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A. Facts of the Case
1. A public sector company registered under the Companies
Act, 1956, is engaged in the construction and operation of hydroelectric
power projects. While procuring plant and machinery for
power stations, capital spares/insurance spares are also procured
either with the mother plant or subsequently. According to the
querist, all such spares are capitalised in line with the accounting policy of the company, which had been framed keeping in view
Accounting Standard (AS) 2, ‘Valuation of Inventories’, Accounting
Standard (AS) 10, ‘Accounting for Fixed Assets’, and Accounting
Standards Interpretation (ASI) 2, ‘Accounting for Machinery Spares
(Re. AS 2 and AS 10)’2 read with an earlier opinion on ‘accounting
treatment of insurance spares’ given by the Expert Advisory
Committee of the Institute of Chartered Accountants of India
[published as Query No. 40 in the Compendium of Opinions –
Volume XXI]. The said accounting policy of the company is as
follows:
“3.1(a) Machinery spares procured along with the plant and
machinery or subsequently and whose use is expected to be
irregular are capitalised separately, if cost of such spares is
known and depreciated fully over the residual useful life of the
related plant and machinery. If the cost of such spares is not
known particularly when procured along with the mother plant,
these are capitalised and depreciated along with the mother
plant.
3.1(b) The written down value (WDV) of the spares is
charged to revenue in the year in which such spares are
consumed. Similarly, the value of such spares, procured and
consumed in a particular year is charged to the revenue in
that year itself.
3.1(c) When the useful life of the related fixed asset expires
and the asset is retired from active use, such spares are
valued at net book value or net realisable value whichever is
lower. However, in case the retired asset is not replaced,
WDV of the related spares less disposable value is written
off.
3.2 Other spares are treated as ‘stores and spares’ forming
part of the inventory and expensed when issued.”
2. The querist has stated that WDV of the capital spares
consumed is charged to the revenue. However, on the replacement
of old capital spares with the new ones, it happens that some of
the capital spares, which are retrieved, are suitable for reuse after some repairs. Accordingly, such retrieved spares are got repaired
depending upon the economically serviceable condition and are
kept in stock for their subsequent use. Cost of repair of such
spares is expensed and a memoranda quantitative account is kept
for such spares. This policy is being followed consistently.
3. The querist has informed that during the audit of accounts of
the company for the year 2007-08, the government auditor has
raised an observation regarding the practice being followed by the
company regarding the accounting for retrieved spares. The
contention of the auditor is that re-usable capital spares retrieved
from the generating units and lying in stock at the end of the year
should be valued on the basis of engineering estimates and
recognised in the accounts. The audit observation was not pressed
further on the assurance that the management shall study the
implication next year.
4. The querist has further stated that as regards the observation
of the auditor, management is of the opinion that re-capitalisation
of such repaired capital spares on assessed value may not be
appropriate owing to the following reasons:
(i) Expenditure on repair of the retrieved capital spares
already stands charged to revenue;
(ii) In hydro-power industry, life of the spare part of the
power generating plant usually depends on the quantum
of silt in the water. Moreover, quantum of the silt content
is also not uniform at all times. In a particular season,
silt content may be more than usual thereby causing
early replacement of spare parts and vice-versa.
Therefore, it is quite difficult to ascertain the life of the
retrieved spares, rate at which it is to be depreciated in
case of re-capitalisation of such retrieved (repaired)
spares;
(iii) At times, engineering estimate may be more than the
cost of repair, in that case, re-capitalisation would
tantamount to recognition of notional income to the extent
of difference between the engineering estimate and cost
of repair, which does not seem to be prudent.
5. The querist has stated that to address the issue of taking
such spares in the accounts in addition to keeping memoranda
quantitative record, the company is of the view, particularly in view
of the reasons given in paragraph 4 above, that the appropriate
accounting treatment would be to capitalise such retrieved (repaired)
spares at a notional value of Re.1 instead of capitalising it at the
value as per engineering estimate. This process of capitalising the
retrieved (repaired) capital spares @ Re.1 would keep on revolving
every time when a capital spare is consumed and the retrieved
one is got repaired for its re-use.
B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(a) Whether the accounting treatment as suggested in
paragraph 5 above would be appropriate.
(b) Other alternative treatment, if any, in lieu of the aforesaid
alternative.
C. Points considered by the Committee
7. The Committee notes that the basic issue raised by the querist
relates to the accounting treatment of parts of a fixed asset replaced
by insurance/capital spares and kept for reuse after some repairs.
Therefore, the Committee restricts itself to the specific issue raised
by the querist and has not touched upon any other issue that may
be contained in the Facts of the Case, such as, appropriateness of
rest of the accounting policy of the company related to spares as
mentioned in paragraph 1 above, identification of the spares as
capital spares, viz., machinery spares which can be used only in
connection with an item of fixed asset and whose use is expected
to be irregular, etc.
8. The Committee notes paragraph 25 of AS 10, which provides
as below:
“25. Fixed asset should be eliminated from the financial
statements on disposal or when no further benefit is
expected from its use and disposal.”
9. From the above, the Committee is of the view that if any item
of fixed asset is having no expected future benefit from its use or
disposal, it should be eliminated from the financial statements.
However, if it has a future economic benefit, it should continue to
be recognised in the books of account.
10. The Committee is of the view that ordinarily, when a part of
the fixed asset gets worn out and is physically replaced by its
capital spare, the part taken out from the fixed asset is of no
further use and is discarded. However, from accounting point of
view, the cost of the part thus removed from the fixed asset
continues to be a part of the cost of the whole fixed asset which
keeps getting depreciated. The capital spare, which now replaces
the original part in the fixed asset loses its separate identity and
becomes a part of the fixed asset. Accordingly, the written down
value of the capital spare is written off in the profit and loss
account. From the Facts of the Case, the Committee notes that in
the case of the company under consideration, sometimes the
original part removed from the fixed asset can be used again after
repair. The original part thus continues to have an economic value
as it can later replace the capital spare which was used to replace
the original part, when that capital spare gets worn out. In such a
situation, when the capital spare replaces the original part in the
fixed asset and that original part can be used again after repair,
the written down value of that capital spare should not be charged
off to the profit and loss account. Instead, only the repair charges
should be charged off to the profit and loss account. The
depreciation should continue to be charged on the value of the
capital spare over the remaining useful life of the fixed asset. This
is so because though physically, original part and the capital spare
get exchanged, they both continue to be of further use to the
enterprise.
D. Opinion
11. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 6 above:
(a) The accounting treatment suggested by the querist in
paragraph 5 above is not appropriate under the
circumstances of the company.
(b) The correct treatment would be to continue to recognise
the written down value of the capital spare in the books
of account. Please refer paragraph 10 above.
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