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Query No. 8
Subject:
Issue of spares and stores to dredgers.1
A. Facts of the Case
1. A public sector undertaking, under the Ministry of Shipping,
Road Transport and Highways, was incorporated on 29th March,
1976 under the Companies Act, 1956. The main objective of the
company is to provide integrated dredging services to all major
and minor ports, Indian Navy, fishing harbours and other maritime
organisations.
2. The dredging activities are carried out by ocean going
dredgers, self-propelled or dumb dredgers. As compared to any
other ocean going vessel, the dredger has got a much greater
amount of machinery installed. The trailer dredgers have almost
twice the amount of machinery fitted as compared to an ocean going ship of the same size. Most of the time, dredgers operate in
various types of soils and sandy waters which affect the outer
surface of hull plates as well as the internal plates of the hopper,
which in turn, results in wear and tear of hull and other soil touching
parts/equipments. These dredgers would normally be working 24
hours a day continuously for a period of about 3 weeks when the
machinery will be stopped for undertaking preventive maintenance.
Such continuous usage of the machinery in the shallow and sandy
waters of the port causes heavy wear and tear necessitating periodic
repairs in a dry dock and also the consumption of spares and
stores.
3. The querist has informed that the spares used are machinery
spares in nature as these spares are intended to be utilised on the
fixed assets, i.e., dredgers. The procurement of these spares is
need-based and against the specific requirement indicated by
Masters/Chief Engineer on board of the dredgers through an indent.
Such spares are replacements for parts worn out during usage of
the machinery. Thus, replacement may take place at the next
following maintenance period or during the next following dry dock
of the dredger. Till such time, the spares so procured may generally
be delivered on board the particular dredger or sent to the Central
Warehouse at Visakhapatnam. In the latter case, the value of the
spares is treated as inventory till the time of issue to the dredgers.
These spares do not increase the future benefits from the existing
assets (dredgers and other crafts) beyond their previously assessed
standard of performance. These spares are procured to keep up
the original functioning of the machinery on board the dredger.
4. The querist has mentioned that the cost of initial spares, i.e.,
the spares purchased along with the dredgers is capitalised. The
cost of spares and stores purchased subsequently during the
operation/repair of the dredgers is charged off as operational
expenditure.
5. The current fleet of the company includes dredgers, tugs,
survey launches and other ancillary crafts like barges, pontoons,
etc. The above crafts are depreciated at the rate of 7% under
straight line method (SLM), as provided in Schedule XIV to the
Companies Act, 1956. The residual value of 2% is carried in the books as Written Down Value. Presently, the company owns 12
dredgers, out of which 9 dredgers have been depreciated to 98%.
All these dredgers are in operation and all these crafts are expected
to have a further useful life of at least 5 to 10 years.
6. During the course of audit of accounts for the year 2006-07,
the Comptroller and Auditor General of India (C&AG) (PDCA&
MAB, Hyderabad) issued a provisional comment on accounting of
stores and spares issued to dredgers. The accounting policy 4(a)
in respect of spares and stores and the provisional comment 4(a)
on this accounting policy of the company along with the company’s
reply are reproduced below:
Accounting Policy
“4. Operational Expenses
(a) Spares & Stores:
Spares and stores and lubricants delivered to the crafts
during the year acknowledged by the Master/CEO are charged
to revenue. Provision is made for the material delivered to
crafts upto 31st March in respect of which acknowledgements
are not received.”
Comment of Government Audit
“4(a) This is understated by Rs. 99.16 crore due to failure to
account for the stores and spares which were acknowledged
by Masters of the vessels and lying on board the dredgers as
on 31 March, 2007. This has resulted in overstatement of
consumption of stores and spares for the year by Rs. 29.91
crore and prior period consumption by Rs. 72.25 crore and
understatement of net profit after prior period adjustments by
Rs. 99.16 crore. There is a need to change the accounting
policy so that it is not in conflict with Accounting Standard
(AS) 2, ‘Valuation of Inventories’.”
Reply of the company
“The accounting policy in respect of spares and stores has
been consistently followed since inception and the same policy is being followed by other companies in similar business. The
accounting policy needs to be viewed in the background of
the dredging and shipping industry.
The company is meeting dredging requirements of various
major and minor ports in India. Practically, it becomes very
difficult to maintain/monitor the suggested method of spares/
stores on board the vessel keeping in view the difficulties
involved.
Some of the important factors that need to be considered in
this regard include:
(a) Dredgers are manned by floating officers and crew
whose skills are highly specialised and confined to
dredging operations. They are not accustomed to record
keeping, except insofar as it may be necessary to
operate the dredger (navigation and dredging).
(b) Floating personnel are continuously changing (3 months
on and 2 months off) as per the rules applicable to
them and every time there are necessary handing over/
taking over formalities.
(c) Dredgers operate most of the time in sea. They require
minimum spares on board all the time.
(d) Spares supplied on board the dredgers are exposed to
sea conditions and therefore, deteriorate at comparatively
faster rate.
(e) Sometimes spares required by a dredger due to urgency
may have to be supplied from another dredger.
(f) Estimating value of spares on board on a particular
date will be impractical as these spares may have been
carried for several years.
Because of the above factors, the shipping industry is following
this specific policy of charging spares as and when delivered.
The value of inventories amounting to Rs. 99.16 crore appears
to be based on the Management report furnished by Dredge Masters. The figures so arrived are not authenticated/supported
by necessary documentary evidence, i.e., invoice giving cost,
taxes, duties, cost of bringing it to its present location, etc.
Besides, the proposed change, if implemented, would seriously
distort the true and fair view of the current year profitability.
It is further submitted that AS 2 is not applicable to the subject
spares as AS 2 specifically excludes machinery spares in
connection with items of fixed assets and therefore, the
question of any conflict with AS 2 does not arise. Hence,
Audit is requested to drop the Comment.”
Further, in respect of the discussions with C&AG (PDCA & MAB
Hyderabad), the querist has informed that it was also submitted
that such procurement of spares and stores do not satisfy any of
the following conditions to capitalise:
(a) enhance the life of the dredger, or
(b) increase the previously assessed standard of
performance, or
(c) it results in reduction of cost of production.
7. According to the querist, the subsequent procurement of spares
and stores has been only to maintain the normal functioning of the
dredger. In view of this position, the cost of such procurement is to
be expensed in the year of its incurrence. Further, as per the
querist, this accounting treatment is in accordance with Accounting
Standard (AS) 10, ‘Accounting for Fixed Assets’, and also with the
rationale of the opinions issued by the Expert Advisory Committee
of the Institute of Chartered Accountants of India. Besides this, the
querist has mentioned that the accounting policy is in line with the
industry practice.
8. The querist has mentioned that after considerable discussions,
the C&AG (PDCA & MAB, Hyderabad), agreed to the contentions
of the company that it does not fall within the scope of AS 2 and
revised the earlier Provisional Comment 4(a) stating that the
accounting treatment of the company is not in consonance with
AS 10 and forwarded the revised Comment 4(a) to C&AG, New
Delhi along with other comments. The querist has provided the Revised Provisional Comment 4(a) along with the company’s reply
for the perusal of the Committee, the relevant extracts of which
are reproduced as below:
Comment of Government Audit
“Profit and Loss Account
B. Expenditure on:
Operations (Schedule X)
Spares and Stores – Rs. 4534.97 lakh
4(a)(i) This includes spares valuing Rs. 9.86 crore issued to
three dredgers which have a residual life. The spares should
have been capitalised in accordance with Accounting Standard
(AS) 10, ‘Accounting for Fixed Assets’ and depreciated over
the remaining life period of these dredgers. Failure to do so
resulted in overstatement of consumption by Rs. 9.86 crore,
understatement of Gross Block to the same extent,
understatement of depreciation by Rs. 1.38 crore and profit
for the year by Rs. 8.48 crore.
(ii) This also includes spares worth Rs. 35.49 crore issued
to remaining dredgers with no residual life. The value of these
spares should have been capitalised and then charged off to
Profit and Loss Account through depreciation account. This
has resulted in overstatement of consumption by Rs. 35.49
crore and understatement of Gross Block and depreciation to
the same extent.
(iii) Such incorrect charging-off of spares issued to dredgers
in the past but not consumed and lying on board the dredgers
as on 31st March, 2007 has led to understatement of Gross
Block by Rs. 72.25 crore. Due to adopting an accounting
policy which is not in consonance with AS 10, the Gross
Block is not being properly accounted for. There is a need to
change the accounting policy No. 4(a) relating to issue of
spares and stores so that it is not in conflict with AS 10.”
Reply of the company
“…For ready reference, we are furnishing below the particular
accounting policies adopted by various similar companies in
the industry:
A Ltd.
Accounting policy No.7 (e) –
7. Valuation of stocks:
(e) Store/spares including paints, etc. are charged to
revenue as consumed when directly issued to ships.
Items of stores/spares, which cannot be delivered
immediately are shown under stores/spares in transit
and are cleared on receiving acknowledgement from
the ship. However, all items of stores/spares purchased
within last 3 months of the financial year, for which
acknowledgement are not received, are treated as stock
and valued at lower of cost or realisable value.
B Ltd.
Accounting policy No. (i) (ii)
(i) Operating expenses:
(ii) Stores and spares delivered on board the ships and
rigs are charged to revenue.
C Ltd.
Accounting policy No.(g)
(g) Stores and Spares:
Stores and spares purchased are directly issued to ships
and the value of such purchases is charged to the
expenses account as consumed.
Further to above, we would like to reiterate that the values
indicated cannot be authenticated/supported by necessary
documentary evidence, such as, invoice giving cost, taxes, duties, cost of bringing it to its present location in respect of
each item of the spare and its present condition on board the
dredger as required to pass necessary accounting entries in
the books.
In view of this, we are unable to vouch for the correctness of
various figures stated in the modified provisional comments,
viz.,
(a) Rs. 9.86 crore in respect of the three dredgers which
have a residual life,
(b) Spares worth Rs. 35.49 crore issued to remaining
dredgers with no residual life, and
(c) Rs. 72.25 crore purported to have been incorrectly
charged off of spares issued to dredgers in the past
9. The querist has informed that the revised comment along
with other comments was discussed and clarified at C&AG’s office,
New Delhi. The C&AG’s office has dropped the above comment
subject to the company’s assurance that the subject Provisional
Comment will be referred to the Institute of Chartered Accountants
of India for its expert opinion. Further, the querist has mentioned
that in this connection, the company has relied on the earlier
opinions of the Expert Advisory Committee on the subject published
in various volumes of Compendium of Opinions, viz., Query No.
13 of Volume XX, Query No. 32 of Volume XX, Query No. 37 of
Volume XX, and Query No. 22 of Volume XXIII.
B. Query
10. In view of the above, the querist has sought the opinion of the
Expert Advisory Committee on the following issues:
(i) Whether the accounting practice followed by the
company, viz., for charging off spares to expenditure as
and when these are issued to dredgers, as per the facts
and circumstances, is in accordance with the provisions
of AS 10.
(ii) If not,
(a) whether such subsequent procurement of spares
and stores needs to be capitalised and depreciated
over the remaining life period of the dredgers as
opined by the C&AG Audit.
(b) whether such procurement of spares and stores
also needs to be capitalised in respect of dredgers
with no residual life. Whether these spares and
stores should be capitalised and then charged off
to the profit and loss account through depreciation
account as opined by C&AG Audit. (The querist
has invited reference to the earlier opinion of the
Expert Advisory Committee published as Query No.
3 of Volume XXIII of the Compendium of Opinions.)
C. Points considered by the Committee
11. The Committee notes the following paragraph of Accounting
Standard (AS) 2, ‘Valuation of Inventories’, which states as below:
“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’.”
12. The Committee also notes the following paragraphs of
Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which
state 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.”
“12. Improvements and Repairs
12.1 Frequently, it is difficult to determine whether subsequent
expenditure related to fixed asset represents improvements
that ought to be added to the gross book value or repairs that
ought to be charged to the profit and loss statement. Only
expenditure that increases the future benefits from the existing
asset beyond its previously assessed standard of
performance is included in the gross book value, e.g., an
increase in capacity.”
“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.”
13. On the basis of the paragraphs of AS 2 and AS 10 reproduced
above, the Committee notes that for accounting purposes, there
are generally two types of machinery spares. The first type are
those machinery spares which cannot be used in connection with
a particular/specific item of a fixed asset and whose use is not
irregular, and are considered as inventories and accordingly need
to be accounted for as per the principles enunciated in AS 2. The
second type of machinery spares are those which can be used
only in relation to a specific item of a fixed asset and whose use is
expected to be irregular, and they should be accounted for as per
AS 10. Such spares are commonly known as capital spares/
insurance spares.
14. The Committee notes from paragraph 8 of the Facts of the
Case that whereas the Government Audit (New Delhi) has given
its opinion on the basis that the machinery spares in question are
capital spares, the accounting treatment followed by the company
is based on the consideration that the spares are of the nature of
inventory except in the instance of initial spares purchased at the time of the purchase of the dredgers itself. The Committee also
notes from paragraph 6 that the Government Audit (Hyderabad)
also appears to consider the machinery spares of the nature of
inventory. The Committee further notes that the Facts of the Case
do not contain information to decide whether the machinery spares
are of the nature of capital spares keeping in view the requirements
of paragraph 8.2 of AS 10. The Committee is, therefore, of the
view that the company should first decide whether the spares are
of capital nature or of the nature of inventory keeping in view the
requirements of the aforesaid paragraph of AS 10. It is also possible
that some machinery spares may be of capital nature while others
may not be of that nature, i.e., these may be of the nature of
inventory, e.g., in case of spares which can be used by different
dredgers and, therefore, not specific to an item of fixed asset as
contemplated in paragraph 8.2 of AS 10. In the absence of the
facts, the opinion of the Committee hereinafter deals with both the
situations, namely, if the spares are of capital nature and in case
the spares are of the nature of inventory.
In case the spares are of capital nature
15. Machinery spares of the nature of capital spares/insurance
spares are to be capitalised separately, whether purchased along
with the principal fixed asset, i.e., the dredgers, or purchased
subsequently. The Committee notes that at present the company
capitalises the initial spares, i.e., those purchased with the dredgers,
and charges to revenue those spares which are purchased
subsequently. In this respect, the Committee reiterates that in
case the spares purchased by the company are capital spares,
these are to be capitalised whenever these are purchased. As per
the requirements of AS 10, capital spares purchased along with
the dredgers should be depreciated on a systematic basis over a
period not exceeding the useful life of the dredger to which they
relate. In case of capital spares purchased subsequently,
depreciation should be charged on a systematic basis over a period
not exceeding the balance/remaining useful life of the particular
dredger to which the spares relate. On the date the capital spare
is actually put to use, i.e., it replaces the worn out part in the
corresponding dredger, the written down value of the capital spare
at that date is immediately written off to the profit and loss account.
This is done as the replacement of the spare does not increase
the future benefits from the existing dredger beyond its previously
assessed standard of performance.
16. In case of spares purchased subsequently in relation to
dredgers whose residual life has expired, the Committee notes
that as per the accounting treatment given in AS 10, the cost of
capital spares should be amortised on a systematic basis over a
period not exceeding the useful life of the principal asset, i.e., the
particular dredger. Thus, where the useful life of the dredger has
expired, i.e., it has been completely depreciated in the books, the
Committee is of the view that capital spares, should be first
capitalised and then charged to the statement of profit and loss
through depreciation in the year of purchase itself. The Committee
also notes that this accounting treatment is in consonance with the
view expressed by the Committee in its earlier opinion published
in Compendium of Opinions, Volume XXIII, Query No.3.
In case the spares are of the nature of inventory
17. The Committee notes from paragraph 8.2 of AS 10 reproduced
in paragraph 12 above that the machinery spares of the nature of
inventory are usually charged to the profit and loss statement as
and when consumed. The Committee notes that the company is
treating the machinery spares as of the nature of inventory and
are charging the same to the profit and loss account when these
are issued for consumption. The Committee also notes the
accounting policies of certain companies quoted by the querist in
paragraph 8 of the Facts of the Case, wherein the spares are
being treated as of the nature of inventory and are considered to
be consumed when issued for consumption. The Committee is of
the view that a spare can be considered as consumed when issued
from store in an event the spare is to be immediately used against
a specific breakdown of the relevant component of the dredger.
However, in case the spares are ordinarily issued to a dredger
awaiting breakdown in the dredger, it indicates that spares are
lying on the dredgers as inventory. In the latter case, it is imperative
for the company to have an appropriate system of inventory
management and control on the dredger in case the spares are
material in amount. The difficulties indicated by the company in paragraph 6 of the Facts of the Case do not override the
requirements of the Standards. What it indicates is the lack of
proper system of accounting for spares of the nature of inventory.
18. The Committee is also of the view that in case the company
considers the machinery spares of the nature of inventory, the
same should be treated as such even if purchased initially along
with dredgers. For this purpose, the value of the spares may have
to be estimated on a reasonable basis.
D. Opinion
19. On the basis of the above, the Committee is of the following
opinion in respect of the issues raised by the querist in paragraph
10 above:
(i) As per the facts and circumstances of the given case,
the current accounting practice of the company of
charging off spares to expenditure as and when these
are issued to dredgers is not in accordance with the
provisions of AS 10.
(ii)(a) If the spares are of capital nature and purchased
subsequently, these need to be capitalised and
depreciated systematically over the remaining useful life
of the particular dredger in whose connection these are
purchased and expected to be used as discussed in
paragraph 15 above.
(b) In case the spares are of capital nature and where the
life of the particular dredger is over, the same should be
charged to the profit and loss account through
depreciation as discussed in paragraph 16 above.
1 Opinion finalised by the Committee on 30.4.2008
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