Accounting for Spare Parts Inventory
Spare parts inventory is the replaceable or service part of the machinery that is used to replace the damaging parts in the repair process. Big machinery requires regular repair and maintenance, they may need to replace some parts to keep its good condition. The company needs to have a spare part to replace when machine breaks down.
Some companies record spare parts as expenses when they are used to repair the machinery. They consider spare parts as the repair and maintenance expense of the machine.
Some companies record spare parts as fixed assets when they are used to repair. They will treat it as an individual fixed asset and depreciate by using the component depreciation method.
Both methods are not wrong, they are used in different situations. We will discuss the detailed method in the following section.
Spare parts as the fixed assets
In general, the criteria to recognize fixed assets include:
- The future economic inflow into the company
- Cost of assets are measured reliable
- Useful life is more than a year
Spare parts meet all of these criteria as they will bring economic benefit to the company when we use them to repair the machine. The cost is also measured reliably when we purchase from suppliers and the useful life depends on its nature.
So based on the standard, we can recognize the spare parts as fixed assets when the useful life is more than a year. It is clear enough that the spare part can be treated as an individual asset when we can quantify the cost and measure the useful life. It will be depreciated over the estimated useful life.
Spare Part Journal Entry – Fixed Asset
When the company decides to capitalize spare parts as fixed assets based on the above criteria, they need to make the following record. The company makes journal entry by debiting fixed assets and credit accounts payable or cash.
|Accounts Payable or Cash
This spare part will be present in the balance sheet as individual assets and needs to depreciate over the useful life.
Spare Part Inventory Example – Fixed Assets
Company ABC uses the excavator in the construction site, it cost around $ 200,000 each. It requires regular repair and maintenance.
On 01 Apr 202X, after inspection, management decides to replace its arm due to a serious accident. The arm costs $ 10,000 and expects to use for 2 years. This excavator has the remaining useful life of 4 years based on the management estimate.
How do we account for this spare part inventory?
Base on the accounting standard, this spare part meets the criteria of fixed assets recognition. It is able to bring the future economic benefit into the company. The cost is measure reliable as it depends on the purchase price. And the company expects to use it for more than a year.
Moreover, the balance is significant if we compare to the main assets, it can impact the company decision. It is also practical to control this asset separately from the main asset. We can use the component depreciation method.
The company should make journal by debiting fixed assets and credit accounts payable (or cash) $ 10,000 on 01 Apr 202X.
|Accounts Payable or Cash
These fixed assets will present on balance as normal. And it will be depreciated over the useful life.
At the end of the month, we need to calculate the depreciation expense for this asset.
The depreciation expense = Cost / Useful life = 10,000/2 year = $ 5,000 per year or $ 416.66 per month.
The journal entry would be debiting depreciation expense and credit accumulated depreciation.
It will be treated as normal fixed assets and depreciate along with the others. The depreciation expense will be present on the income statement and accumulated depreciation reduce fixed assets balance on balance sheet.
Spare part as the Expense
The spare part, that use to repair the main assets, may meet all criteria as fixed assets capitalized. However, the company decides not to capitalize but recorded it as an operating expense.
It is not necessary to capitalize due to the small amount. The purpose of capitalized assets is to spread the expense (depreciation) over assets’ useful life. But if the amount is very small, it is not important to allocate it over a period of 2 or 3 years. The amount will not impact the decision making but it will increase more admin work for the company.
For example, when the computer is broken and we replace the RAM costs $ 50 which can be used for 5 years. It meets the criteria of fixed asset capitalization, but the amount is too small. So it should be recorded as an expense immediately.
In order to prevent this problem, the company can set the accounting policy by determining the minimum amount to be capitalized as fixed assets. Any amount below that needs to record as an expense regardless of its nature.
Spare Part Journal Entry as Expense
When company decides to classify spare parts as an expense, they need to make journal entries by debiting expenses and credit cash or accounts payable.
|Repair & Maintain Expense
|Accounts Payable or Cash
The total cost of spare parts will hit the income statement on the day we repair the assets.
Spare part inventory example – Expense
Company XYZ repairs its car and requires changing the tires cost $ 200. The company is considering recording it as an expense or capitalized as fixed assets.
This amount is below the company’s capitalized threshold, but it has had useful life for over a year.
The purchase of new tires meets the fixed assets definition. They can bring future economic benefits to the company. The cost is measured reliably and we expected to use them for more than a year.
However, the amount is not material to the company as they set a higher threshold to recognize as fixed assets. The balance of $ 200 will not have any influence on the company, it may not different between recording immediate expenses or allocating overtime.
It is also hard for the company to control such small assets. The controlling cost is much higher than the benefit.
So the company should record this transaction as an expense immediately. The journal entry is debiting spare part expense and credit cash or payable.
|Spare Part Expense
The purchase of a new tire will record as an expense and it will appear in the income statement.
Inventory Vs Spare Part inventory
Inventory is the current assets present in the company balance sheet, it includes:
- The raw material used in the production: it is the main component that necessary to produce the output.
- Work in progress in production: It is the material that is in the middle of production but not yet finished.
- Finished goods: It is the final product that is ready to ship to the customers. For the trading company, it refers to the items they purchase and sell back to customers.
The spare part is just the items that use to replace in the repairmen process of another bigger asset. We cannot use spare parts alone, it be attached with other items in order to provide benefit to the company.
One item can be both inventory and spare parts in different companies. The tire is the finished goods for the manufacturer that produces it. They use rubber which is the raw material to produce tires which is the final product.
For the car owner, the tire is just the spare part as it cannot be used alone. They need to use with the car and require to replace from time to time.