How to Account for Spare Parts under IFRS
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 spare parts are recognised in accordance with this IFRS when they meet the definition of property, plant and equipment (thus they need to meet the definition of 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!
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177 Comments
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Hi Silvia,
Thank you for this valuable article
Hi Silva.
What should be the treatment of spare parts movement? Let’s say a we replace a certain part of the machine with our spare. Should we dispose the recorded spare since it was used already?
If the removed part is repairable, therefore no movement in the books? Just the details like serial number?
You should derecognize the disposed part only when its carrying amount is zero and is no longer used. So the part that you have just installed should not be derecognized – it merely moves to form a part of an item of PPE and, depending on the type of the spare part, its depreciation starts.
Hi Silvia,
Happy new year.
I would like to clarify some thing related to the PPE treatment. Assume, the spare parts are considered as part of PPE. When we issue a part as a replacement, do the value of asset increase by the value of parts issued or not. The parts that are getting replaced does not have a separate value as it is part of the main asset (and there is no separate value for components). What is the correct treatment basis the standards.
Thank you,
Saddik
Hi Siva
I am working with an Elevator maintenance company having stock of spare parts to be use during maintenance if required, advise if these parts were not used for a period of time shall we consider taking provisions for the same.
Thank u
Good day
I really enjoy reading your articles.
They are very informative and up to date.
Thank you once again.
Hi Sylvia,
Thank you very much for such insightful article.
I work for a cement manufacturing and at intervals we buy spare parts ranging from grinders to bolts and knots. With grinders, it is easy to classify as PPE. However, the bolts & knots are bought in large quantities making the amount significant. other times in small quantities with insignificant values. Should i captitalize and expense on these two occasions ?? please i need your clarity on this.
Than you!
Hi Aloys,
thank you!
Well, you should really apply aggregation & materiality principle in this case. So if in aggregate the amount is material, you should treat it as PPE. IAS 16 mentions something about “unit of account” – this is exactly referring to this issue. S.
Hi, Apparently we have ordered too much IT equipment for our project and not all was installed.
We will be performing sales of some of those items. I do not know what would be the spare parts it equipment status after this sales.
In case we would still have some should we exclude them from AUC as they were not installed? Should we keep them as spare equipment and amortize by different rate as not used? I suppose that due to advance technological development those items would still be amortized despite not being used?
Thank you in advance for your help
Hi Sylvia, I have a question regarding, repairing or refurbishing of a partial asset that is removed from Service, then placed back in inventory to be used as a spare. For example: a valve fails and is removed from the system; that valve is sent away to be repaired/refurbished and placed in inventory for future use. a valve from inventory is installed in its place. For the valve that is removed (we retired it and removed it from the books); we’ve expensed the repairs; we’ve put it in inventory at a $0.00 value. This means that the next project to use it in a replacement project though has $0.00 material cost. Is this treatment correct?
The cost of the new valve replaced with the retired one should be expensed rather than the repairing cost of the retired one. The repairing cost of the retired valve must be added to it and should be carried to inventories and this repairing cost will be the cost of this retired valve for future accounting treatments.
Hi Silvia,
In the past, I have always been having issues classifying replacement parts. Thank you for breaking the treatment down for me in this article.
Hi Silvia, I wonder about spare parts which arrives with the equipment and included into the purchase prices of PPE. Is it ok to put them to inventory with the zero price? Second question when we replace broken part of the equipment and place this part for the repair first and then back to inventory – do we capitalized those costs to inventory?
Hi Irina, first question – no, second question – I did not get it. S.
First answer;
When parts are replaced with new ones the replacement cost is normally expensed in P&L but it depends upon the materiality or significance of that replaced part. Cost may be allocated to complementary spare parts of PPE using the stand-alone pricing technique just like we do as per IFRS 15 Revenue from contracts with customers. It’s not good to put spare parts in inventories with zero value.
Second answer;
Yes, one should capitalize the cost of repairs to the old removed spare part and put them in inventories to be used in future. When the part is replaced the cost of new part should be expensed rather than the repair cost of the old part.
Thanks
Thank you Silvia for the great article
I need your kind assistance for case facing me
At my new work there is a production line had been purchased and recorded as a on item in the fixed asset register I mean they did not separate the main component of production line in order to set useful life for each component and depreciate it separately, In this year during maintenance they replace main component of production line
The accounting treatment for this component should be registered as fixed asset or expense maintenance? Knowing that the amount of purchased component is very material
If the residual quantity of oil is PPE, how would depreciate it? Would it be “attached” to the equipment that it must be used with?
Or is the oil circulating inventory since the residual amount is constantly being replenished?
Thank you Silvia for the well articulated article.
How then should one initially recognize the Capital Spare parts when they are bought but awaiting replacement upon which depreciation will commence.
Is the double entry to Dr – PPE Cr- Bank or Dr – Capital Work In Progress Cr – Bank ?
Hi Sylvia,
I find this article very helpful and interesting. I would like to ask further questions as I have encountered this in my client.
So the case is they have Spare parts bought in 2018 but not yet depreciated since it was not yet installed. So technically those are Assets held for use. Then they installed these spare parts on January 2020 and depreciated the same but for a useful life of 1 year only. The standard says that a PPE should be used for more than 1 period. How should I account this? Can I advise my client to adjust the useful life since the machinery that the spare parts has been installed into is still useable for more than 1 period?
Hope you can help me with this. Thank you so much!
Hi Danielle, the spare part that is installed can be depreciated over one year, as soon as it will be in use for just one year. If this is not the case, then the client should adjust the depreciation of the spare part in line with its planned useful life. Also, let me remind you “component accounting” – any significant part of an asset shall be depreciated separately from the remaining asset. So, it is possible to depreciate the spare part itself over different useful life than the underlying asset.
Hi Silvia,
This is such a helpful article. When we talk about spare parts, the though on major repairs of assets comes to my mind. How would you classify the cost of repairing an motor vehicle that was involved in an accident? The cost of this repair is almost 75% of it’s current carrying amount. Kindly assist.
I have a question. A company had a policy of capitilising spares above $10000. After two years, it changes the policy to capitalisation above $15000. Is it a change in accounting policy or change in accounting estimate?
Hi Atish, I tackled the similar issue here, maybe it will help. S.
Great article. My #1 go to place for explanations
Great article! Thank you
Hi Sylvia, I was wondering what happens when an item leaves the pool and is replaced by the repaired item.
Do we write off the depreciation and start depreciating the new item or is it a straight swap for which we continue depreciating as if the item was not replaced?
Hi Hena,
technically speaking, you should have separately depreciated that item which has a different useful life. To be completely correct, you need to derecognize (remove) the carrying amount of old item and recognize the carrying amount of the new item. S.
Dear Silvia, Thank you for your article!
Please advise what to do with the many spare parts that constantly need replacement at the oil project. The usefull life and cost meet the asset criteria. For example: valves are very numerous at the plant: both in quantity and variety. If we register them all, how can we do a physical inventory in the future? There is no way to get inside the working well to count the valves:)
I see. Well, you should really account for items with different useful life separately from the rest of the asset, thus valves should really be treated as separate items of PPE for the purposes of depreciation. How to do physical inventory count – that’s up to you, but you should at least have good “paper” registry of what’s inside the well.
Silvia, thank you for reply!!!
However, we have the next: almost all spare parts on our project with a high cost, with a usefull life of more than 1 year, their cost can be determined, and all bring economic benefits. It is unrealistic to register everything as assets. It is unrealistic to make a physical inventory of them.
That’s why we decided to register only the major spare parts of assets, such as motor, engine, pump, etc., and others are considered as minor spare parts and treated as operation expenses.
Please advise whether this approach meets the IAS /IFRS requirements.
Hello ,
I’am asking if I have a big machine and I replaced a motor inside it but I don’t have a separate depreciation for the old motor , as it’s part from the big machine , but at all the remaining life of machine is 45 moths out of 105 month , what should be the useful life of the new motor ????
Hi, In my opinion, you should de-capitalize the old motor at its deemed cost which should be arrived at based on the cost of the new motor using price indices etc. and the New motor should be capitalized and depreciated based on its own useful life or the life of the main machine whichever is lower.
Hello,
Shall the spare parts that currently exists in our inventory and being used for production be reevaluated? If yes, is it mandatory?
What do you mean by ‘reevaluated’? or do you mean revalued?
Ms Silvia
Hope you are doing good.
I need your help, my question is I have purchased small inventory such as spare parts , and those spare parts are needed by our foreign subsidiary, we are exporting those inventory to our foreign subsidiary, at the year end (June 30) those inventory are at our port, our foreign subsidiary made 100% advance payment to us.. What entries will be made at the year end and after the year end to close the advance account earlier opened ? please advise
NOTE : TRANSACTION IS NOT SALE OF GOODS
Hi Salman,
If the document (Invoice from vendor) is named under your Company, you should record the purchase of asset (Spare Parts) in your books. Thereafter, you can prepare a deed of sale to your subsidiary (which is an intercompany sale). Apply the advance from your subsidiary as their payment to the sales transaction.
Initial transaction (Advance from Subs):
Dr. Cash xx;
Cr. Advances from Subs xx
2nd Transaction (Payment to Supplier):
Dr. Spare Parts;
Cr: Cash
3rd Transaction (Sale of Spare Parts):
Dr. Advances from Subs xx;
Cr. Spare Parts xx
If the document is named after your subsidiary (which I think is not the case), you can just close the advances account to the cash account you credited to the supplier.
Initial transaction (Advance from Subs):
Dr. Cash xx; Cr. Advances from Subs xx
2nd Transaction (Payment to Supplier):
Dr. Advances from Subs; Cr: Cash
As we purchased a new generator and supplier provided with it spare parts for 3 years. so we no need to buy parts for next 3 years. Plz explain how to account for free spare parts which comes with new machinery.
hello Silva,im very happy to be part of your routine training.I also love the insights and knowledge you have been impacting on me. I will love to sit for the IFRS examinations.Would you please inform me on what it will take for this. I also want to purchase your IFRS book and other materials you have been releasing to me.I also love the training simplicity of each topic rolled out. Continue the good work.
Hi
Thanks for this special article. Still most of the industry, ignore to depreciate such critical spares and continue to show under inventories. i have still some doubt and an opinion to share. You have categorized in two categories, critical & capital spare. We can define those spares as insurance spare. Business keep some critical/capital spare of their plant/equipment for future use (in case of any break down etc) to avoid stoppage of production. Hence these spare should be capitalized along with mother asset for which these spare part has been purchased and hence should be depreciated along with mother asset, even it is lying in the warehouse. Once the useful life of the mother assets is over, WDV of insurance spare is also NIL.
Hi Silvia,
Thanks for the nice article. If the spare parts are used for producing goods for more than 1 period, in such cases, should the spare parts are considered inventories or PPE. Pls advise.
Dear Silvia,
How can I find cost of spare parts which are already in use with other machines. As we dont have record of those spare parts. Is there any way for valuation of such parts?
This is a very critical discussion. Thank you for sharing your knowledge on it. The area of consigned as you mentioned above, is when you have 500 harmers and aggregate of it might be substantial but then currently using one are you going to depreciate the rest that are not currently in use? Once again thank you.
Hi Apenuola,
see, there is a lot of room for your judgement and you have to select the best and most suitable accounting treatment for your own situation. S.
Regarding when to start depreciation of a spare part determined to be treated as PPE, would it not always be when the part is installed. The argumentation for this arises from consideration that the spare part is PPE so all items of IAS 16 then generally apply. Under 16.16(b) costs associated with “bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management” are capitalized with the asset. No spare part is intended to operate sitting in inventory therefore I contend only after being installed is the spare part ready to be capitalized. “Recognition of costs in the carrying amount … ceases when the item in in the location and condition necessary for it to be capable of operating in the manner intended by management.” (IAS 16.20) The further implication is that installation cost, if measurable and, as always, material, should be capitalized with the spare part.
Hi, I just want to find out if you capitalize the motor of the machine or expense it? and also the engine of a vehicle? If so why? what factors do you need to consider before you capitalize or expense?
Thanks
Hi Super,
In my opinion, you need to assess whether the motor or the engine extends the useful life of the vehicle. If yes, you may capitalize it.
Hi Silvia, many thanks for the article. Please can you help on following scenarios ? If we receive free inventory or major maintenance parts for free along with a machinery that we bought from the vendor, how do we account for that? We need to control and recognise the inventory as it in our possession but we did not pay anything for it so how to account for it? If we should account for it the FV of the parts, then which account to credit and what would be the implications of taxation? Thanks.
Hi, in my opinion,, parts cannot be capitalized at FV, Initial measurement of PPE is at cost. Subsequently cost or FV model can be selected . Free spares received alongwith main machine can be assumed to be part of the main machine whose record can be maintained as memoranda record. Actually the cost of free spares is inbuilt in the cost of main machine. and hence they cannot be considered as free although they are described as such because individual cost of such free spares is not available. Secondly they cannot be accounted for as inventory. So no separate accounting is needed only Memoranda record is to be maintained for controlling their issue.
This is just like computer. we know computer has components like CPU, Monitor, mouse, keyboard etc. but it is described only as computer and not as CPU, monitor etc. It is assigned only one asset identification code because individual cost of monitor, keyboard etc. is not available in the invoice. No separate record is maintained in r/o monitor, keyboard, mouse etc. unless they are bought separately.
Kindly share your views.
Hello Silvia,
Greetings, and wish you a happy new year. At the outset, let me thank you for explaining use of accounting standards for actual / practical scenarios. Your website is the go-to place for all kinds of accounting queries.
With reference to unit of account, I had a query. Considering the units are aggregated and capitalized as 1 asset (for instance, A1 for 5000 units of screw-drivers), in this case how will the disposal of assets be treated. The proportionate value will be disposed off the A1 asset value, or is there any other way to deal with this. Specially in an ecosystem where are physical asset movement is high this becomes a difficult task. Looking forward to your view / inputs on this. Thank you.
Hello Silvia,
An additional question to the above, what if these screw drives are different models and not exactly the same product. In that case also the aggregation should work? Awaiting your reply. Thank you.
Hi Karan,
The best way is to assign cost to each unit. This is not PPE but should be under Inventories. Do an inventory count every period end and charged to expense the units already consumed/used.
Hello Silvia,
I have a motor vehicle that is accounted for under PPE. I have purchased 2 engines for this vehicle. One of them is to replace the dead engine immediately. So I have accounted for the first engine under repairs of maintenance because the engine is not to enhance the performance of the vehicle beyond its normal operating capability. I hope I am right with my treatment?
How should the second engine be treated at the time of purchase. Spare part under PPE? Note that the idea for buying the second engine is to keep as replacement engine if the first replacement engine goes down.
Hi Oti
Your treatment is not correct, accounting for first engine under repair & maintenance. for example, assuming life of motor vehicle being 5 yrs, you could have capitalized second engine (spare one, which u kept for replacement, if first goes down) along with motor vehicle and could have shown it separately under PPE as insurance spare. accordingly depreciation exp of spare engine could have been charged to profit & loss proportionately in 5 yrs instead of charging it in the first year under repair & maintenance.
Hi Silvia,
Thank you for nice article.
The IAS 16 paragraph 8 has been amended in the Annual improvement cycle 2009-2011 to remove the sentence regarding “If spare parts and servicing equipment can be used only in connection with an item of PPE, then they are accounted for as PPE.” Your article still includes that as one condition for recognising spare parts as PPE.
Best regards,
Cippe
Thank you!
Hi Silvia,
If I am not wrong both the conditions of IAS 16 Para 8 should be satisfied to classify spare parts as PPE. Please correct If I am wrong.
Hello Silva,
Thanks for this useful sharing.. May i know what means by 1 period ? thanks
Normally 12 months (1 Accounting period).
I want to know that if we use spare parts as consumption when issue for machine. but if he use it partially and have intention to reuse it in next year. what shall be the treatment as we have already expense out the full value of spare parts ?
Hello Silvia,
i have one doubt regarding accounting of spare parts.
should i need to do the component based accounting for spare parts if i know the different estimated useful life of the spare part or
i need to depreciate as per the useful life of the remaining asset.
Please assit..
Thanks.
Whichever is shorter.
Hi,
I want to discuss something here. A machine is capitalized and is ready to use. Management operated it once then decides to change the shape of the unit. For that, the management has to import spare parts for the machinery which will produce the desired units. Spare parts cost 7.5% of the total present cost of the machinery. What can be the possible treatments of this case in relation to IAS 16 and IAS 2.
Dear Silvia,
Great work & Big hallow from the Nile country-Sudan
I have question & need your advice
1-I am working in Food manufacturing company ,selling flour & provide Mixers for free to the Bakery who purchase considerable quantity of flour as custody,some time the mixers need Motor we give them new one for free & fixed the old & we would like to included in our books as stock carrying the maintenance cost ,what do you think is it aright treatment .
dear Silvia, could you advise should we capitalize replacement costs of spare parts that was installed to the Asset due to Obsolescence of previos spare parts on market. Spares unavailability on market puts reliability of critical equipment under high risk. should the costs capitalized as asset or expensed as part of maintenance?
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
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.
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 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.
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.
Very well explained!!
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.
I’ve got that we doesn’t need to depreciate capital spare part until installation even though we’ve bought that already. Am i right?
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!!