Accounting for spare parts
The question of accounting for spare parts for assets (i.e. plant and equipment) is one which needs some judgement on the part of an accountant. Before outlining some options, let me describe one experience I had. I worked for a global paper company in the past and the policy to deal with such spares was as follows:
- spares bought with machinery were capitalised as items of plant/equipment and depreciated with the asset
- all spares bought at other times were treated as inventory.
Then, the company merged with another and they had a different policy in that only spares valued over $1000 per unit were inventory, all others were expense. I can recall the month this policy changed, the accounts had a few hundred thousand dollars extra expenses as the lower value inventory items were written off to the income statement.
In IFRS terms, there may be two standards at play, IAS 2 on inventories and IAS 16 on Plant, Property & Equipment. So how is it decided whether a spare part is inventory or treated as an item of PPE? The general consensus, although not specifically stated in any IFRS, is to treat higher value items as an asset and lower value items as inventories. If an asset, then the question arises if the spare should be depreciated. There is a good logical argument that a spare should not be depreciated until it is put in use, so it remains on the books at cost value with adjustment for any impairment. Whatever is chosen, the accounting policy probably should disclosed if the value of spares is material – and in large manufacturing concerns it can be.
Just to complicate things further, from my experience, maintenance staff may still want to have an inventory of some low value, but critical spares even if expensed. I have seen SAP being used to track the quantity of spares held, but with no value attached (as they have been expensed). A good example might be a control panel for a machine. It may be for example a small touch screen worth $300, and expensed in the accounts. But the machine cannot work without it, so it is good to know if a spare is in stock and where it is – the latter being important when perhaps another plant in the group has a spare on hand.
Finally, here is a nice tutorial on accounting for spares.
Marginal costs of a coffee?
Image from wikipedia
A colleague pointed to an article on The Guardian Food and Drink blog recently which posed a question “Is £2 a fair price for a cup of hot water and lemon”. The article describes a review of a coffee shop on TripAdvisor where a customer complained about the price. The manager duly drafted a long and detailed reply, justifying the cost. The justification included everything from the staff member cutting a slice of the lemon, walking in and out of the kitchen and so on – you can read it all at the above link. He argued the cost might be even more than £2.
So what is my view? The manager is right if you include all costs (i.e. full costing). But here is another way to think about this. The waiter, chef, light, rent, cups, equipment, decor etc have all been paid for and are sunk costs. Thinking about it this way, the extra cost of the coffee/tea/water & lemon or whatever else is simply the water and ingredients. Thus, a cup could be sold for a few cent and still make a profit on that one cup as long as the costs are covered. Of course to do this all the time would probably not make business sense, but sometimes if a business has already covered all its costs (or wants to minimise losses) it can engage in such marginal cost thinking – take GroupOn vouchers as an example. Such thinking about pricing and costs is not of course supported by financial reporting, which encourages us to think only in full cost terms. But going back to our coffee shop, if a waiter costs €/$/£10 per hour to employ, then this cost will not change regardless of whether (s)he serves 1 cup or 20 cups in an hour. Lowering prices might bring more people in, and they might buy more than just a cup of coffee – but to do this the manager needs to be aware of the nature of costs and make an informed decision.
Marginal costs and revenues – at a Mark Knopfler gig
Twenty five years ago, I first saw Dire Straits live in Dublin. It was one of the first gigs I ever went to. Back then, there was a guy on O’Connell St in Dublin selling bootleg cassettes of live gigs for maybe £5. The quality was awful, but fans loved it. And it was illegal of course, making it all the more fun.
Move forward to 2015, and I was lucky enough to see Mark Knopfler live in Leipzig. Still an amazing guitarist. Of course, times have moved on and almost everyone has a smartphone to record a gig on – I hate doing this, but some artists don’t seem to mind. To my surprise, Knopfler in his 2015 tour not only seemed to encourage recordings at gigs, but found a way to make some extra revenue.
At each gig – including Leipzig, and yes, I did buy – you could download the actual gig recording for €15. This was sound desk quality, and unique. Add an extra €20 and you got the recording posted to your home on a souvenir USB stick.
Now think of this in marginal costs and revenues. The marginal cost is close to zero, as the stadium is fitted out, staff there and the sound desk set up. Maybe the only cost is a bit of rented space on a cloud server somewhere. On the revenue side, it is pretty much a no-brainer really – the full amount of the €15 per download is revenue, as I just argued the cost is close to nil. So if 1,000 fans at each gig buy the recording, that’s €15,000 x maybe 20 gigs = €300,000, a tidy sum. And of course, it is a legal recording 🙂
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