1.58 - Query

Accounting Treatment for Replacement of Stores and
Spares of high value.

We are in the business of iron ore extraction from various mechanised/semi-mechanised iron ore mines in India. In respect of conveyor belts which are used in our industry, we have certain doubts as to the method of treating the expenditure on replacement of belts. The facts are briefly indicated below:

Conveyor belts are our major replacement items (costwise) at periodical intervals in all of our mechanised iron ore mines. The cost of each of these belts varies between few thousands and Rs. 70/80 lakhs depending upon the length and quality of the belt.

When the plant was originally erected the cost of the belts was capitalised together with the cost of the plant and depreciated along with the plant in the normal course. However, when the belts are replaced, they have been treated hitherto as spare parts and the cost of the belts is charged off to the Profit and Loss Account in the year in which these are put to use. Whenever a costly belt is replace in a particular unit, the profitability of that unit improves vitiating the comparison of the stores consumption figures between different years. Therefore it is proposed to create a ‘Provision for Conveyor Belts Replacement Account’ from the accounting year 1979-80, onwards with a view to equalise the charged the Profit and Loss Account on account of replacement of costly belts in different years.

Based on an analysis conveyor, belts used in the projects will be divided into two categories namely belts which are 200 metres or more in length and others which are less than 200 metres. These belts will further be classified as belts the life of which is less than 3 years, 3 years to 5 years, and more than 5 years.

It is proposed to charge off the cost of all the belts which are less than 200 metres and also the cost of those belts the life of which is less than 3 years though the length is more than 200 metres. For the other two categories, it is proposed that the estimated cost of belts which are in use as on 31-3-80 whose life is more than 5 years and also those whose life is more than 3 years but less than 5 years will be divided by 5 and 3 respectively and the amounts so ascertained will be increased by 15% (estimated by us) to cover the likely escalation in the cost of belts for replacement in future years. The amount thus worked out will be debited to the ‘Consumption of Stores Account’ by corresponding credit to ‘Provision for Conveyor Belts Replacement Account’.
The actual cost of belts replaced during the year 1979-80 will be debited to the ‘Provision for Conveyor Belts Replacement Account’ as and when they are drawn from the stock and put to use. If the ‘Provision for Conveyor Belts Replacement Account’ in a particular project (we have four projects with separate project-wise accounts and Balance Sheets at project levels) has a credit balance the same will be carried forward to the next year and if it shows a debit balance at the end of the year the same will be transferred to ‘Consumption of Stores Account’ and charged to the Profit and Loss Account in that year itself. This procedure will continue and the provision will be carried forward from year to year in respect of each project till such time the provision is not less than the cost of belts in use plus 15% for which the provision has been created.

We shall be grateful for your clarifications on the following points in this respect:

(i) Is it correct from the accounting point of view to debit the replacements in the same year in which the provision is created? To be more clear, the doubt is whether we can debit the replacements of belts made during the year 1979-80 against the provision created at the year end i.e. as on 31-3-1980 on the lines suggested above.

(ii) Whether the provision created on the lines suggested above is to be treated as a ‘Provision’ or a ‘Reserve’ under the provisions of the Companies Act for giving accounting treatment in the final accounts.

(iii) Is it correct to debit the provision created for replacement of belts to the consumption of stores account and show it in the Profit & Loss Account as a separate item.

(iv) If the provision so created is to be treated as ‘Reserve’ is it necessary to bring it ‘below the line’ as appropriation of profit or it can be shown above the line?

(v) If the provision so created is to be treated as a ‘Reserve’ only can such a Reserve be created when the organisation is continuously incurring losses and there are no profits available to make appropriation for creating such reserves?


March 11, 1980

The point-wise opinion of the Committee is as follows:

(i) It is preferable to show the expenditure of the actual replacement as stores consumption in accordance with the past practices. If the equated amount as determined by the company exceeds the amount of actual expenditure during the year, the additional amount may be provided as mentioned in the query with adequate disclosure of the provision so created. In the subsequent years gross amount of the actual expenditure on replacement may first be shown and thereafter the adjustments of the provision may be made and the net amount may be reflected in the outer column under the head ‘Consumption of Stores and Spare Parts”.

(ii) If the provision is created on a reasonable basis and on scientific lines with the objective of equalising the charge to the Profit and Loss Account for replacement of belts in different years and the amount to be provided for the year has been worked out on the basis of reasonable estimates of the expenditure based on past experience and on the reasonable estimate of the life of the conveyor belts and the need for replacement, the amount to be provided may be treated as ‘Provision’ under the provisions of the Companies Act.

(iii) The amount of provision created for replacement of belts may be shown under the head ‘Consumption of Stores’ after adequate disclosure about the provision created during the year or the amount adjusted against provision during the year.

(iv) If the amount provided has been computed as indicated in the reply to point (ii) above, and if the objective is just to equate the expenditure and the amount provided is not excessive or unreasonable, it may not be treated as reserve and in that case the question of showing the amount as appropriation of profit ‘below the line’ does not arise.

(v) If the precautions mentioned above are taken the amount provided is not in the nature of ‘reserve’ and in that case the point (v) raised by the querist does not arise.