The high cost of ‘free’ parts packages
Often when companies upgrade an existing plant, expand facilities or build new “green field” sites, the new equipment comes with a spare parts package. This is sometimes called a two-year spares package. The cost of these parts is then absorbed into the capital cost of the project and the parts are entered into the spare parts inventory at zero cost. When issued for use they are treated as free of charge.
Of course, they weren’t free. The company paid for them. It’s just that the allocation of that cost went into a different accounting bucket.
The problem is that these so-called “free” parts can have a very high cost for the company in some important ways that lead to higher costs in the long run.
Superficially, the issue of free parts seems like a bonus for the maintenance team. After all, the cost of these parts is not allocated to the maintenance budget when the parts are used. The work gets done and someone else pays, it seems like a good deal.
Of course, this also means that the cost center doesn’t accurately reflect the actual cost of maintaining the equipment. Therefore, any decision making or benchmarking on costs is pointless at best and misleading at worst.
Further, most companies set their budgets by reflecting in the coming year the cost of the the previous year, so when it comes to the budget allocation in Year Two of the life of this equipment, the budget is likely to reflect artificially low records from the previous year.
When the “free” parts are replaced in the storeroom at full cost and later used by maintenance, the department struggles to maintain equipment within the artificially low budget.
Then, when the budget is exceeded because the actual parts cost is now allocated to the equipment, the department is pressured to reduce the maintenance expense to meet the artificially low budget. In order to achieve this, maintenance may need to take short cuts, reduce some of the work and/or reduce staffing and overtime. With reduced maintenance, the equipment will in time experience increased operational downtime. This is a cost that could have been avoided if the parts cost had been properly allocated in the first place.
So much for free parts.
While all that is happening, a problem also develops in the storeroom.
As mentioned above, when the “free” parts are used, they will be replaced with parts purchased at full value. This will result in an increase in the reported value of the inventory – even though there are no more inventory items than there were previously.
This apparent increase in working capital commitments gets the attention of the same accountants who thought it a good idea to put zero-cost parts in the storeroom in the first place. Keen to manage the working capital, pressure is then put on the manager responsible for the storeroom value whose only choice may be to delay reordering of parts or reduce the quantity held.
So much for free parts.
Unfortunately, the consequences of our actions are not always immediately obvious. So while it may seem like the right decision at the time, there can be a high cost for those “free” parts. NP