Companies involved in the manufacturing process have assets that assist in this process. Usually, these assets include machinery, which helps them alter raw materials into finished goods. Companies acquire machines through capital investments, usually an upfront payment to a supplier. In some cases, they may also feature leased machinery.
Regardless of the source, companies need machines to facilitate their production process. Sometimes, however, these machines may also need repair and maintenance. For some of these, companies will also maintain a spare parts inventory buffer to help in the process. The accounting for spare parts inventory can be complex due to various reasons. Before that, however, it is crucial to understand what inventory is.
What is Inventory?
Inventory is a term that defines a company’s physical stock. Usually, it includes raw materials and finished goods. In some cases, it may also consist of work-in-progress or work-in-process items. For a company, inventory defines any physical stock that they keep for their operations. Companies that manufacture products or resell them keep inventory to meet customer demand.
Under the accounting definition, inventory includes items that a company expects to keep for less than a year. Accounting standards require companies to record these items at lower of costs and net realizable value. An item’s cost usually includes its cost of purchase and any conversion expenses incurred on converting them. On the other hand, net realizable value is its estimated selling price.
For most companies, raw materials and finished goods will constitute a large portion of inventories. In some cases, it may also include products that are still in the production process. It is known as work-in-progress. Some companies may also consist of spare part inventories in their inventories. However, the accounting for spare parts may change that.
Overall, companies maintain inventory to meet customer demand for a specific period. Some companies keep buffer inventory to facilitate their continuous production process. In some cases, companies may choose not to keep any physical stock. These companies use a business model that does not require holding inventories, for example, dropshipping. At each year-end, companies report these inventories in their current assets on the balance sheet.
What is Spare Parts Inventory?
Spare parts include small items that are extra to a company’s requirements, as implied from its name. It consists of small parts that companies can use to repair other assets. Usually, spare parts relate to the machinery that companies use in their production and other processes. Companies keep these items on hand to repair machines when the need arises.
Spare parts do not contain items that companies sell. Instead, these are items that companies use to enhance, improve or repair existing resources. In most circumstances, spare parts last less than a year and fall under current assets. However, some spare parts may have a longer use and be a part of a company’s non-current assets.
Spare parts are standby items that companies use if an asset gets lost, broken or worn out. Companies keep these items to reduce or eliminate the idle time of machinery and other auxiliary processes. As a whole, spare parts are a part of a company’s contingency plan to deal with unexpected or sudden breakdowns. By keeping these items, companies can ensure that there is no or minimal stoppage in production.
Overall, spare parts include items that are part of another asset. Companies keep these items on hand to ensure there is no wastage or stoppage in the production process. Spare parts are a part of a company’s inventory and, therefore, fall under current assets. However, they may also have a longer use and may come under non-current assets.
What is the Accounting for Spare Parts?
Accounting for spare parts is a complex process. Under accounting principles, these items are resources that can result in future inflows of economic benefits. Therefore, they will be a part of a company’s assets, which meets the above definition. Therefore, accounting for spare parts is straightforward when it comes to journal entries.
However, the process becomes complex when it comes to the classification of spare parts. As mentioned above, spare parts may be a company’s current or non-current assets. When a company acquires these items, it is critical to determine whether they are long- or short-term. This classification is crucial since it changes how companies present these spare parts in the balance sheet.
When it comes to classifying spare parts, companies can treat them as either inventories or fixed assets. In the former case, the accounting standard that will deal with spare part inventories is IAS 2 Inventories. Therefore, companies must treat them as inventory items and record them at lower of cost or NRV. In the latter case, the accounting standard will be IAS 16 Property, Plant and Equipment. The relevant requirements will also change.
In some cases, companies may also purchase spare parts for resale. In those cases, the categorization above does not matter. Therefore, companies will treat them under the accounting standards for inventories. In other cases, the classification will remain the same as above. Overall, the purpose and length of use of these assets will dictate their accounting treatment as well.
What are the Journal Entries for Spare Parts Inventory?
The journal entries for spare parts are the same for any other asset. When a company purchases these spare parts, the accounting entries will remain the same. However, the classification into different accounts will be crucial. Before passing the journal entries for spare parts inventory, companies must answer some critical questions.
These questions relate to the acquired spare parts. Firstly, companies must determine the purpose of these assets. If these are for resale or a part of the production process, they are more likely to be inventory items. Similarly, if a company keeps these items for more than a year, the classification as inventory will be mandatory. In other cases, companies may have to treat them as property, plant, and equipment.
When a company purchases spare parts, it must know the classification. If these spare parts fall under inventories, the account for these items will differ. Usually, companies acquire these parts using cash, bank, or credit. Overall, the accounting for spare parts that companies classify as inventories will be as follows.
|Spare Parts (Inventory)||XXXX|
|Cash / Bank / Payables||XXXX|
However, the accounting treatment will differ if these qualify as fixed assets. The journal entries will remain the same. However, the classification will vary. The journal entries for spare parts classified as fixed assets will be as follows.
|Spare Parts (Fixed Assets)||XXXX|
|Cash / Bank / Payables||XXXX|
A company, ABC Co., owns various machines that are part of its production process. The company acquires spare parts worth $10,000 for these machinery items on credit. ABC Co. determines that these spare parts will last less than a year since they are usable in the period. Similarly, these spare parts are not for resale purposes.
Although the company won’t resell them, ABC Co. determines the classification to be as inventory. Therefore, ABC Co. will record these spare parts using the following journal entries.
|Spare Parts (Inventory)||$10,000|
Similarly, ABC Co. has various vehicles which do not contribute to the production process. Despite that, they are crucial to the company’s operations. ABC Co. purchases $5,000 worth of spare parts for these vehicles by cash. The company determines these parts will last longer than a year since the vehicles don’t break down often. Similarly, the company does not intend to resell these items.
Due to the above points, the spare parts for vehicles will fall under fixed assets. The accounting for these spare parts will be as follows.
|Spare Parts (Fixed Assets)||$5,000|
Spare parts are inventories that companies keep on hold for when other fixed items break down or wear out. By doing so, they can reduce or eliminate any unexpected stoppages in their operations. However, the accounting for spare parts inventories will differ based on their classification. Companies can either treat these items are inventory or fixed assets.