Economic benefits to be derived from an item of PPE can be direct or indirect. An item of PPE may generate economic benefit individually or in association with other assets and liabilities.
An item of PPE like safety and environmental equipment does not generate any direct economic benefit. Still, such items are recognised as PPE since they generate economic benefits along with associated assets. For example, a piece of safety equipment creates value enhancement to a chemical processing plant as the plant is not permitted to operate without the safety equipment. [IAS 16.7 and IAS 16.11]
Component-wise recognition of PPE
A complex PPE is segregated by significant parts. Accordingly, at the time of initial recognition costs are allocated to various components. An entity may adopt the following policy for breaking up the investment in certain components of PPE:
- a component is separately identifiable and measurable, and can be separated from the complex asset;
- the useful life of component is shorter than that of the main asset such that it requires replacement during the life of the complex asset to which it belongs;
- the cost of the component exceeds the capitalisation threshold of the entity;
- the cost of the component is significant in relation to the total cost of the complex asset; and
- the useful life of the component is different from the complex asset such that failure to depreciate the component will create a material difference in depreciation charge.
When any of those components are replaced, carrying amount of the replaced component (i.e. old component) is derecognised and the new component is recognised. For this purpose, each of the significant components is accounted like an independent asset. Each such significant component is depreciated separately. [IAS 16.44]
For the purpose of IAS 16.44, level of significance may be set at 10% of total cost or less. Any entity decides its capitalization threshold in the absolute amount commensurate to the size of its total assets. Often an item of asset costing less than CU 10,000 is written off as expense in the year of purchase even if that has useful life more than one year.
IAS 16.13 requires major parts are also separately recognized. Significance of parts may be set at the same level as that of a component.In other words, there is no difference between major part (IAS 16.13) and significant part (IAS 16.44).
Major spare parts and stand-by equipment qualify as property, plant and equipment when an entity expects to use them during more than one period. Similarly, if the spare parts and servicing equipment can be used only in connection with an item of property, plant, and equipment, they are accounted for as property, plant and equipment [IAS 16.8]. Accordingly, on the replacement of major parts and stand-by equipment, the carrying amount shall be derecognised and the cost of new items shall be recognised.
Example Components and parts
A complex asset is comprising of many major and small parts. Its cost excluding directly attributable costs is CU 1,000,000. One of its part costs CU 12,000 and another CU 18,000. All other parts cost less than CU 10,000. Estimated useful life of the main asset and two parts are as follows: Main Asset 30 years; Part1 10 years; Part 2 30 years.
In this case, the company shall break up the investment in the following components:
Useful Life 30 years, Scrap value 5% of costs
Part 2 & Other parts
Cost CU 1,000,000
Useful Life 30 years, Scrap 5%
|Component 1( Part 1)|
Cost CU 10,000
Useful Life 10 years,
|Major Part 2|
Cost NPR 12,000
Useful Life 30 years, Scrap 5%
As displayed in the figure above, the first level classification is componentization as per IAS 16.44. The main asset and its components are depreciated separately. A major part is not depreciated separately but a sub-account is maintained for replacement purposes.
Table 1 Treatment of spare parts and standby equipment
|Type of spares parts||Accounting Treatment|
|1. Major spares and stand by equipments which are expected to used for period over more than one accounting periods||To be recognised as property , plant and equipment and depreciated over their useful lives.|
|2. Spares parts and servicing equipment which can be used only in connection with a particular item of property , plant and equipment ( i.e. non-inter changeable items)||To be recognised as property , plant and equipment and depreciated over the periods not exceeding the remaining useful life of the related asset.|
|3. Other items of spare parts and servicing equipment||Expense on use|
Unused items form part of inventory.
Treating components of PPE as assets rather than inventories
PPEs are recognised component-wise. This means each significant part is treated just like an asset. When that part is replaced , it is derecognised and new part is capitalised.
Therefore, the stock of such significant parts are not classified as inventories. They are just like capital work in progress. The stock of significant parts awaiting utilisation may be classified as Stock of Capital spares. IAS 2 Inventories does not apply to capital spares.
Repairs and maintenance
Normally spare parts and servicing equipment are accounted for as an item of inventory and expensed when used. Day to day maintenance expenses are expensed as repairs and maintenance. This type of costs include labour, consumables and small parts.
In case spares parts and servicing equipment can be used only in connection with a particular item of PPE ( i.e. non-inter changeable), they are accounted for as property, plant and equipment but should not be depreciated over a period which extends beyond the remaining useful life of the main asset to which the part relates. IAS 2 Inventories applies to stock of maintenance spares and consumables.
Certain assets require regular inspection as preventive measures whether any parts to be replaced or not. An example is aircraft inspection or dry–docking of ship. IAS 16.14 sets out that when each major inspection is performed, its cost is recognised in the carrying amount of the item of property, plant and equipment if the recognition criteria are satisfied. Any remaining carrying amount of the previous inspection (distinct from the physical asset) is expensed.In other words, inspection cost shall be accounted for as a separate component and depreciated over its useful life. The useful life of inspection cost is the time between two inspections.