Accounting treatment of insurance spares (also called irregular or critical spares in technical jargon)

Dear Mr. VS Kumar ji, Just registered and regret for late response. Clarification is as under:- 1). An insurance / critical / irregular spare is a spare part that will be used to replace a worn out / failed identical part of an operating equipment whose downtime cost is very high. To define, it is an insurance against such failures for which the down time costs are very high. They are not obsolete until the parent equipment is retired from service / declared as obsolete no matter if it does not move for years. Point to be noted is the spares to be declared as insurance spares if it is not readily available in market / of the shelf and procurement of such spare accrues considerable lead-time for procurement / fabrication / imports. 2). Date of acquisition is the capitalization (receipt) date. To sight an example- suppose an equipment is purchased which is used in the production process line and along with that, a back-up engine / motor device for the same is also purchased as a stand by to be used in case of equipment breakdown. In this case back-up engine / motor is treated as a capitalized Spare Part. 3. All these spares appear in inventory exception being capatilazied spares which is defined as an ASSET as that of plant and machinery, to be depreciated. These spares are to be accounted with acquisition value only. Warmest Regards, Prabhakar Acharya

Sir,

I have some queries on the same:

We have a few items as insurance spares ( Capital Spares &  Normal Spares ) shown as inventory of stores & spares.

1. Should I transfer Capital Spares to Fixed Assets?

If yes, When should I start depreciation on capital spares.

2. What should be useful life- Life of main asset or insurance spare?

3. We have some spares items as inventory of stores & spares also which is purchased to comply with safety norms(This may be capital spares/ Normal Spares). Should these Capital spares also be capitalized as per IND AS? 

 

Thanks in advance.

Hemant Sheth

 

 

Dear Mr. hemant Sheth ji, An insurance items is a spare part that will be used to replace a failed identical part in an operating equipment whose penalty cost for downtime is considerably high. It is an insurance against such failures for which the down time costs are very high procurement lead time being even high. They do not become obsolete until the parent equipment is retired from service no matter if they do not move for many years. WHERE AS - Capital Spares: These are vital spares for critical equipment. The stock-out cost for such spares is very high and the unit cost also is very high. Capital spares, although acknowledged to have a long life OR a small chance of failure, would cause a long shutdown of equipment because it would take a long procurement lead time to get a replacement for them. As such, decision has to be made as to the quantity of items to be stored. Capital spares are, by definition, not inventory because they are capitalized as an ASSET- plant / equipment OR machinery. Accounting treatment of - Capital Spares: 'Spare', as the name suggests, refers to additional or extra to what is required for ordinary use. That purely means an item kept as standby, in case the other similar item in production line / assembly is lost, broken, OR worn out. These are purchased for the purpose of reducing the idle/ down time of machinery. FOR EXAMPLE: A machinery / equipment is purchased which is used in the production process and along with that, a back-up engine for the same is also purchased, to be used in circumstances of machinery breakdown. In this case back-up engine is treated as a 'SPARE PART, which can even be CAPITALIZED. It is essential to be consistent in the application and your procedure should be documented to ensure continuity in the organization. ACCOUNTING TREATMENT OF SPARE PARTS: Treatment of spare parts shall be done in accordance with the prevailing provisions of Accounting Standards (AS) as prescribed. Spare Parts should be treated as per the definition and recognition criteria mentioned in Indian Accounting Standard. For AS of spare parts under various aspects, we need to understand:- (A). Earlier - traditional Concepts: Spare Parts' treatment as per earlier approach was governed by two accounting standards namely, AS 2, 'Valuation of Inventories' and AS 10, 'Accounting for Fixed Assets' which are discussed below :– 1. As per AS-2, Valuation of Inventories- It was stated that '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 AS-10, Accounting for Fixed Assets. 2. As per AS-10, Accounting for Fixed Assets: 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- parent equipment OR machinery. (B). Revised / Present Concepts: Ministry of Corporate Affairs, vide notification dated 30/03/2016 has amended the Accounting Standard 2, Valuation of Inventories, Accounting Standard 10 and Accounting Standard 6, now as 'Property, Plant & Equipment' applicable from the Financial Year 2016-17 on companies & from Financial Year 2017-18 for non-corporate-assessees. 1. AS-2 Valuation of Inventories: It would not include those spare parts and stand by equipment under inventory that are considered as PPE (Property, Plant & Equipment) as per Revised AS-10. Other than those stated above, all other spare parts are classified under inventories. 2. Revised AS-10 Property, Plant & Equipment: Now, it has been specifically provided that, for any spare part to be covered under the scope of property, plant & equipment must satisfy the below mentioned definition criteria of PPE which states that: Assets which are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and, Assets which are expected to be used during more than a period of twelve months. On fulfillment of both the conditions an asset is considered as PPE (property, plant & equipment). (A). Earlier - traditional Concepts: Spare Parts' treatment as per earlier approach was governed by two accounting standards namely, AS 2, 'Valuation of Inventories' and AS 10, 'Accounting for Fixed Assets' which are discussed below :– 1. As per AS-2, Valuation of Inventories- It was stated that '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 AS-10, Accounting for Fixed Assets. 2. As per AS-10, Accounting for Fixed Assets: 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- parent equipment OR machinery. (B). Revised / Present Concepts: Ministry of Corporate Affairs, vide notification dated 30/03/2016 has amended the Accounting Standard 2, Valuation of Inventories, Accounting Standard 10 and Accounting Standard 6, now as 'Property, Plant & Equipment' applicable from the Financial Year 2016-17 on companies & from Financial Year 2017-18 for non-corporate-assessees. 1. AS-2 Valuation of Inventories: It would not include those spare parts and stand by equipment under inventory that are considered as PPE (Property, Plant & Equipment) as per Revised AS-10. Other than those stated above, all other spare parts are classified under inventories. 2. Revised AS-10 Property, Plant & Equipment: Now, it has been specifically provided that, for any spare part to be covered under the scope of property, plant & equipment must satisfy the below mentioned definition criteria of PPE which states that: Assets which are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and, Assets which are expected to be used during more than a period of twelve months. On fulfillment of both the conditions an asset is considered as PPE (property, plant & equipment). Items purchased under safety norms can even be capitalized. All insurance capital spares may be treated as ASSET items and needs to be depreciated from the date of purchase as per accounting standards with the decision of management. The life of an asset may vary from 5 To 20 yrs OR even more if it is a plant / machinery / equipment. Traditional practice was to treat the tools / instruments having life span of 3 to 5 years as ASSET duly capitalized. Accounting standard & practices can be changed with the decision of management as may be convenient leading to corporate benefits. Hope this clarifies the subject matter. Warmest regards, Prabhakar Acharya

Thanks for the detailed reply sir. Sorry for the delayed response.

Sir, You are always welcome.

Warmest Regards