Balance sheet lists inventory as an asset, because money is spent on it and it has a value. Too much or too less of Inventory may cripple business. Maintenance, Repair & Operation (MRO) type of inventory requires better attention for asset intensive plant
and so is their optimization. Apart from reason for fast buildup of MRO inventory and subsequent creation of dead inventory, this article also discusses MRO Inventory accounting and need for skilled Valuer.

1. INTRODUCTION:

Inventory is the major part of a Company’s working capital that necessitates their optimization. There are mainly four types of inventory such as Raw material, Work in Progress, Finished Goods and Maintenance, Repair & Operation (MRO) stores. Some organization treats packing materials as fifth type of Inventory. In general, inventory is classified as current assets because it is typically consumed within a year as part of the production process.

MRO inventory is all about materials, equipment and supplies used in the production process at a manufacturing plant but are not part of the finished goods being produced so does not become part of Cost of Goods Sold (COGS). They may include consumables like Gloves, masks, safety equipment and other stores like Valves, motors, industrial equipment, Repair tools, Laboratory equipment, electronic cards, proprietary spares etc.

Inventory management for most manufacturing companies is focused around a combination of raw materials, work-in-process (WIP), and finished goods. Manufacturers try to optimize by following lean or just in time practices. However, in asset-intensive businesses and in the maintenance operations of traditional manufacturing, MRO inventory management takes on a whole different flavor. When downtime is especially costly, the last thing a business needs is to have production halted while waiting for spare parts for repairs.

At the same time there is the necessity to perform periodic maintenance, either preventive or predictive, which requires maintenance of certain level of MRO inventory. When a company buys set of machines, they are supplied with certain percentage of critical spares and most companies embrace the OEMs’ recommendations, then adjust upwards/downwards if experience shows those levels are inadequate/adequate. However, in reality they rarely adjust downwards. In this way level of spares under MRO category keeps on increasing in due course of time and become a problem both in terms of their storage, their usability as well as a major cost component in the balance sheet.

Further, during the course of the life of the plant & machinery, it is quite common for equipment to be replaced or modernized, particularly due to advent of new technology. In certain areas like electronic & software-based systems, planned end of life also plays into the equation as OEMs try to phase out to remove clutter of multiple versions of equipment and their difficulty to support, forcing investments in newer generation equipment. This creates an environment of serious mismatch of spares with existing footprint of the installed equipment. This leads to holding of dead inventory of spare parts affecting overall performance of an organization.

2. TREATMENT OF MRO INVENTORY IN ACCOUNTING:

During the normal running of a company, there are some materials which are consumed as part of the daily operations, but cannot be considered as part of actual cost of goods sold (COGS) rather, their consumption is shown as an expense in the PL statement, under other expenses. These are materials in stores- like indirect consumable, spares parts (used for maintenance of
equipment) etc. Since they are basically assets of the company and are most likely consumed in a year, they have to be recorded as current assets, and therefore logically in the inventory,

Stores and spares are also sometimes capitalized in the balance sheet along with the fixed asset (like machinery) for which they are consumed. In general, repairable spare parts are classified as other non-current assets similar to property, plant and equipment, rather than inventory because such parts are repaired and re-used over a long period of time, may be the same period over which such parts are amortized.

Ind AS Provision: Items such as spare parts, stand-by equipment and servicing equipment are recognized in accordance with Ind AS 16 when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory hence their fair value measurement shall be as per the provisions of Ind AS 2.

3. SPARE PARTS VALUATION FOR FAIR MARKET VALUE MEASUREMENT:

All three approaches to valuation can be applied to Inventory valuation. Valuer should use judgment in making the determination of specific method depending upon the purpose of valuation and those methods can fall under Cost Approach, Market Approach, and Income Approach.

Before deciding the approach and methods, valuer is required to understand the state of affair with detailed analysis in case of MRO inventory. Some of the obvious questions related to MRO inventory would be

  • Status of in-house inventory verification with the help of user department & their findings
  • Classification of inventory in terms of Critical, Insurance, General etc
  • Further classification of inventory falling under General Category with regard to Fast Moving, Slow Moving and Non-moving.
  • Standard Operating Procedure pertaining to storage and classification of MRO Inventory
  • Status of dead inventory

It is seen that company will not discard spares under critical & insurance category even if they are non-moving unless and until related equipment has met with end of life. However, chances of non-moving inventory under general category to get classified under dead inventory is quite high.

So based on above findings (again not exhaustive and may require further in-depth analysis), a valuer may proceed the valuation of MRO inventory using valuation approaches and methods applicable to them. Steps could be different than the valuation of manufacturing inventories (raw material, work in progress, finished goods) and this may not even match with valuation of assets
like Plant & Machinery. This happens because of MRO Inventory being unique, may have unusual cost, having limited usability by others, sometime proprietary in nature and also limited availability.In spite of all these facts they have unique value to the organization and so to determine their right value requires special skill and industrial experience from the valuer side.

4. Conclusion:

Buildup of spare inventory in an organization depends on organizational philosophy & nature. These centralized inventories require regular attention & decluttering exercise from the user department. Level of MRO inventory & their treatment may vary in different sectors. Proper assessment of their value during course of time is one of the challenging exercise and require services of Skilled Valuation Professionals.

ABHAY KUMAR, B.Sc.(Engineering)
Insolvency Professional | Reg. Valuer(P&M) | Business & Software Consultant | Chartered
Engineer | Trainer