1.3 - Query


Accounting treatment of capital spares procured subsequently in an electricity generating company.


1. The company in question was established with the objective of construction, operation and maintenance of super thermal power stations in the country. The querist has stated that the company has 11 thermal power stations and 4 gas power stations. In addition to these, two/three units are under construction.

2. The company, being an electricity generating company, is government by the provisions of Electricity Supply Act, 1948, though it is incorporated under the Companies Act, 1956, and came into existence on 7th November, 1975. The company is maintaining its accounts in the format prescribed as per Schedule VI to the Companies Act, 1956, as Government of India has not prescribed any statement of accounts for the central undertakings engaged in the electricity generating operations. These accounting formats have been adopted since inception and have been accepted by various audit agencies like statutory auditors and auditors of the C&AG.

3. The company has been following the practice of capitalisation of its various thermal power stations as on the date of commercial declaration. After the unit is declared commercially operative, income and expenses including interest etc., are charged to revenue. Prior to commercial declaration of the unit, such expenses/income are taken into incidental expenses during construction, interest during construction and pre-commissioning expenses. These expenses are charged to various packages which are capitalised alongwith the unit declared commercially operative.

4. The querist has stated that it is a normal convention that the suppliers while supplying the main plant/machinery to the buyer, also supply mandatory spares as per the terms of agreement. The plant/machinery takes two to three years for construction, installation and completion. After completion of the plant/machinery, it is synchronised with various associated systems which become ready for use along with the main plant. Similarly, the spares procured along with the main plant are kept in capital work-in-progress till the main plants are capitalised. From the date of capitalisation of the main plant, these spares are transferred to normal inventory which is charged to revenue at the time issue to operation and maintenance department. Some of the spares which are of the capital nature are capitalised along with the plant/machinery and treated as fixed assets. Depreciation on the main plant as well as on the capital spares is charged accordingly. Such spares are normally rotational/unit assembly and high value items and are kept ready for stand-by use for the plant and their utilisation depends upon the need of the plant.

5. The querist has stated that the company has been following the practice of capitalisation of thermal power stations, gas power stations and also capital spares procured along with the main equipment and also capital spares (Stand-by unit assembly spares like rotors, generators valuing between Rs. 15-20 crores) subsequently procured, if any, from the date of procurement.

6. According to the querist, an issue was raised during the review of accounts for 1994-95 by the Government Auditor, that the company’s practice of capitalisation of capital spares needed a relook, since they were of the view that the capital spares capitalised initially were procured with the main equipment, the same accounting treatment will also be applicable to such capital spares procured, if any, subsequently. In other words, the company cannot have different types of accounting treatment of the same items.

7. The issue was posed to the statutory auditors during the current year 1995-96 for their view on accounting treatment of capital spares which are procured by the company along with:

(i) Main equipment.

(ii) Procured subsequently after the unit has gone into commercial operation.

The statutory auditors agree that capital spares purchased along with the main Equipment be capitalised but have strong reservations about the accounting treatment of capital spares procured subsequently and they were of the view that in the first place such capital spares should not be capitalised and must be charged to inventory, irrespective of their similarity with capital spares procured initially. Alternatively, if these were to be capitalised, the cost of spares should be written off during the remaining life of the pant.

8. The issue was again formally discussed with the Government Auditor before taking a view by the company. The Government Auditor again maintained the same stand that the capital spares whether procured initially or subsequently have to be given the same accounting treatment, i.e., they cannot be given treatment differently as indicated in the above paras. The Government Auditor quoted from Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, (para 8.2) which is reproduced below:

“Stand-by equipments and servicing equipments are normally capitalised. 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 assets 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.”

9. According to the querist, the Institute’s pronouncement prescribes that capital spares which are of the nature of stand-by equipments and servicing equipments have to be capitalised and there is no demarcation or distinction given in the Institute’s pronouncement that initial spares or subsequent spares can be given different accounting treatment.

10. The querist has also given a reference to the Electricity (Accounting) Rules, 1985, approved by the Comptroller and Auditor General of India, which relate to Electricity Boards, whose main business is only to generate electricity, also lay down the emphasis on accounting treatment of capital spares. According to these Rules, besides capitalising the initial spares procured along with the main equipment, procurement of capital spares subsequently has also to be capitalised. The querist has referred to the relevant rule of the Electricity (Supply) Annual Accounts Rules, 1985, which is reproduced below:

“ Capitalisation of capital spares at generating stations

Capital spares at a generating station purchased prior to commissioning of the generating station shall be capitalised upon ‘Commissioning of the Generating Station’ for which the spares are purchased.

Capital spares subsequent to the commissioning of the generating station shall be capitalised upon purchase.”

11. According to the querist, Accounting Standard 10 issued by the Institute of Chartered Accountants of India and the Electricity Rules referred above, support the accounting treatment of capital spares suggested by Government Auditor that the capital spares procured initially and subsequently have to be capitalised. In this regard, it has also been mentioned that the company is following the same practice since long. This was, however, objected to during the review of financial accounts for 1994-95 by statutory auditors, who insisted that procurement of spares subsequently should not be capitalised. Accordingly, a disclosure of accounting treatment on capital spares was given in Schedule 18 on ‘Notes on Account’ as below:
“The rotational spares/unit assemblies purchased initially with the main equipment are being capitalised.”

12. The querist has desired the opinion of the Expert Advisory Committee on accounting treatment of the capital spares procured subsequently, i.e., after the commercial operation of the unit.



Opinion



January 15,1997

1. The Committee notes that the querist has sought the opinion only on the issue of the accounting treatment of capital spares procured subsequent to the commencement of commercial operations of the unit. The Committee has not, accordingly, gone into other accounting issues dealt with in the query, e.g., accounting for capital spares during the period prior to the commencement of commercial operations.

2. The Committee notes from the facts of the query as stated by the querist that Electricity (Supply) Annual Accounts Rules, 1985, relate to Electricity Boards, whose main business is only to generate electricity. The querist has not stated whether the said Rules are applicable to the company in question. The Committee has not examined the matter of applicability of the Electricity Supply Act, 1948, and the Electricity (Supply) Annual Accounts Rules, 1985, to the company in question, since the Committee is prohibited to go into matters involving interpretation of legal enactments as per Rule 2 of the Advisory Service Rules.

3. The Committee notes para 8.2 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which states as below:

“8.2 Stand-by equipment and servicing equipment are normally capitalised. 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 for fixed assets 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.”

4. The Committee also notes the relevant rule of the Electricity (Supply) Annual Accounts Rules, 1985, which is reproduced below:

“Capitalisation of capital spares at generating stations

Capital spares at a generating station purchased prior to commissioning of the generating station shall be capitalised upon ‘Commissioning of the Generating Station’ for which the spares are purchased.
Capital spares subsequent to the commissioning of the generating station shall be capitalised upon purchase.”

5. Based on the above, the Committee is of the opinion that spares which are of the nature of capital spares*, e.g., stand-by unit assembly spares like rotors generators etc., should be capitalised whether procured prior to or subsequent to the commencement of commercial production.
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* The opinion refers to only capital spares used as the stand-by equipment which were so technically determined and in respect of which equipment the depreciation was t be charged in the normal course.