Question

Spare the Rod

Stellar Bright Solar (SBS or the “Company”) is a European business that contracts to develop, construct, and operate solar power plants.

SBS entered into a contract to support the Big Desert solar power plant in Northern Africa. According to the contract terms, SBS is responsible for the day-to-day operations of Big Desert as well as for general maintenance and repairs. Big Desert expects SBS to provide routine maintenance for continued operation of the plant and respond to equipment breakdowns and failures by providing immediate repairs. In addition, the terms of the contract require SBS to procure necessary materials to operate, maintain, and repair the plant. To comply with this requirement, the Company must maintain a certain level of materials and supplies (the “spare parts”) at all times.

On a regular basis, SBS reviews a listing provided by Big Desert of recommended spare parts for various components of the solar power plant and procures the necessary parts. Vendors deliver the parts to SBS along with a complete listing that describes the quantity and cost of the parts provided. SBS maintains this listing and uses it to (1) track expected usage of the spare parts and (2) determine their expected useful lives.

The spare parts consist of customized and generic parts that vary in cost, procurement time, expected usage (i.e., emergency replacement, standard replacement), and expected useful life. Big Desert uses the composite depreciation method for substantially all of the plant, and it expenses all major plant maintenance.

SBS prepares financial statements under IFRS.

Required

How should SBS classify the spare parts— as inventory or property, plant and equipment? Does it matter whether it expects to use the spare parts within one year or not within one year?

Answer 1

This problem refers to IAS 16- Property, Plant and Equipment. According to that,

“IAS 16 recognises that parts of some items of property, plant, and equipment may require replacement at regular intervals. The carrying amount of an item of property, plant, and equipment will include the cost of replacing the part of such an item when that cost is incurred if the recognition criteria (future benefits and measurement reliability) are met.The carrying amount of those parts that are replaced is derecognised in accordance with the derecognition provisions of IAS 16.67-72. [IAS 16.13]”

Hence it should show the parts as property, plants and equipment as it satisfies the above condition provided it fulfils the recognition criteria. It does not matter whether the individual parts are used for one year or not. Under the composite scheme each and every part is collection of the entire plant and every spare part should be recognized or derecognized as per above mentioned principle.