One of the biggest issues related to property, plant and equipment is accounting for spare parts, servicing equipment, stand-by equipment and similar items.
IFRS standards are pretty silent about this topic, the guidance is very limited and as a result, companies need to rely on careful assessment of the situation and their judgment.
There are 2 main issues related to spare parts and similar items:
- Should we recognize and present them as property, plant and equipment (“PPE”) or as inventories?
- How should we depreciate major spare parts that are a part of PPE?
Let’s try to analyze them.
Spare parts = PPE or Inventory?
The first major issue with spare parts is to determine whether they are considered as “inventories” and thus accounted for under IAS 2 Inventories, or they are considered as “property, plant and equipment” and thus accounted for under IAS 16 Property, Plant and Equipment.
You should be very careful in assessing whether you deal with IAS 2 or IAS 16, because the wrong selection can have serious implications on your financial statements, for example:
- Incorrect measurement of your spare parts (depreciate or not?);
- Incorrect presentation of your spare parts (non-current assets or current assets?)
For all spare parts it’s good to remember that in most cases, they are inventories.
But it’s not so simple as that.
The standard IAS 16, paragraph 8 specifically says that
- When major spare parts and stand-by equipment are expected to be used during more than 1 period, then they are accounted for as PPE; and
- If spare parts and servicing equipment can be used only in connection with an item of PPE, then they are accounted for as PPE.
As a result, you should consider the following criteria when assessing your spare parts:
- Purpose of the spare parts
Are spare parts consumed in a production process (whether to produce goods or render services) or held as merchandise for resale?If yes, then it might indicate they are inventories.
If not, then spare parts might be considered PPE.
- Time aspect
Do you need spare parts to operate some other asset during more than one period? Do you plan to use these items during more than 1 period?
If yes, then they might be PPE.
If not, then they are inventories.
Some spare parts are easy to classify, for example back-up engine with significant acquisition cost is a major spare part and thus accounted for as PPE.
Some other items might not be that easy. Therefore, apart from the 2 criteria above, there are even more issues to consider:
Materiality
Sometimes, you can have an asset that is used in the production process for more than 1 period, but its acquisition cost is very small.
And sometimes, you can have a huge amount of similar spare parts or servicing equipment.
For example, small tools, moulds, pallets or containers used for more than 1 period.
In this case, these assets are PPE rather than inventories, but it’s not very practical for keeping track of these assets and their accounting, is it?
It would be very hard to label each individual screwdriver, not mentioning depreciation!
In this case, you need to assess materiality, or significance of similar spare parts and servicing equipment for your financial statements.
And not only materiality on an individual, asset-by-asset level, but also materiality of the whole group of these assets.
So, if you have 2 hammers and 1 screwdriver, then although it’s in fact PPE, it’s reasonable to account for these items as for inventories and expense them in profit or loss.
However, if you own 10 000 hammers and 5 000 screwdrivers, then if their cost is material with respect to your financial statements, you shouldn’t simply expense them.
This brings me to the second consideration – unit of account.
Unit of Account
The standard IAS 16 says that it’s up to an entity to determine how it will apply the recognition and measurement criteria – whether to an individual asset, or to a group of assets on an aggregate basis (IAS 16.9).
Simply speaking: what is our item of PPE in the case of large amount of small items?
Is it the individual single screwdriver with the cost of USD 5?
Or, is it the set of 5 000 screwdrivers with the cost of USD 25 000 (5×5 000)?
Both options are possible, but the first one does not make much economical sense, as it would be difficult to keep records for 5 000 small assets.
As a result, when you have a lot of servicing equipment or spare parts with small individual cost, then it’s reasonable to account for them as for PPE under IAS 16 if their aggregate value is material.
In such a case, it’s practical and totally acceptable to apply paragraph 9 of IAS 16 and measure these small assets as 1 item of PPE – a set of assets.
Minimum Levels
In some businesses, minimum levels of inventories must be maintained in order to operate assets.
In this case, “inventories” are not separable from an item of PPE and such “inventories” are in fact a PPE.
Take oil refinery, for example. My limited knowledge about refineries tells me that refineries must contain some minimum quantity of oil to operate. This oil must stay there until the plant ceases operations.
Is this minimum level of oil classified as inventories or an item of PPE?
As it is not consumed in a production process, but it is necessary for plant’s operation and it’s going to stay there until the plant closes (for more than 1 year), it’s PPE.
And as strange as it might be, you need to account for a minimum level of oil as for PPE, and for the remaining oil as for inventories.
How to Depreciate Spare Parts in PPE?
After we learned how to classify an item as PPE or as inventories, the question is when and how to depreciate major spare parts that are classified as PPE.
Depreciation of spare parts is not specifically addressed by the standards and therefore, we must apply our judgment.
IAS 16 in paragraph 55 only says that the depreciation should begin when an asset is available for use.
What’s the issue here?
Often, the spare parts are in the warehouse and not directly in use and therefore, it’s questionable when to start depreciation charges.
Should you depreciate spare parts only when they actually replaced a defective part and are in operation?
Or, should you depreciate spare parts once they are in the warehouse, regardless their actual usage? In such a case, what is their useful life?
It depends on the nature of the spare part.
If you keep the spare part to ensure smooth operation of some machinery without interruptions, then the depreciation period should start immediately.
The reason is that such a critical spare part is available for use immediately when an original part in the machine stops working.
However, if you keep the spare part to be used as a replacement part at some future time and you are sure that this part will be installed and put into use at a later date, then the depreciation should start when the part is installed.
You should carefully assess the nature of your spare parts, their function and future use and only then decide. Here, judgment is necessary.
This issue was addressed by several IFRS Discussion groups in the past and I’m pretty sure that this is a great discussion topic even now, so please go ahead and leave me a comment right below this article. Thank you!
89 Comments:
That is a wonderful article on the very important topic! I really liked it.
Well, I would rather name the section ‘How to Depreciate Spare Parts in PPE?’ as ‘When to Start the Depreciation of Spare Parts’.
And what about the depreciation methods for spare parts mentioned? I suspect they are to be the same as it was chosen for the related PPE. Or not?
And, obviously, something has to be written in the Accounting Policies?
Sure sure sure
You are right about the depreciation methods – in most cases, they are the same as for the related asset. Also, the useful lives are the same (or at least, they end at the same time). And of course, appropriate disclosures are needed.
Thank you and have a nice day! S.
Hi Silvia
Thanks for this useful article. I just have a concern about minimum stock (that you referred in your oil example) that has to be kept for a longer period. I would assume it refers to buffer stock but that will always be treated under IAS 2.
Would you please explain it bit more.
Many Thanks!
It is not so clear how to deal with low-acquisition-price-long-live items (depreciate, control, valuate). I really enjoyed the example with screwdrivers!
There are some problems with such items, however..
1. If they are inventories and we provided our worker with a screwdriver, in a year he/she could come and ask for another one (we do not have it in the records already!).
2. If we account a big amount of screwdrivers as a PPE item, so how to depreciate it? And how we should revalue it? (Let’s say, we provided our departments with some of the screwdrivers, some are still in the warehouse… And in some time, some of them – around the facilities – are broken, stolen, lost etc.)…
Thank you!
Hi Sergey,
All the best, S.
sure, I got your point. As usual, there is some common sense and judgment to apply. For example – how about performing the count of screwdrivers at the year-end, hm? This is exactly the area in which good IFRS consultant comes to play and is supposed to set up reasonable and manageable system
Many thanks for pretty Silvia,
it’s a fantastic and simple explanation for critical case
Best regards
I was always confused on this topic but atleast after reading this article I can handle It now. Thank you Sylvia
Hi Silvia,
Appreciate your effort to clarify How to account spare parts as per IFRS. Very informative article.
Consider the scenario of a Whole sale Dealer. Say this Whole sale dealer is a distributor of Chip and food stuff to Supermarkets. They have display stands which is provided to supermarket to display their product. Value of individual stand is low and collectively have medium material value.
This items Company can use more than for one or two year. So Can’t treat as Inventory is it ? But these stands not under the control of Company. Kept with supermarket and can be damage at any time. But company can take back stand at any time.So how to treat this kind of asset. I strongly consider this item should not be consider as PPE neither as Invedntorey.
Thanks and regards,
Srinath.P
Dear Srinath,
indeed, this depends on the careful assessment of the situation. In my practice, I saw 2 different kinds of treatment – some companies put the cost of stands in profit or loss as they argue that they don’t control the asset at all, but some of them treated these assets as some PPE as they argued that although it’s in the external place, they performed regular check ups or had a contract with retailer to do it. Auditors seemed to accept both treatments. S.
Dear Silva, thanks for taking your time to educate and enlighten this generation in the area of your expertise.
With regards to spare parts measurement and presentation in the financial statement, lets consider the aviation industry or better still aircraft industry where planes are used for charter per transportation and other logistics.
How do you measure and present spare parts use to service the aircraft own by the company and the spare parts use to service other aircraft own by third party. Note that all spare parts in this situation are stored in one and the same ware house .
Await your good response.
Thank you.
Joseph
Dear Joseph,
S.
I repeat myself again: assessment and judgement is needed. If servicing third party’s aircraft is a revenue generating activity, then these spare parts should be recognized as PPE
Hi Silvia
I am interest of your IFRS course .could you please feed me if this course enough to Pass ACCA IFRS exam?
regards,,
Thanks sylvia for helping everyone to learn ifrs. I have two question
1.Intially i held a particular spare parts to use in production process but later due to need i used in ppe, so i charge depn only when installed,so will it be a change in accounting policy but it was wholly unitentional?.
2.what is small assets as per para9 of ias 16, is it company decision ?can it be with reference to percentage on value basis?.
I can see that i am able to grasp & getting a good command over ifrs , its because of ifrskit.Thank you once again.
J
Hi sivya
My concern about spare parts which is for replacement
You said should be depreciated right away in the stores that mean could be deprecisted before being installed
Am i right
Jumaa,
it depends on what kind of spare part it is. All spare parts are there for replacement, isn’t it? But if this is so-called “insurance” spare part, or critical spare part (meaning that the item of PPE would be out of operation and it would significantly affect some activity without this spare part), then yes, these spares can be depreciated immediately. S.
Sylvia,
Thank you so much. your article on how to account for spare parts under IFRS is quite explicit and understood. You have really made this simple for even a layman. Thank you once again.
Comet
Very usefull indeed.
Many thanks Silvia
Hi Silvia
After recognize the minimal quantity of Oil as PPE, will you depreciate it later on or how to deal with itafter ?
Thank you
Amr
Dear Amr,
sorry for my poor industry knowledge, but let me ask (maybe stupid) questions: will you keep the same oil there? or will you eventually replace it? Let’s say you keep minimum quantity of oil in pipes, and you assume the useful life of the pipes is 30 years, then you would depreciate the oil over 30 years. Of course it can have some residual value (for which you would sell it), so you need to take this into account. S.
Thanks a lot, Silvia!
How should a company accounted for/ recognize equipment which are bought as part of a system (set of asset) and then, until the system is ready, the equipment is held by the supplier in custody?
Hi Silvia, Thank you for this article. For me it is so timely as I am currently dealing with a similar issue. But I must confess I’m still a bit unsure of when to start depreciation if it meets the PPE criteria. Can you maybe share an example, of when the spares are held for the smooth running of the equipment and when it is held for a future date. Thanks again your articles have been very helpful in areas where the standards are not clear
Superb’…very useful.Thanks
Hi Silvia,
Thanks for your regular update and transfer of knowledge.
I will like you to write on partnership deferred tax when the tax rates are graduated rates.
Cheers.
Many thanks for pretty silvia and God bless you and guide you in jesus name amen
Dear Silvia.
Thank you so much for your easy to understand IFRSs lessons. They really do come in handy.
Kindest Regards,
NELSON NCUBE.
This is awesome. thanks. Please i don’t know if you can assist me on IFRS conversion template?
Hi Slyvia
Could you please explain the different between, For consumption in production process and for operation in connection with an item of ppe?
regards
Samson
Hi Sylvia,
Big thanks for the detailed information. This gives me better tools in exercising judgement.
Quite educating. Thanks for the tutorial.
KUYE O.I
Great Job you are doing. Please my question is if you will depreciate the assets at future date, would have to classify them as PPE or what pending the time they will be due for depreciation? Thanks
Silvia
Thanks a lot for the article. what happens if i have recognised 5000 units of hammer as a single unit and i take 1 hammer out of it do i start depreciation on only thing1 hammer or all 5000 units.
Thanks a lot for
This is beautiful…, Sylva, do keep it up.
Gr8 work Sylva, keep it up
This is a very important issue that have not been given serious thought.The article has given me a better understanding.Keep it up
Thank you madam for bringing up this article. Its very useful.
This is a good article and indeed helpful
Superb and crisp article
Hi Silvia
Happy New Year 2016 to you.
I gone through your article about the new concept for treatment of spare parts. Really it is very thoughtful and interesting to know more about. I an working in a big construction co have a lot of spare parts ,tools and tackles related to vehicle,machinery etc. Presently we are treating as inventory. How can I work about it as PPE as you explained in your article. Can you please illustrate
Thanks and regards
Hello Silvia,
You have explained it well.
Thanks,
Hello Silva,
I work in an Automobile company with various cost centres which is subdivided into vehicle sale, spare parts dept and after sale service. How do we harmonise the inventory of vehicles and that of spare part into 1 financial statement? Should we treat it like when the company is consolidating.
Urgent response would b highly appreciated.
Thanks.
Hey Alade,
as you know, under IAS 1, you should draft your own format of the financial statements, while meeting the necessary requirements.
In this case, you should check whether you need to do the segment reporting under IFRS 8 Operating segments (IFRS 8 tells you when you need to apply it) and in this case, you would need to present these segments separately.
If you don’t fall within the scope of IFRS 8 (and thus you can ignore it), you can present inventories in 1 line, with giving sufficient disclosure (breakdown by subclassifications) in the notes to the financial statements. Hope this helps!
S.
This para8 has been amended in 2012 and now they require meeting definition of PPE to capitalize any spare parts, see below:
Para 8, IAS16 – Spare parts and servicing equipment are recognized in accordance with IFRS when they meet the definition of PPE. otherwise, such items are classified as inventory.
Farrukh, the whole article turns around that paragraph,so please revise. Thanks. S.
As for Capital Spare Parts, the depreciation will be started when the asset is installed.
Then my question is what shall be the debit entry at the time of the purchase of that asset? Shall we account it as PPE and not apply depreciation till it is installed or there is something else?
Yes. Exactly.
If within my inventory of spare parts, I have items such as safety shoes, helmets , uniforms for workers in production , these materials may be condiserados to as parts of spare parts, considering what is said within IFRS ??
Take oil refinery, for example. My limited knowledge about refineries tells me that refineries must contain some minimum quantity of oil to operate. This oil must stay there until the plant ceases operations. (quoted from your lecture)
i am confused whether this will be depreciated or not? if yes then how?
However It’s really a good note that help me lot.
Thank you Silvia.
Hi Shohug,
yes, sure, it is depreciated over the useful life. Useful life will be the period over which you will maintain the capacity in the refinery. S.
Very useful Silvia,
My query is related to transition from then until now.
Previously we held all spare parts in the Inventories box on the BS and consumed them to the P+L on use. This hit the maintenance cost line on the P+L and obviously within EBITDA.
However IFRS is stating that assuming a piece of Spare part meets the criteria it should move to PP&E and be depreciated. The only P+L effect is to the depreciation line i.e. below EBITDA.
Visually on a P+L this is a significant change.
Am I correct in my understanding?
many thanks
Hi Garvan,
hmmm, that depends on where you put the cost of spare parts in P/L when you treated them as inventories. I guess to cost of sales. So yes, if you start treating spare parts as PPE rather than inventories, it will impact your EBITDA, because cost of inventories enters to EBITDA, while depreciation does not. S.
Your presentations are very simple and easily understood
Hi Silvia ,
TQ for the good write up for IFRS116. The amendment to this standard to treat spares as PPE affecting not only our financial reporting but operationally.
Previously we treat spares as inventory & it was chargesd to Repairs & Maintenance upon issuance from stock & we would knwo how much is the R&M cost per month for cost controlling purpose . In addition , for spares , we have set minimum stock reordering level for auto PR generation in SAP .
With the changes in standard to clasiify as PPE , we will face difficulty in tracking R&M cost & ordering of parts at min level .
May I know whether the similar issue is raised by others with the amendment to IFRS 116 & what is the solution to the above ?
Considering its capital spare part is connected to to a equipment ( not critical) .
So we are pretty sure its to be treated as PPE.
Here my question goes related to when to depreciate.
you gave an option either to depreciate immediately ( if critical) or to depreciate when installed ( capital spare).
Does it mean in case of capital spare treat it as PPE only when its installed and start depreciate upon installation.
In other words if we capitalise spare ( capital spare) at the time of aquisition, can we choose to depreciate when installed ?
Glad if you can remove my doubts.
Capitalizing something does not necessarily imply it is a depreciable asset. Spare parts could be used for repairs and maintenance or to extend the lives of fixed assets. Under the matching principle, I believe once the part is placed in service, it should be either expensed if deemed for repairs and maintenance or depreciated if deemed to extend the asset’s original life or enhance its value.
RMAU: i´m not sure. I´m looking for answer if all spare parts that are qualified as PPE should be depreciated, or whether they could be accounted for as an expense for repairs and maintenance when they are spent. But my opions is that only those spare parts could be capitalized they will use as a replacement of existing parts. I mean replacement according to 16.70. So finally all spare parts recognized as PPE will be depreciated (it doesn´t matter when depreciation starts).
What do you think, Silvia?
RMAU, do you think that it makes sense to accout for spare parts as PPE (without depreciation) and to recognize it in profit and loss when it is placed in servise?
Dear RMAU and gabika,
I think I described my position above – i.e. depreciation starts based on the character of a spare part. I agree with gabika that all spare parts will eventually be depreciated.
Also, dear RMAU, please note that something like “matching principle” does not exist in IFRS. Instead, there is an accrual principle stating that you should recognize an expense when you actually consumed the benefits of an asset (not when you produce revenues out of the asset). S.
Dear Silvia,
Our company has stated this policy for spare parts:
Spare part, which costs more than 1700 euro (for im/materiality), and when is used (replacing existing part in PPE), it is supposed to be used for more than 1 year, we capitalize – it means it is shown as part of PPE in our financial statements.
Subsequently we divide these spare parts into two groups:
– the first group – spare parts have character of stand-by equipment, they are usually bought with item of PPE and they are usually unique for this item of PPE, there is no assumption that they will use
- The second group – spare parts whit useful life shorter than is useful life of PPE, for which they can be used, and there is an assumption that this spare parts is changed at least once during using of PPE item.
These two groups differ in commencement of depreciation (or whether they are at all depreciated).
Depreciation of the first group spare parts starts when they are acquired (and ready for use), together with specific PPE item, and is calculated for the same period as PPE item.
Depreciation of the second group spare parts depends on the way how spare parts is used. Because in this situation we follow national accounting rules:
– if spare part is used as for maintenance/repair (according our national accounting standards it means expense) of PPE item – for ifrs/ias is recognized as expense in P&L, and is not depreciated!;
– if spare part is used within the activity, that extends the useful life of PPE item or that improves this PPE item (according our national standards it is added to cost of PPE item) – for ifrs/ias it is also added to cost and depreciated with PPE item.
It means that we don’t follow an idea that I have written above – all spare parts recognized as PPE should be depreciated because they should be accounted for as replacement of existing part and subsequently depreciated separately of together with PPE item.
The reason is we prepare statements in accordance with our standards and we do only elimination of differences.
1. In balance sheet we add PPE spare parts to PPE and reduce inventory.
2. In P&L:
- for the first group spare parts we do only elimination of expenses (when they are used during maintenance/repair) of our depreciation (when they are used for our improvement) and we add depreciation mentioned above;
- for the second group spare parts we do nothing – replacement of spare parts is part of maintenance/repair expenses or they are depreciated from the time they are used.
In both cases we do not derecognise remaining amount of replaced part.
That’s why I asked RMAU for why he/she thinks it is possible to recognise spare parts as PPE and subsequently account for their consumption as expense. Maybe he/she found some support for this opinion in IAS16.
Because my opinion is different (how I have said above) but I need change it and has some good argument for that.
Silvia, what do you think is our policy for spare parts totally incorrect or it is acceptable? Because to prepare it correctly it would take a lot of effort and maybe this is imposible…
thank you.
Dear Gabika,
) S.
this is a bit too long to reply, but I’ll try within some days (BTW, you can write me an e-mail in Slovak – I’m Slovak
If a spare part is to be used for repairs and maintenance it should not be capitalized to the fixed asset register, but should be included in Working Capital (i.e. Held in Inventory) and be expenses when consumed.
Hello Silvia
thanks for the article, Greetings from Colombia, I have a question, what happens to assets that normally qualify as fixed assets for a sector as it can last more than a period (eg 15 months), but what happens if that asset mime is used in a sector where the use and lasts less frequency of a period (example 9 months), in this case if it had acquired the asset in September x1 it will last me until June x2, as you would treat it as inventory and send results for 9 months (deferred expense) or send it as an expense from the date that withdrawal from warehouse, as presented at December x1,
Something similar happens to me with uniforms to employees, these last me less than a year, when results would send, at one time (removal from storage) or throughout the months using the uniform.?
Thank you
First of all thanks for Clarification of IFRS
If the spare parts (computer) related to warranty, the how its recorded.
Hollo sylvia, good explanation. But, i want to ask, if the spare parts is obsolete and left untouched in the store room? So we need to consider it as PPE or inventories?
Hi Ejan,
it really does not matter on whether it’s obsolete or not – you need to look at the purpose of your spare parts and classify it accordingly. If it’s related to PPE, then it’s an item of PPE and if it’s obsolete – well, then you need to test it for impairment under IAS 36.
If you classify your spare parts as inventories, then you need to show them at lower of cost or net realizable value. S.
HI Silvia,
This is Waseem from KSA. I work in a manufacturing company where we sell Ait Conditioner. I have a concern regarding our RM inventory. If I’m right, as per IAS 2, as we are not selling RM as it’s, the rule of cost or NRV doesn’t apply to our RM.
But, our auditors are telling that rule does apply 2 RM also.
Another thing is NRV is entity specific one. Not like fair value.
Advise in this regard.
Who is right auditor or us
Dear Waseem,
I guess that RM inventory means raw materials, is that right?
In this case, I would notify your auditors about the paragraph 32 in IAS 2. It says that materials and other supplies used in the production process of inventories are not written down below cost IF FINISHED PRODUCTS ARE EXPECTED TO BE SOLD AT OR ABOVE COST. So no, you should not determine the NRV of your raw materials. If you expect to sell finished products below cost, then you can write down raw materials and in this case, you should use the replacement cost as a good estimate of NRV. Hope this helps S.
Thank you silvia for your reply. Is this general rule for all manufacturing company.
I have another concern regarding your IFRS KIT.
Is there any option to go for several users with one subcription or does each one want to buy separately.
Dear Waseem, please, for questions regarding the IFRS Kit, e-mail me
Thank you, S.
Hi Silvia,
we are selling cars and also own some cars as replacement cars in the event that customers need replacement cars. Sometimes we use car for more than 1 year and sometimes we sell it before. Can we clasify these cars as inventory, even though these are not bought primarily with a view to resale? Can we have it in inventory for more than 1 year? Can we have some cars as inventory and some as PPE, even though the purpose is the same, just different period of usage?
Dear Bales,
you need to classify the replacement cars based on what you do with them in average. If you normally hold the car for more than 1 year and then sell it, then it’s PPE. It does not matter that you sell minority of replacement cars before 1 year. But, if you sell majority of your replacement cars before holding them for 12 months, then it’s inventory. S.
Great piece! what is the position where there are a number of items which individually are immaterial but collectively they pass the materiality and purpose test. Do we recognize such item of inventory as PPE
Hi Eke,
it depends on their useful life and purpose. If the useful life is more than 1 year, then it’s PPE. If it’s less than 1 year, then inventories. E.g. take library with books. Individually, the book’s cost is immaterial, but for library, all books are material in total. It’s appropriate to account for them as for PPE and depreciate over their estimated useful life. S.
Hi Silvia,
Thank you so very much for the informative education. I appreciated it. I just have a quick question hopefully you could help me out.
How would you treat commissioning spare parts that are procured at the same time with the original equipment? Should I consider capital threshold when assessing whether they are an item of PPE? Also, if they are components of fixed assets, how do you depreciate them?
I will greatly appreciate your response on this.
Thank you,
Leo
Dear Leo,
it’s the same issue as described in the above article. In relation to threshold – there is no specific guidance, but if it’s material in relation to your company and its PPE, then yes, you should treat it as PPE, too. If it’s not material, then you can treat it as expenses.
All other questions – how to depreciate spare parts… described above. I would just repeat myself here. S.
Thanks so much, once again, Silvia. :). You are very helpful as always and I really appreciated your expertise.
Cheers
Leo
Hi Silvia,
Thanks for the wonderful article. You are really helpful. I have a question.
What if an airline training institute for pilot use some small tools, equipments etc which are consumed in the process of providing training to the pilots. I think it would be right to treat them as inventories rather as PPE. Am I right in my understand? Thank you!!
Dear Sara,
it depends. Are they consumed in less than 1 year? Then yes, treat them as inventories.
Are they consumed in more than 1 period? Then it would be appropriate to look at their aggregate value and recognize them in PPE as a SET rather than on individual basis. Hope this helps. S.
Thanks a ton, Silvia. You replied much more than I expected. You are way too helpful. Thanks!!
Very good article Slivia.
I have a question on how to identify spare parts are used for smooth operation vs. replacement parts? I see there is no difference. We keep the spare parts for replacement if old part is damaged. I am not able to clearly understand the difference.
Kindly share any examples to identify?
As per this article your spare parts will be critical spare parts as you are keeping them as a back to ensure smooth uninterrupted machine operation and hence it should be depreciated immediately. However, if you know that your existing original part will expiry in 6 months time or must be replaced after a specific use time then it is capital spare part and in this case it should be depreciated only when it is installed in the machine.
Hope it will help.
Very well explained!!
Dear Silvia, I would really appreciate your thought in this. I work in the oil & gas upstream industry, and when we drill a well, we have spare parts that are often not used within 1 year. I estimate that 2/3 of our inventory has not been used in the last 24-months. Spare parts include for example drilling bits, casing equipment etc, and they are of high value.
When the inventory is cost recovered (we get it back through oil in kind) through our agreement with the government, the inventory belongs to the government. However, we have exclusive right to use it over the license period.
(1) Would you consider this as PPE (held for use in the production, >1 year) or Inventory? Considering the facts above, especially the last one.
(2) We use the Unit of production, when depreciation Oil producing assets. Do you think we should use this method also for spareparts? or straight line (over the license period)?
Many thanks!
Dear Sir,
I would consider these spare parts as PPE, because they can be used only in connection with PPE (e.g. drilling bits with drills etc.). I would treat them as a set (please see the above example with screwdrivers and hammers).
Now, I’m not sure I understood the part with “license period” correctly. Does it mean that when the license period expires, you need to give these drilling bits and other equipment back to government? So, you buy an equipment at your own cost, use it (or store it as spare parts) during the license period and then give it to the government? S.
Thank you so much for your reply Silvia! Yes, correct – when the license expires, the government owns the inventory (it does not belong to us). You may say, we only have the right to use these assets. We and the partners of the licence spend X amount of $ on the spare parts, but we get cost recovery of our expenditures through “cost oil” (we ger oil volumes to cover our costs). I was thinking two methods for depreciation; Straight line over the license period (makes sense), or UoP method (together with the other assets).
The reason why I am confused, is because it seems to be common practice among the oil and gas companies to treat “smaller” spare parts as inventory, while others classify “major” spare parts as PPE. Do you have any thoughts about what can be considered as “Major” (relatively speaking)?
OK, so in my opinion, the most reasonable method would be to depreciate over the license period, because whether these spare parts are used or not, they will go to the government after the license period expires.
Unfortunately, there’s no clear guidance on what’s major and judgment must be used. You should think about materiality and aggregation – if aggregated value of these parts is material, then it’s probably major. S.
Hi Silvia,
I have a question. We have a huge fleet of trucks in the company for logistics and we experience a lot of accidents because of which we write off the whole truck and use the remaining spare parts from that truck to fix others. Now these used spares are not taken as inventory up til now but if we want to take such used spares in inventory, what is your opinion about valuation and whether it will be applicable in IFRS. At what price should we take it in inventory?
Dear Nasir,
that’s tough. First of all, if you are using some parts of the damaged cars, then I would NOT write them off fully – just the part that you cannot use. Secondly, in the ideal situation, you should be able to estimate the carrying amount of parts that can be used (and thus not written off with the damaged car). For example, let’s say that you can use engine (I apologize if that’s non-sense, but I’m not a technician). You can see what’s the replacement cost of an engine is (or the cost of a new engine) and you can estimate the depreciation reflecting the usage of engine until the accident. But, it’s a difficult process. Do you think it’s material for your financial statements? S.
Please let me have a question -if we have a major spare part which need to be accounted for as PPE, but most likely will be put into service just months/years later (when replacement is needed) how to classify them in the meantime? Can it be sit on CWIP till installation? Thanks!
Hi Silvia,
I like your article, its very useful. I have one more question. Normally inventory includes consumables that is consumed in the production process. I have a situation tell me how to deal with this. Suppose there is a manufacturing co. of Air conditioner. In the factory for the workers company buy 1000 safety shoes. They put it as stock. Whenever any worker required or new worker comes then they will issue to him. Now how to deal with this stock of shoes. Is it record as inventory or expense. In my opinion it should not be inventory. Because it is not consumable. Also Such shoes has life more than a year than we should have to book as PPE.
Very Useful article, one question if you may assist though
Following example,
-Gearbox failure as part of a conveyor, Spare gearbox booked out and replaces the broken gearbox
-Broken Gearbox goes out for repair and is re-furbed and booked back in as a spare item
-Cycle continues like this
Should the initial spares item booked out for repair be expensed to P&L as it is for repair?
Should the refurbishment cost be booked to P&L as an expense?
Which cost should the re-furbed cost be booked back in at? The Refurb cost or original cost?
Ash