Accounting Treatment of Spare Parts

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Karankhanchandani

Kabhi kisi “EXTRA” ko “extra” mat samajhna, kyunki kya pata us “extra” ka accounting
treatment “EXTRA ordinary” ho.!!!

SPARE PARTS– “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 another item
of the same type is lost, broken, or worn out. These are purchased for the purpose of
reducing the idle time of machineries and other auxiliary processes in case of sudden
breakdowns or any other contingencies.

For Example: Machinery 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‛.

ACCOUNTING TREATMENT OF SPARE PARTS:

Treatment of spare parts shall be done in accordance with the prevailing applicable
provisions of Accounting Standards as prescribed from time to time. Spare Parts should be
treated as per the definition and recognition criteria mentioned in Accounting Standard or
Indian Accounting Standard. Now let’s understand the treatment of spare parts under
various aspects:

(A) Earlier 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 item.

(B) Revised 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 noncorporate
assessees.

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1. AS-2 Valuation of Inventories: It would not include those spare parts and stand by
equipments under inventory that are considered as PPE as per Revised AS-10. As the
same would be dealt as per 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.

Recognition Criteria: The cost of an item of property, plant and equipment should be
recognized as an asset if, and only if:

It is probable that future economic benefits associated with the item will flow to the
enterprise; and
The cost of the item can be measured reliably.

From the above mentioned conditions we can say that the revised accounting standard has
become very specific regarding definition and recognition criteria. However, broadly the
overall concept is similar to the criteria of previous Accounting Standard. Apart from that,
some companies have to follow the provisions of Indian Accounting Standards, if
applicable. Indian Accounting Standard 16, Property Plant & Equipment shall be taken into
consideration for accounting treatment of spare parts. However, the treatment in Ind AS for
accounting of spare parts is same as in Revised AS 10, as the revised AS-10 is drafted in
accordance with the Ind AS 16 only.

Let’s comprehend the above discussed concepts through some examples:

(A) Y Ltd. purchased a Gang saw machine for Rs.1,00,00,000 and extra cutting blades for
Rs.5,00,000 for the machine which may be used whenever needed in other dissimilar
cutting machines also. Useful life of the plant is 10 years and of the blades is 4 years.

As per old AS: The blades purchased can be used with other mounting/cutting machines
also, though the use of blades is irregular, but still it would be treated as an item of
inventory.

As per Revised AS: For the purpose of treatment an asset as PPE, the revised AS strictly
provides for the definition criteria (discussed above). Herein, both the conditions provided
are fulfilled as the purchased blades are for the purpose of production only and also its
expected use is more than a period of 12 months. So as per Revised AS-10 it would be
treated as a part of PPE and would be depreciated accordingly.

Emphasis over Materiality Concept

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At times, we come across the dilemma regarding treatment of some assets that are used in
the production process and also have life for more than 1 year, but its acquisition cost is
very minute or you have a huge number of similar spare parts or servicing equipments. For
example, small tools, moulds, pallets or containers are used for more than 1 year. In this
case, these assets, however fulfill the definition criteria of PPE, but are to be treated as
part of inventories, as it’s not practical keeping track of these assets and their accounting.
Is it? The judgment of the situation is very necessary as one should understand the generic
intention behind the law instead of going by the law BLINDLY. In such cases, we need to
assess materiality, or significance of spare parts. After learning the accounting treatments
of spares under PPE, now let’s understand the depreciation accounting for spares
purchased in future and spares as at transition date. Any spares which are treated as
assets as per revised accounting standard 10, property plant & equipment shall be
depreciated as per the provisions contained under this standard only as the new standard
merges AS-6 ‚Depreciation Accounting‛ with the PPE itself. Also the useful life of an asset
may be shorter than its economic life.

The estimation of the useful life of the asset is a matter of judgment based on the
experience of the enterprise with similar assets. As per AS-10, Property Plant &
Equipment, “Depreciation of an asset begins when it is available for use, i.e., when it is in
the location and condition necessary for it to be capable of operating in the manner
intended by management.”. Therefore, we can say that spare parts shall also be
depreciated irrespective of their actual usage because they are available for use whenever
required.

For Example, B Ltd. Purchased a machine in addition to the main plant & machinery to be
used in business, then depreciation as per AS-10 shall also be applied on additional
machine since it is available for use whenever required. This is the major transformation
from old AS, since the spares which were considered as inventory till date would also be
subject to depreciation.

Now let us take a look over the Income Tax implications also. As the ultimate
*GODFATHERS” are INCOME TAX AUTHORITIES, which are the decisive judges for
outflow of money.

Implications in Income Tax on application of provisions of Revised AS-10:

Now, it is very imperative to ascertain the treatment of transitional provisions as well the
treatment of future purchases of such spare parts under Income Tax Act. The Income Tax
Act does not provide for any particular definition of capital asset or fixed asset. Moreover,
there is nothing mentioned about the recognition criteria of fixed asset or capital asset in
section 43(1) which provides for the definition of ‚cost of asset‛.

As earlier also, before the introduction of Revised AS-10, the spares and other assets were
capitalized under Income Tax either according to the particular provisions provided
regarding the same under Income Tax Act or in absence of any specific provision, the same
was accounted for in accordance with the accounting policies practiced by the entity. As
decided in case of CIT, Delhi VS Woodward Governor India (P.) Ltd. (2009) 312 ITR 254 ‚in
case of absence of any specific provision under the Income Tax Act 1961, the Hon’ble
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Supreme Court has adjudicated to abide by the accounting principles‛. In this case, it was
held by the Supreme Court of India that profits for Income Tax purpose need to be
computed as per ordinary principles of accounting and in line with the relevant Accounting
Standards, unless such principles stand superseded or modified by legislative enactments.

Therefore, accounting method followed by assesse is presumed to be correct till Assessing

I hope this article proves to be a smog remover vis-à-vis all the ambiguities regarding the
book keeping and tax implications in ACCOUNTING OF SPARE PARTS.

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