Classification and Valuation of Spare Parts

No. 007/11PL

Philips Lighting
Finance and Accounting directive
No. 007/11PL

Classification and Valuation of Spare Parts

General information

To Controllers (ORU, GBU, RBU, BG, Sector) Lighting Sector, Controller

Mechanization, Controller Industrial Transformation Office
Author Tobias Mesecke, Controller Supply Chain
Approved by Sector Controller Lighting
Effective from October 1, 2011
Version 1.1
Scope This directive provides guidance on classification and valuation of spare parts.
Objective The purpose of this directive is to provide sector-wide guidance on the
classification and valuation of spare parts, reflecting Philips Accounting Policies
and IFRS requirements.
Main changes This guideline supersedes Instruction 012/09PL. With this, following major
changes took place:
- Clarification for accounting treatment of spare parts as PPE versus
Inventories
- Alignment with IFRS requirements
- Accounting Treatment
Interrelation with other Corporate Accounting Manual (AM) section 3.2 (PP&E), 3.8
policies (Inventories)
Lighting Sector N/A
Classification and Valuation of Spare Parts
No. 007/11PL

1. Introduction
Within the sector Lighting, spare parts can generally be held for two different reasons: firstly to ensure that parts
of machinery or equipment can timely be replaced or repaired when needed, or secondly spare parts are held for
retail purposes. For each of the two purposes, the related IFRS accounting treatment is treated individually. This
guideline clarifies the classification and valuation of spare parts.

This directive supersedes Instruction 12/09PL.

2. Definitions used within this directive

Inventories
Inventories are assets: held for sale in the ordinary course of business (finished goods); in the process of
production for sale (work-in-progress); or in the form of materials or supplies to be consumed in the production
process or in the rendering of services (raw materials and consumables). [IAS 2.6] – AM 3.8.10.10

Net Realizable Value (NRV)

NRV represents the amount an entity expects to realize from the sale of stock in the ordinary course of business.
This is represented by the expected sales price minus selling expenses. In case of a production inventory when a
decline in the price of materials indicates that the cost of the finished products exceeds net realizable value the
replacement cost of the materials may be the best available measure of their NRV.

Property, Plant and Equipment (PP&E)

PP&E comprises tangible assets held by an entity for use in the production or supply of goods or services, for
rental to others, or for administrative purposes, that are expected to be used for more than one period. [IAS 16.6]
– AM 3.2.10.10.

Spare parts
Spare parts, stand-by and servicing equipment (e.g. tools, consumables, lubricants, etc.) are classified as
inventory unless they are expected to be used during more than one period or can be used only in conjunction
with an item of property, plant and equipment, in which case they are classified as PP&E. This applies to assets
held for use within the entity and to those held to provide maintenance services to others. Spare parts held and
located in third party premises for which risks and rewards belong to Philips should also be recognized as spare
parts in Philips books. – AM 3.8.30.

3. Classification
First step in the classification is to decide, whether an asset has to be treated as inventory or as PP&E.
Generally, all spareparts held for retail are to be treated as inventory. In case of internal usage, an asset will
become PP&E, when directly associated with a specific PP&E. If this is not the case, the differentiating factor is
the expect usage: if within one year, the asset has to be treated as inventory; if usage is expected to take place
after one year, it qualifies as PP&E. Annex 1 shows a flowchart, detailing the above and providing guidance on
how to separate PP&E and Inventories.

In the following, each topic is split into a) Inventories and b) PP&E.

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Classification and Valuation of Spare Parts
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4. Initial Recognition
a) Inventories
Spare parts are to be recognized according to inventory valuation rules. In most manufacturing organizations pre-
calculated standard costs are used. Standard costs is an acceptable basis for spare parts inventory valuation
provided that there is no significant variation between the standard costs and the actual cost as indicated by the
price- variance account (account 777 “Price differences on goods purchased”).

Spare parts classified as inventories and used in the production process are debited to account 100 “Production
inventories” while spare parts classified as inventories and used to provide maintenance services are debited to
account 110 “Commercial inventories”.

b) PP&E
For those cases in which spare parts are to be used exclusively with a specific PP&E, the spare part should be
classified in line with the asset (eg account 010 Buildings, 030 Machinery, etc). All other spare parts are to be
classified to account 040 “Specific tools”.

According to AM 3.2.20.20.1 Policy choice, assets are only to be capitalized above EUR 5,000 or equivalent local
currency. Spare parts with an individual value of less than EUR 5,000, but with similar nature and useful life, and
purchased at the same time, should be combined. If the combined value is higher than EUR 5,000, the spare part
will be capitalized as one PP&E, and depreciated accordingly.

5. Valuation and Depreciation

a) Inventories
Spare parts in excess of 1 year demand, where no alternative use exists, should be written-off completely. In
case the NRV is lower than cost, spare parts should be measured at its lower NRV.

The following entry is made at the time of write-off:

Acc. no. Acc.title Debit Credit

787 Losses arising from obsolescence xxx
103/113 Value adjustment because of obsolescence of
production/commercial inventories (subitem 210) xxx

Damaged spare parts are generally written-off in full, unless the ORU can prove that there is market for this. In
this case, it should be written-down to its expected selling price, less any costs to sell these inventories (e.g.
transportation, import duties, warehousing, etc.). This amount is considered NRV.

The following illustrate the write-downs of spare parts to its net realizable value:

Acc. no. Acc.title Debit Credit

789 Changes in the value adjustment to the lower cost or market xxx
and other changes in inventories
105/115 Value adjustment production/commercial inventories to
the lower of cost or NRV xxx

If spare parts are written down to a net book value of 0 EUR, they need to be scrapped within a timeframe of 3
months. The total value is then booked against the built value adjustment.

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Classification and Valuation of Spare Parts
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The following entry is made at the time of scrapping:

Acc. no. Acc.title Debit Credit

103/113 Value adjustment because of obsolescence of xxx
production/commercial inventories (subitem 220)
100/110 Production/commercial inventories xxx

b) PP&E
Spare parts classified as PP&E are depreciated on a systematic basis over their useful lives. Spare parts that
are specifically to be used for production of inventories are depreciated applying the unit of production method.
Under unit of production method, depreciation is based on the level of output or usage expected to be achieved.
While this method may provide a more accurate picture of the consumption of an asset, it may difficult to
estimate the expected output over the life of the assets. If the expected level of output or usage could not reliably
estimated, straight line method can be applied.

If this method cannot be applied practically, the spare parts are to be depreciated on a straight-line basis over the
shorter of the useful life of the spare parts, or the remaining useful life of the related PP&E.

Depreciation is also to be recognized when an asset is idle.

Below is the entry to record the depreciation of Spare parts:

Acc no. Acc. Title Debit Credit

620 Depreciation of tangible fixed assets xxx
041 Depreciation of specific tools (sub-item 155) xxx
Or
0* Related PP&E account (see 4(b)) [sub-item 155] xxx

Controllers of the ORU should assess each year whether there is any indication that an asset is impaired.
Examples for asset impairment include, but are not limited to:
 Decline in expected production level
 Technical and physical obsolescence
 Withdrawal of the related products in the market
 Damage
 Abandonment
 Restructuring of the organization

If such indication exits, the controller of the ORU has to estimate the assets recoverable amount. Recoverable
amount is the higher of fair value less cost to sell and the value in use (commonly known as discounted cash
flows). If the recoverable amount is below the assets net book value, the asset is written-off to its recoverable
amount. Please refer to Chapter 3.10 of the Philips Accounting Manual for details.

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Classification and Valuation of Spare Parts
No. 007/11PL

Annex 1: Flow Chart – Inventory vs. Property, Plant & Equipment

Held for Sale Held for Lighting Use

Spare-
parts

Inventory

Yes
PP&E

Directly
5000 EUR Yes assoc. with
and higher (= no altern. specific
use) PP&E
No
Expensed
(acc. 626 - Non-
capitalized equipment)
No

Yes
PP&E
expected use
> 1 year
5000 EUR
Usage
and higher

Expensed No
(acc. 626 - Non- Expected
capitalized equipment) use
< 1 year

Inventory

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