Recognition and Depreciation of Standby Assets under Ind AS 16

1. Facts

Delta Metals Limited (hereinafter referred to as “the company”) operates a large metal processing facility where production activities are highly dependent on a continuous and stable supply of electricity. Any interruption in the power supply, even for a short duration, can halt production and result in significant operational and financial losses.

To meet its energy requirements, the company has installed a captive power generation system within its manufacturing premises. The system includes a primary generator, which is regularly used to generate the electricity required for the plant’s day-to-day operations.

Considering the critical nature of an uninterrupted power supply, the company has also installed a backup generator. This generator is intended to function as a standby unit and will be operated only when the primary generator becomes unavailable due to an unexpected breakdown, major repairs, or scheduled maintenance.

Under normal operating conditions, the standby generator is expected to remain idle for most of the time, and its actual usage is likely to be infrequent. Nevertheless, management believes that the backup generator is essential to ensure operational continuity and prevent production disruptions in the event of the primary generator’s failure. The useful life of both generators is assessed to be the same, as they are designed to operate within the same power generation system and technological environment.

The company’s management is in a dilemma regarding the accounting treatment of the backup generator. Considering that the backup generator is expected to be used only in exceptional circumstances and may remain idle for most of its life, the management wants to understand whether the cost of the standby generator should be recognised as Property, Plant and Equipment and depreciated over its useful life, or should it be treated differently due to its infrequent use under the Indian Accounting Standard (Ind AS) framework?

2. Relevant Provision

Ind AS 16 – Property, Plant and Equipment

Para 7 of Ind AS 16

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

(a) it is probable that future economic benefits associated with the item will flow to the entity; and

(b) the cost of the item can be measured reliably.

Para 8 of Ind AS 16

Items such as spare parts, stand-by equipment and servicing equipment are recognised in accordance with this Ind AS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory.

Para 55 of Ind AS 16

Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with Ind AS 105 and the date that the asset is derecognised. Therefore, depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.