In May 2012 International Accounting Standards Board (IASB) as part of its annual improvement program 2009-2011 amended paragraph 8 of IAS 16 ‘Property, Plant and Equipment’ to state that “items such as spare parts, stand-by equipment and servicing equipment are recognized in accordance with this IFRS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory”.
The above amendment opened a new Pandora box for accounting of such spare parts, stand-by equipment and servicing equipment, which were previously accounted for as inventory in accordance with IAS 2 ‘Inventories’. IASB did make the above amendments to include the recognition of spare parts, stand-by equipment and servicing equipment in accordance with IAS 16 however, no detail guidance was provided. Therefore, different interpretations have been developed to address this so-called accounting ‘grey area’.
General recognition criteria of PPE are as follows:
- it is probable that future economic benefits associated with the asset will flow to the entity; and
- the cost of the asset to the entity can be measured reliably.
Recognition criteria for spare parts, stand by equipment and servicing equipment is as follows:
Items such as spare parts, stand-by equipment and servicing equipment should be recognized as property, plant and equipment when they meet the definition of property, plant and equipment i.e. those spare parts, stand-by equipment and servicing equipment are held for use in the production or supply, for rental to others, or for administrative purposes and are expected to be used during more than one period. Otherwise, they should be classified as inventories in accordance with IAS 2 Inventories.
Useful lives and depreciation
There is no clear guidance on the useful lives and commencement of depreciation of such item. Whether the item should be the date on which it is available for use (but the item is not put to use but kept idle) or when it is actually put in to use i.e. the date on which the stand-by equipment is put into service.
From various guidance issued by accounting firms and professionals, the depreciation of spare parts, stand-by equipment and servicing equipment will depend on the underlying nature of the spare part.
These may be classified as follows:
Critical spares or stand-by equipment – These are major items and parts critical to be kept on hand to ensure uninterrupted operations of the equipment. The depreciation period on these critical spares or stand-by equipment should start immediately over the lesser of its useful life or the remaining expected useful life of the equipment to which it is associated.
Classic example of critical spares or stand-by equipment will be a turbine kept as backup for the first turbine. The probability that the spare turbine will ever be used is very low. The spare turbine is necessary, however, to ensure the continuity of the production process if the first turbine fails. The useful life of the stand-by turbine will be equal to the life of the plant, which is the same as the useful life of the primary turbine.
Although the definition in IAS 16 requires that the entity should expect to use the turbine during more than one period, it does not state that such use should be regular. Therefore, the spare turbine is classified as property, plant and equipment and should be depreciated from the date it becomes 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).
Capital spares – These parts are not considered as critical and are used as a replacement part at a future point in time. The depreciation period commences when they are put into use, rather than when they are acquired.
Example of capital spares, an entity buys 4 machines for use in its production facility. Simultaneously, it purchases a spare motor to be used as a replacement if a motor on one of the 4 machines breaks. The motor will be used in the production of goods and, once brought into service, will be operated during more than one period. It is therefore classified as property, plant and equipment. The motor does not qualify as stand-by equipment because it will not be ready for use until it is installed. Therefore, the useful life of the motor commences when it is available for use within the machine rather than when it is acquired.
The carrying amount of the spare parts, stand-by equipment and servicing equipment will be derecognized:
- On disposal; or
- When no future economic benefits are expected from its use or disposal.