COMPONENT ACCOUNTING OF DEPRECIATION

DEFINITION
As per note 4 Schedule II to the Companies Act, 2013 -“Useful life specified in Part C of the Schedule is for whole of the asset. Where cost of a part of the asset is significant to total
cost of the asset and useful life of that part is different from the useful life of the remaining asset, useful life of that significant part shall be determined separately.”

∙ As per the amendment dated August 29, 2014 notified by the MCA, the said requirement shall be voluntary in respect for the financial year commencing on or after the April 1, 2014
and mandatory for financial statements in respect of financial years commencing on or after April 1, 2015.
∙ Under ‘component accounting’, companies will need to identify and depreciate significant components with different useful lives separately
∙ The component approach is already allowed under current AS 10, paragraph 8.3. Under AS 10, there seems to be a choice in this matter; however, the Schedule II requires application of component accounting mandatorily when relevant and material.
Component accounting is required to be done for the entire block of assets as at 1 April 2014 if a company opts to follow it voluntarily and as at 1 April, 2015 mandatorily. It cannot
be restricted to only new assets acquired after 1 April 2014 or 1 April, 2015 as the case may be.

PROVISIONS RELATED TO COMPONENTS ACCOUNTING

∙ As component accounting was until now not mandatory in India, it is possible that the separate cost of each significant component of an asset is not available in the books of accounts. In order to determine the cost of such component following criteria can be used:
− Break up cost provided by the vendor
− Cost break up given by internal/external technical expert
− Current replacement cost of component of the related asset and applying the same basis on the historical cost of asset

PROCEDURE STEPS

Step 1: Identify the significant components of a PP&E item

To apply the component approach, it is necessary to identify the significant parts of an asset. IAS 16 specifies two different types of components: (1) a physical component and (2) a non-physical component that represents a major inspection or overhaul.

Component accounting for inspection or overhaul costs is intended to be used only for major expenditures that occur at regular intervals over the life of an asset and last more than one period; this is referred to as ‘planned major maintenance’ under US GAAP. Costs associated with routine repairs and maintenance are expensed as incurred.

Step 2: Determine the cost of the components

Each component is measured at cost at initial recognition, which can create many practical issues. Assets are usually purchased for a single sum without knowing the cost of the individual components.

In our view, the cost of the individual components should be estimated either with reference to current market prices (if possible), in consultation with the seller or contractor, or using some other reasonable method of approximation (e.g. relative values).

Other complexities arise in determining the implicit cost of a major inspection or overhaul, and in allocating the total costs to the different components when the underlying asset comprises a number of physical and non-physical components (e.g. major inspection or overhaul).

Step 3: Depreciate each component separately

The components identified in Step 1 are depreciated separately over their respective useful lives in a manner consistent with their pattern of consumption. However, regardless of the components identified for an underlying asset, on the balance sheet the respective carrying amounts are all presented within the single line item, PP&E.

Step 4: Replace the components

The remaining carrying amount of a component that is replaced by a new component is derecognized. However, any amount written off is included in depreciation instead of being classified as a loss on disposal. We believe the extra depreciation is in effect a revision of the estimated useful life of the component. Costs associated with replacing items not identified as a component are expensed as incurred.

EXAMPLE

Let’s say the machine part is $150,000 with a useful life of 10 years .it also has a cylinder for $25000 and a compressor for $25000 each which must be replaced every 5 years. the ,machine ,cylinder and compressor will all be depreciated separately over each of their useful lives

CHALLENGE OF APPLYING COMPONENT APPROACH

Identifying each component and the required data, such as the date purchased and the original cost, can be challenging. This will particularly be true for companies engaging in capital intensive businesses and transitioning to IFRS. The detailed recordkeeping needed to apply the component approach may not have been required under the company’s current GAAP.

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