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Identifying capital projects and determining which costs should be capitalized is a key focus in the accounting for construction projects and plant additions. Capital costs may include labor, materials and supplies (including stores expense), transportation, engineering services, certain overheads, insurance, employee benefits, compensation for damages, taxes, and capitalized interest. Similarly, an expenditure that adds to the productive capacity or improves the efficiency of an existing facility can be considered a capital item. Costs that are not necessary in readying an asset for use should be treated as an expense in the period in which they occur.
This section primarily focuses on capitalization policies for power companies and other projects for which construction is not subject to regulation, including special considerations for projects constructed for sale or rental (lease). It also specifically addresses the determination of components, accounting for capital spares, and the determination of a facility’s commercial operation date. The capitalization policies for regulated utilities may differ from the guidance discussed in this section, due to the regulatory process. See UP 18.2 for further information.

12.2.1 Initial measurement

ASC 360-10-30-1 provides the overall guidance for the initial measurement of capital projects.

Excerpt from ASC 360-10-30-1

[T]he historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.

Costs incurred during the construction of an asset that are directly attributable to its construction should be capitalized. U.S. GAAP does not currently include any specific guidance on capitalization policies for facilities constructed for a reporting entity’s own use. In 2001, the Financial Reporting Executive Committee of the AICPA (FinREC) issued a proposed Statement of Position, Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment. FinREC approved this proposed SOP (referred to herein as the proposed PP&E SOP) in 2003 subject to the FASB’s clearance; however, it was not approved for issuance by the FASB and therefore never issued in final form. Nevertheless, the proposed PP&E SOP is often referred to for guidance on cost capitalization. Many of the concepts in the proposed PP&E SOP related to the capitalization of costs of an asset constructed for a reporting entity’s own use continue to reflect current practice regarding the appropriate accounting treatment for these costs.
ASC 970, Real Estate - General, includes incremental guidance on capitalizing the costs of real estate developed for sale or rental. That guidance explicitly excludes capital projects constructed for a reporting entity’s own use. However, in the absence of other authoritative guidance, utilities and power companies often apply the guidance in ASC 970 by analogy in developing their overall capitalization policies. See PPE 1.7 for information on capital projects built for sale or rental and see UP 12.2.2 for specific industry considerations for capital projects built for sale or rental, including certain power plants built in connection with a long-term power purchase agreement.
The cost of acquiring an asset includes the costs incurred required to bring it to the condition and location necessary for its intended use. The proposed PP&E SOP identified four phases where costs may be incurred related to plant assets: the preliminary phase, the pre-acquisition phase, the construction phase, and the in-service phase. The following sections discuss capitalization considerations through the time when property, plant, and equipment is placed in service.

12.2.1.1 Preliminary phase

The preliminary phase occurs before construction of the project is probable. ASC 720, Other Expenses (ASC 720), addresses costs associated with the start-up of a new facility and states that such costs should be expensed as incurred, with limited exceptions (see section on Other start-up costs below). ASC 970-340-25 also indicates that all costs should be expensed before a project is probable of being constructed, except for the cost of an option to acquire land. Options to acquire land (that do not meet the definition of a derivative) may be capitalized and should subsequently be accounted for at lower of cost or fair value, less cost to sell.
Figure UP 12-3 (included in UP 12.6) summarizes the accounting for some of the common types of costs incurred during all phases of construction of a plant, including the preliminary phase. ASC 720-15 includes examples of other costs that should be expensed as part of start-up or preliminary activities.
Question UP 12-1
How should a reporting entity assess whether a project is probable of construction?
PwC response
There is no authoritative guidance on how to determine whether a project is probable of construction. However, this topic was addressed in the proposed PP&E SOP.

Excerpt from paragraph 16 of the proposed PP&E SOP

In assessing probability, the entity should consider whether (a) its management, having the relevant authority, has implicitly or explicitly authorized and committed to funding the acquisition or construction of a specific PP&E asset, (b) the financial resources are available consistent with such authorization, and (c) the ability exists to meet the requisite local and other governmental regulations.

In the proposed PP&E SOP, the word “probable” is used consistent with the guidance in ASC 450, Contingencies.

Other start-up costs
ASC 720-15-15-4 discusses certain costs that may be incurred in connection with start-up activities but that are outside the scope of the guidance for start-up costs. For example, ASC 835, Interest, provides guidance on the accounting for costs to arrange financing for the construction of a new plant (ASC 835-30). Other costs described by ASC 720-15-15-4 that may need to be assessed as part of the start-up or construction of a power project include:
  • Costs relating to mergers and acquisitions
  • Costs of acquiring or constructing assets and getting them ready for their intended use (however, the cost associated with long-lived assets used to support start-up activities, such as depreciation of computers, is within the scope of the start-up cost guidance)
  • Costs of acquiring or producing inventory
These types of costs typically would not be incurred until the pre-acquisition or construction phase. Nevertheless, if financing and other start-up costs outside the scope of ASC 720 are incurred during the preliminary stage, they should be accounted for in accordance with other applicable U.S. GAAP.

12.2.1.2 Pre-acquisition phase

The pre-acquisition phase begins when the acquisition or construction of specific property, plant, or equipment is probable, and prior to the acquisition or start of construction. One of the concepts addressed in the proposed PP&E SOP is the differentiation between accounting for costs that are directly identifiable and those that are an allocated or overhead cost. Directly identifiable costs should be capitalized whereas allocated and other overhead costs should be expensed as incurred. Similarly, ASC 970-340-25-3 states that costs that meet specified criteria should be capitalized once the project is probable.

ASC 970-340-25-3

Payments to obtain an option to acquire real property shall be capitalized as incurred. All other costs related to a property that are incurred before the entity acquires the property, or before the entity obtains an option to acquire it, shall be capitalized if all of the following conditions are met and otherwise shall be charged to expense as incurred:
  1. The costs are directly identifiable with the specific property.
  2. The costs would be capitalized if the property were already acquired.
  3. Acquisition of the property or of an option to acquire the property is probable (that is, likely to occur). This condition requires that the prospective purchaser is actively seeking to acquire the property and has the ability to finance or obtain financing for the acquisition and that there is no indication that the property is not available for sale.

Refer to PPE 1.2.1.2 for further information on directly identifiable costs. Consistent with this guidance, it is appropriate to capitalize direct costs during the pre-acquisition phase however, overhead and allocated costs should be expensed. Figure UP 12-3 summarizes the accounting for common costs incurred by utilities and power companies during all stages of construction, including the pre-acquisition phase. Pre-acquisition costs should be reclassified to construction work in progress once construction begins. If construction is no longer probable, the reporting entity should consider whether an impairment loss should be recorded. If the project will be abandoned, the costs should be recorded at the lower of cost or fair value, less cost to sell. In such cases, the fair value less cost to sell is likely to be zero.

12.2.1.3 Construction phase

The construction stage begins at the time the reporting entity obtains ownership of the PP&E or obtains the right to use the PP&E through an agreement (e.g., a lease). During this stage, costs are incurred to acquire, construct, or install the PP&E. This stage includes costs incurred prior to the long-lived asset being available for its intended use.
During the construction phase, a reporting entity should capitalize directly identifiable costs of construction in accordance with its capitalization policies. In general, indirect costs should continue to be expensed during construction. However, as further discussed in UP 12.2.2, ASC 970 provides specific guidance for the construction of real estate assets for sale or rental whereby certain overhead costs may be capitalized. In addition, regulated utilities may be able to include construction-related costs in rate base that would otherwise be expensed. To capitalize such costs, a regulated utility should ensure that it is probable such amounts will be included in future rate base (see UP 18.2).
Figure UP 12-3 (included in UP 12.6) summarizes the accounting for costs incurred during all phases of construction of a power or utility project constructed for a reporting entity’s own use. The following sections discuss specific additional considerations for certain of the costs that may be incurred during construction. See UP 12.2.2 for incremental considerations for a reporting entity constructing a project for sale or rental.
Contributions received
Question UP 12-2
How do contributions received from developers or others impact the cost of plant?
PwC response
The accounting will depend on the type of payment received and varies by type of utility.
Utilities and power companies may receive amounts known as contributions in aid of construction (CIAC) that are generally intended to defray all or a portion of the costs of building or extending existing facilities. CIAC is a permanent contribution and in practice, electric and gas utilities record CIAC received as a reduction of the cost basis of plant. This concept is consistent with the Federal Energy Regulatory Commission’s accounting requirements and with a regulated utility’s ratemaking treatment because rate base is generally determined net of CIAC received.
Utilities and power companies also may receive construction advances from developers. Such amounts may be refunded to the developers once the development meets certain service milestones (e.g., number of customers added, volume of commodity delivered); amounts are retained if the milestones are not met in a specified time period. Advances are generally recorded as a liability until refunded or until the milestone period lapses. If the milestone period lapses, and the amounts are retained by the utility, the construction advances are usually reclassified to reduce the related plant balance. Additionally, because of the refund obligation, activity related to advances is usually classified as a financing activity in the statement of cash flows. Refer to FSP 6.8.14 for further consideration of classification of CIAC within the statement of cash flows.
Water utilities may also receive CIAC; however, industry practice usually is to record CIAC as a liability and reduce the balance over the useful life of the related asset.

Contributions made
Municipalities and other government entities sometimes require entities to construct additional assets or infrastructure unrelated to the project as a condition of obtaining a construction permit. For example, if a company’s project plan eliminates trees or green space, the government entity may require that the company build a park or plant a certain number of trees along the municipality’s roads or make a charitable contribution to an environmental not-for-profit organization. ASC 720-25 defines contributions of cash and other assets.

Partial definition from ASC 720-25-20

Contribution: An unconditional transfer of cash or other assets, as well as unconditional promises to give, to an entity or a reduction, settlement, or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Those characteristics distinguish contributions from:
  1. Exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately commensurate value
  2. Investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners
  3. Other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers.
In a contribution transaction, the resource provider often receives value indirectly by providing a societal benefit although that benefit is not considered to be of commensurate value. In an exchange transaction, the potential public benefits are secondary to the potential direct benefits to the resource provider.

Contributions should be expensed in the period made, unless the contribution is in substance the purchase of a good or service. Payments made or other services provided to a municipality or governmental entity to obtain a permit, zoning change, or other licenses necessary for construction are not contributions. Instead, such amounts are being paid in exchange for the ability to construct a facility (i.e., they are reciprocal and represent an exchange transaction). Therefore, if the payment is made once the project is probable or is in construction and can be directly identified with the receipt of the permit or license, capitalization of the payment as part of the plant asset is generally appropriate.
Similarly, an entity may be required to make certain commitments in order to obtain Federal Energy Regulatory Commission (FERC) operating licenses or as part of the negotiation for a license renewal. These may include commitments for capital related expenditures (e.g., pledges for plant improvements that will improve the environmental impact of the facility) or expense-type costs (e.g., commitments to fund environmental clean-up programs or perform remediation). Improvements to facilities made as part of the response to the negotiation for a FERC license may still be capitalized as part of plant provided that they meet the criteria for capitalization in ASC 360.
For “expense-type costs,” the entity is committed to pay the expense in conjunction with the attainment of the license or license renewal. Accordingly, these commitments meet the criteria for liability recognition under ASC 405 and the discounted value of the obligations should be recognized in the financial statements. As such costs were agreed to in consideration of the benefit of operating the facility, the offset to the liability may be recorded as an intangible asset in accordance with ASC 350, and the asset would be amortized over the license period.
Capitalized interest and allowance for funds used during construction (AFUDC)
Generally, unregulated entities should capitalize interest during construction in accordance with ASC 835. In addition, PPE 1.3 describes the guidance on capitalizing interest for reporting entities in general, including the following topics:
  • Qualifying assets
  • Capitalization rate and eligible expenditures
  • Capitalization period
  • Financing through tax-exempt borrowings, such as pollution control bonds
  • Capitalization of interest associated with land expenditures
  • Capitalization of interest for equity method investments

Regulated utilities should capitalize allowance for funds used during construction (AFUDC) during the capitalization period, if allowed by the regulator. See UP 18.3 for further information on recording AFUDC and refer to PPE 1.3 for discussion on capitalized interest.
Test power
During the testing phase of a new plant, the facility will produce power that may be sold as “test power” under a related power purchase agreement, and delivered to the facility owner’s customers, or sold to the market. In accordance with ASC 360-10-30-1, the historical cost of an asset includes “the costs necessarily incurred to bring it to the condition and location necessary for its intended use.”
Amounts to be capitalized include eligible costs incurred prior to the commercial operation date (see UP 12.2.5). Costs during the testing phase are part of the preparation of the plant for its intended use; therefore, the cost to generate test power should be incorporated as part of the initial measurement of the capitalized cost of the plant.
Question UP 12-3
How should a reporting entity determine the earnings and related expense, if any, for test power?
PwC response
The accounting literature does not directly address the calculation of amounts earned and expenses associated with test power. In some situations, such as in the case of a company with multiple plants and customers, it may be difficult to directly attribute certain megawatt-hour sales to the test power. In other cases, there may be contractual cash flows specifically related to the plant and any test power produced.
The FERC Uniform System of Accounts, Electric Plant Instructions, 3.A(18)(a) and (18)(b) provides a framework for test power for utilities subject to its jurisdiction. In accordance with these requirements, the amount earned from sales that is credited to plant should equal the contractual amount, if applicable. Otherwise, it should be the fair value of the power. The related expense is the incremental cost of producing and delivering the power. In practice, the amount recorded is usually the contractual amount or the market price of power during the test period (as applicable), net of any incremental fuel and transmission costs.
This guidance is specific to FERC-regulated utilities, but we believe other utilities and power companies can follow the same approach. There also may be other methods of calculating amounts earned and related expense that are appropriate in the circumstances.
Question UP 12-4
Should amounts received from the sale of test power be included as a reduction of the capitalized construction costs?
PwC response
Yes. When testing a facility, a reporting entity typically will sell the test power. ASC 360-10-30-1 and 30-2 acknowledge that the “activities” required to complete construction may extend over a period of time.

Excerpt from ASC 360-10-20

Activities: The term activities is to be construed broadly. It encompasses physical construction of the asset. In addition, it includes all the steps required to prepare the asset for its intended use. For example, it includes administrative and technical activities during the preconstruction stage, such as the development of plans or the process of obtaining permits from governmental authorities. It also includes activities undertaken after construction has begun in order to overcome unforeseen obstacles, such as technical problems, labor disputes, or litigation.

Amounts received for testing power are incidental to the facility’s operations because they are earned prior to the start of commercial operation. The process of producing and selling test power is one of the steps required to prepare the asset for its intended use. Therefore, consistent with the definition of activities and the requirements of ASC 360-10-20, a reporting entity should record amounts received as a result of the sale of the test power, net of any incremental fuel or other incremental production costs, as a reduction of the construction work in progress balance. Only power sold after the commercial operation date should be recorded as revenue.

Interconnection costs
To provide power to its customers, a power plant requires an interconnection between the generating facility and the transmission owner’s transmission system. During the construction phase of a generation facility, the developer of the facility may be required to construct or fund the development of an interconnection to the transmission system, but the transmission system owner may retain ownership of the interconnection. There are certain generally accepted treatments of the assets in these types of arrangements as described below.
Interconnection costs as part of property, plant and equipment
One view is that the costs associated with the interconnection are costs of the plant itself. The cost of an asset should include “the costs necessarily incurred to bring it to the condition and location necessary for its intended use.” As the construction of an interconnection is required for a facility to be able to provide its output to the transmission system, costs incurred related the interconnection may be considered as having been incurred in order to bring the facility to the condition necessary for its intended use. Accordingly, interconnection costs may be capitalized within plant costs by the developer/owner.
Interconnection costs as an intangible asset
Although the developer/owner may have incurred costs related to the construction of interconnection, the actual ownership of the interconnection may be retained by the transmission owner. However, the facility will be granted a right to use the interconnection as part of an interconnection agreement. Accordingly, the developer/owner may classify the asset related to the interconnection as an intangible because the asset is not the underlying physical asset but rather a right to use the asset.

12.2.2 Construction for sale or rental (real estate)

In addition to the general considerations for capitalization discussed in UP 12.2.1, reporting entities constructing assets for sale or rental should consider the additional guidance specific to that type of construction provided by ASC 970-360 and ASC 970-340. Factors to consider in assessing whether a plant was built for sale or rental are summarized in Figure UP 12-1.
Figure UP 12-1
Factors indicating whether a plant was constructed for sale or rental or for an entity’s own use
Evidence supporting construction for sale or rental
Evidence supporting construction for a reporting entity’s own use
  • Facility has a long-term power purchase agreement that meets the definition of a lease in accordance with ASC 842
    • Power purchase agreement was signed as part of the initial design of the facility (e.g., as a condition of financing)
    • All or substantially all of the capital costs will be recovered through a power purchase agreement
    • Plant will be sold or leased again at the end of the lease term
    • Project is constructed for purpose of immediate sale; signed sales agreement is in place
  • Facility will be operated to serve retail customers or to sell into the power markets
  • Facility is subject to only a short-term lease (typically less than five years) with no expectation to continue leasing
  • Recovery of costs is expected through sales of power to the reporting entity’s retail customers
  • Absence of a long-term power purchase agreement that meets the definition of a lease in accordance with ASC 842 during initial construction
  • Facility is designed for the owner’s use
Not all of the factors included in Figure UP 12-1 are required to be present in order to conclude that a facility was constructed for sale or rental; however, to reach such a conclusion, a long-term power purchase agreement or sales agreement (accounted for as a lease under ASC 842) should generally be part of the initial design of the facility. The existence of a short-term lease could also result in a conclusion that construction is for the purpose of sale or rental if the reporting entity has the intent and ability to renew the lease or subsequently enter into a similar agreement with another party.
If a reporting entity determines that a facility was constructed for sale or rental, the accounting for indirect costs and ground lease rentals should be considered during the pre-acquisition (if construction is probable) and construction phases.
Refer to PPE 1.7 for further discussion on accounting for certain real estate costs in accordance with ASC 970-340 and ASC 970-360.
Indirect costs
Indirect costs can be capitalized if an asset is constructed for sale or rental. If constructed for the reporting entity’s own use, indirect costs would not be capitalizable. Indirect costs are defined in ASC 970-360-20.

Definition from ASC 970-360-20

Indirect Project Costs: Costs incurred after the acquisition of the property, such as construction administration (for example, the costs associated with a field office at a project site and the administrative personnel that staff the office), legal fees, and various office costs, that clearly relate to projects under development or construction. Examples of office costs that may be considered indirect project costs are cost accounting, design, and other departments providing services that are clearly related to real estate projects.

Reporting entities constructing property for sale or rental should have specific policies for the accumulation and capitalization of qualifying indirect costs. Indirect costs that do not clearly relate to projects under development or construction should be charged to expense as incurred. When identifying the costs to be capitalized, the reporting entity should consider whether specific information is available (such as timecards) to support the allocation of overhead costs to specific projects. Furthermore, the costs incurred should be incremental costs. That is, in the absence of the project or projects under development or construction, these costs would not be incurred. It may be difficult to distinguish between indirect project costs and other costs (e.g., general and administrative expenses). When it is unclear, the general presumption is that they are not indirect project costs and would be expensed as incurred.
Indirect project costs that relate to a specific project, such as costs associated with a project field office, should be capitalized as a cost of that project. In accordance with ASC 970-360-25-3, indirect project costs that relate to several projects, such as the costs associated with a construction administration department, should be capitalized and allocated to the projects to which the costs relate.
Ground lease expense
ASC 842-10-55-21 provides specific guidance on the accounting for ground lease expense by a lessee during construction. This guidance prohibits a reporting entity from capitalizing such amounts for property constructed for a reporting entity’s own use. However, as noted in ASC 970-340-35-2, the guidance in ASC 842 does not address the treatment of these costs for real estate projects constructed for the purpose of sale or rental. Consistent with the guidance under ASC 970, we believe that ground lease expense during the construction period can be capitalized for projects built for sale or rental.

Excerpt from ASC 970-340-35-2

Topic 842 does not address whether a lessee that accounts for the sale or rental of real estate projects under Topic 970 should capitalize rental costs associated with ground and building leases.

Refer to Figure UP 12-1 for factors to consider in evaluating whether a project is being built for sale or rental.

12.2.3 Commercial operation date

The date on which a plant is considered ready for its intended use is often referred to as the commercial operation date (COD) or the placed-in-service date. Figure UP 12-2 summarizes industry practice in determining the COD:
Figure UP 12-2
Determining the commercial operation date
Type of plant
Considerations
Fossil fuel
COD is usually defined as the point at which the plant has been fully operational for 48 continuous hours. This definition has become common in practice because it parallels definitions in typical warranty contracts from turbine manufacturers.
Nuclear
Nuclear generating plants operate under the jurisdiction of the Nuclear Regulatory Commission (NRC). The NRC licensing process usually involves two dates. The first is the granting of a low-power license, usually representing the right to operate at five percent of rated capacity. At this point, steam is produced but no power is generated. The second is the granting of a full-power license, which occurs after completion of the appropriate testing.
A common scenario for nuclear plants is for management to declare the COD when the plant is producing power at a minimum of 50 percent for a sustained period of time.
Renewable
The COD is typically the date at which the project is mechanically complete and begins delivering power.
As noted in PPE 1.2.1.4, the in-service stage of long-lived assets begins when the asset is substantially complete and ready for its intended use. For many utility projects, this coincides with the COD. Accordingly, for accounting purposes, the COD is important because it is the date at which some types of costs are no longer considered capital costs (but rather become operating or maintenance costs). It is also the point at which the reporting entity places the asset in service and begins to record depreciation expense and ceases capitalizing interest costs. In addition, the COD is often the effective date for power purchase agreements related to new construction.
There is no formal accounting guidance on how to determine the COD. It is a point in time, declared by management, at which all testing and commissioning for the unit has been completed and the project is deemed available for dispatch. There are, however, some customary industry practices for determining the COD, as summarized in Figure UP 12-2.
In addition to the considerations in Figure UP 12-2, engineering, procurement, and construction contracts or power purchase agreements may define the point at which commercial operation is reached.
Refer to PPE 1.2.1.4 for further discussion on accounting for costs once the asset is placed into service. Generally, once the in-service stage has begun, costs incurred to acquire additional PP&E or replace existing significant components of PP&E are capitalized while the costs of normal and recurring repairs and maintenance are generally expensed. Refer to UP 12.2.4 and UP 12.4 for considerations and accounting implications for a reporting entity when determining an accounting policy for components and the related maintenance activities, including major maintenance.

12.2.4 Determining components

Components are identifiable units of property—comprising individual items or a group of individual items—that have an economic life greater than one year. A reporting entity should establish a policy for how components are determined; this will have a significant impact on future depreciation, major maintenance policies, replacements, and retirements. For example, consider the following policies for a newly constructed power plant:
  • Multiple components
The reporting entity could separate a power plant into multiple components (e.g., establishing lives for turbines that are different from the rest of the plant). The individual components would be depreciated over their respective lives. Replacements would result in retirement of the existing component and capitalization of the cost of the new component.
  • One component
The reporting entity could define the entire power plant as one unit of property. In such case, the entire plant would be depreciated using the composite method over the plant’s useful life. Major maintenance, including replacements of individual parts, would be expensed as incurred.

There is a range of industry practice in developing policies for components; however, reporting entities generally should be as specific as possible in the identification of components. There also may be additional considerations for regulated utilities as a result of the regulator’s requirements. A reporting entity should apply its policy consistently to similar properties. Refer to UP 12.4 for information on determining an accounting policy for maintenance, including major maintenance.

12.2.5 Capital spares

Property, plant, and equipment consists of long-lived tangible assets used to create and distribute a reporting entity’s products and services and includes machinery and equipment. It is not unusual for utilities or power companies to acquire capital spare parts and hold them in storage prior to their installation or addition to operating plant. Additionally, companies often maintain spare parts for machinery to prevent shutdowns in the event of equipment failure, which could be time consuming and costly. Spare parts are also held on hand if the lead time to acquire new parts is long or contractual maintenance agreements require that the reporting entity maintain such parts on hand.
The accounting guidance does not define capital spares; however, in determining whether parts are capital spares, industry practice is to consider whether the parts possess the following characteristics:
  • Long lead time to procure
  • Costly
  • Vital to the continued operation of the facility
  • Used for emergency replacement only
  • Require customization

In addition, the Internal Revenue Services’ Revenue Ruling 81-185 provides definitive guidelines on emergency spare parts. Although this guidance is applicable only for income tax purposes, the points outlined are a reference for reporting entities developing an internal policy. Capital spares may be classified as part of the plant balance prior to use in the plant. The parts would be expensed or capitalized as plant in service when used, depending on the reporting entity’s policies for components and major maintenance (see UP 12.2.3 and UP 12.4.1, respectively). In addition, depreciation on capital spares prior to being put in use would depend on the entity’s policy for componentization and other factors.
Refer to PPE 1.5.3 for further information on accounting for spare parts, including guidance provided by the AICPA Audit and Accounting Guide, Airlines (Airline Guide), which is often used by analogy in other industries, including utility companies. Furthermore, according to the Airline Guide, spare parts that have significant value, such as spare engines, should generally be capitalized and depreciated over their useful lives or the remaining service lives of the related equipment. Alternatively, some companies consider spare parts as a current asset (e.g., inventory) that are not depreciated, but instead expensed when they are placed in service (similar to maintenance expense). Companies should consider the relevant facts and circumstances to determine whether spare parts should be classified as long-lived assets or inventory (e.g., materials and supplies inventory). The policy should be consistently applied. Refer to FSP 8.6 for additional information related to classification of spare parts. The classification should drive the related classification of such activity within the statement of cash flows.
1 Rev. Rul. 81-185, 1981-2 C.B. 59, Depreciation; Public Utility; Major Standby Emergency Spare Parts.

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