capitalised, and when actually put to use, i.e., when it
replaces the worn-out part of the fixed asset, is
expensed. Whether the two events occur in the same
financial year or different financial years is incidental.
This has also been explained in paragraph 9 above.
(v) As far as the accounting of the repairable capital spares
is concerned, the Committee observes that in those
cases, since the original part removed from the fixed
asset can be used again for replacing the taken out
spare, the original part still has an economic value and
accordingly, when the spare replaces the original part in
the fixed asset, the written down value of the spare
should not be charged off to the profit and loss account,
instead depreciation should be continued to be charged
on the spare as a separate capital spare. The reason
being that no replacement has taken place. The repair
charges incurred should be charged to the profit and
loss account.
D. Opinion
11. On the basis of the above, the Committee is of the opinion
that the earlier opinion of the Committee published as Query No.
40 of the ‘Compendium of Opinions – Volume XXI’ with respect to
the issues reproduced in paragraph 4 above, is correct and there
is no need of revising it.
|