Fixed Asset Componentization
Separation of the Fixed Asset into various parts can have significant benefits for the company in asset tracking and fixed asset amortization.
Organizations whether product or service-oriented, for-profit or non-profit, all have assets that they need to buy, deploy and utilize in order to generate output, turnover or outcomes that provide value. Machinery, furniture, equipment of various types – all fixed assets have a specific life and depreciation cycle. The objective of any firm is to achieve maximum productivity and asset value realization in order to build profitability. Timely tracking, care and maintenance therefore become essential for the continued use of these assets.
In the case of certain assets, the cost of the individual components can be a significant portion of the overall cost, and may contribute significantly to the balance sheet. In such cases, asset componentization is a technique frequently used to achieve maximum productivity.
So what is asset componentization?
Asset componentization essentially involves the separation of an asset into its various components in the accounting books. This allows companies to account each component as an individual asset and take advantage of difference in physical and economic life of individual components of asset. By using different rates to depreciate the assets based on their physical life, those with a shorter life are depreciated with higher rates as compared to assets with longer lives. Normally, an asset would be considered as the sum total of its parts, and the life of the asset would be based on the total useful life of the asset as a whole. However, in the new Companies Act 2013, it is clearly stated,
“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”
The maximum residual value of assets should not exceed 5% of the actual cost.
What this means is that if a certain component of an asset has a significant value and has a different life from that of the overall asset, it can be measured separately, as a single asset. Aircraft are a classic example of such an asset. The airframe (i.e. the body of the aircraft), the engines and the interiors have different individual useful lives. While the life of the body is usually much higher, that of the interiors or the engines may be lower, necessitating a lower lifespan for engines and interiors and amortization in line with the useful life of that component. Say the airframe has a life of 25 years, while the engines have for 15 years and the interiors for 5 years. The provisions for their replacement (depreciation / amortization) will then be mapped individually.
As per the provisions of component accounting in in Para 43 to 47 in Ind AS 16, Property Plant and Equipment:
Each part of an item with a cost that is significant in relation to the total cost shall be depreciated separately.
The entity allocates the amount initially recognized in respect of an item to its significant parts and depreciates separately each such part.
If two or more items are of same useful life and depreciation method may be grouped for determining depreciation.
For the balance of the parts, the useful life and depreciation can be determined from approximation.
The entity may choose to depreciate separately the parts of an item that do not have a cost that is significant in relation to the total cost of the item.
The main objectives of implementing component accounting are:
To ensure depreciation is in line with the actual usage of assets and to maximize the usage of significant components of the asset
To ensure that the financial position is fairly reflected in the balance sheet and that the income statement appropriately reflects the consumption of economic benefits inherent in those assets.
It is good practice to split the assets in to different components to ensure the component with significant value in relation to whole assets is fully utilized.
Fixed Asset Componentization can be implemented by any organization irrespective of industry.
Tracking the value of your fixed assets either as a whole or split into components requires a comprehensive solution which meets compliances and rules while providing suitable flexibility to the organization. One such comprehensive Fixed Asset Management Solution helping organizations to effectively track, optimally manage and effortlessly comply with government policies is Tracet. Tracet manages end-to-end asset lifecycle starting from procurement to disposal of asset and includes asset assignment, asset split, asset componentization, asset revaluation & tracking the movement of assets, etc.
Tracet also offers fixed asset auditing services including physical verification, asset mapping and asset tagging with barcodes/RFID tags. It enables organizations to gain great control over their fixed assets. To know more on how Tracet can help your organization in its fixed Asset Management and Tracking, fill out the form below or contact us at firstname.lastname@example.org