Capital Assets Guidelines: Definitions, Classification, and Capitalization Thresholds, Lecture notes of Accounting

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FIXED ASSET

GUIDE

For Financial Reporting

Purposes

CAFR Group, State Auditor’s

Office—June 24, 2008

Objective

To assist with the accounting for and reporting of the State's assets including new building construction and improvements in conformity with Generally Accepted Accounting Principles and in principal with Governmental Accounting Standards Board Statement 34.

Policy

Governmental Accounting Standards Board (GASB) Statement 34 requires that all capital assets be reported in the government‐wide balance sheet net of accumulated depreciation if applicable.

Each agency is responsible for reporting accurate, complete, and timely capital asset information to the State Auditor’s Office (SAO) annually.

The CAFR Group of SAO is responsible for compiling the capital asset information from agencies for inclusion in the State's Comprehensive Annual Financial Report.

Capital Asset Definitions and Guidelines

Capital assets are tangible and intangible assets acquired for use in operations that will benefit more than a single fiscal period. Typical examples are land, improvements to land, easements, water rights, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and various intangible assets. (Land associated with infrastructure should be reported as land rather than as part of the cost of the related infrastructure asset).

A capitalized asset is a capital asset that has a value equal to or greater than the capitalization threshold established for that asset type. Capitalized assets are reported for financial reporting purposes.

Capital Asset Classification

The State has invested in a wide variety of capital assets used in State operations. These assets are broadly classified as follows:

 Land/Land Improvements/Easements  Buildings/Building Improvements  Leasehold Improvements  Equipment  Other Tangible and Intangible Assets  Infrastructure  Assets Under Construction  Capital Leases  Works of Art/Historical Treasures

Capital Asset Donations :

GASB Statement No. 33, Accounting and Financial Reporting for Non‐Exchange Transaction s, defines a donation as a voluntary non‐exchange transaction entered into willingly by two or more parties. Both parties may be governments, such as the Federal Government, another state, a county or municipality, or one party may be a nongovernmental entity, including an individual.

PLEASE NOTE: A voluntary contribution of resources between State agencies is not a donation. The timing of recognition of the asset and related revenue is outlined as follows:

When an asset has been received and the eligibility requirements to receive the asset have been met, capital assets are debited and revenue is credited in the fund financial statements of an enterprise fund and the government wide financial statements for a governmental fund.

When an asset has been received but the eligibility requirements to receive the asset have not been met, capital assets are debited and deferred revenue is credited in the fund financial statements of an enterprise fund and the government wide financial statements for a governmental fund.

Appraisal of Assets (Gifts and Donations)

Donated property must be recorded at its estimated fair market value on the date of acquisition, using a reasonable market study.

The method used to appraise the value computed for gifts and donations should be based on a reasonable assessment. This method must be fully documented and maintained on file to support the value.

Capital Asset Categories

Land

Land is defined as the surface or crust of the earth, which may be used to support structures or grow crops, grass, shrubs, and trees. Land is characterized as having an inexhaustible life. All expenditures made to acquire land and to ready it for its intended use should be considered as part of the land cost

Examples of expenditures to be capitalized as land:  Purchase price or, if donated, fair market value at time of donation  Commissions  Professional fees (title searches, architect, legal, engineering, appraisal, surveying, environmental assessments, etc.)  Permanent landscaping such as land clearing, excavation, fill, grading, drainage (includes movement of earth in preparation for water impoundment)  Demolition of existing buildings and improvements (less salvage)  Removal, relocation, or reconstruction of property of others on the land so that the land may be used differently (railroad, telephone and power lines)  Interest on mortgages accrued at date of purchase  Accrued and unpaid taxes at date of purchase  Other costs incurred in acquiring the land

 Water wells (includes initial cost for drilling, the pump and its casing)  Right‐of‐way.

Land Improvements

Land improvements are defined as attachments to the land that have limited lives and therefore are recorded separately and are depreciable.

Examples of expenditures to be capitalized as land improvements:  Fencing and gates  Landscaping of temporary nature  Parking lots/driveways/parking barriers/roadway  Outside sprinkler systems  Recreation areas & athletic fields (including bleachers)  Golf course  Paths and trails  Septic systems  Swimming pools, tennis courts  Fountains  Plazas, pavilions  Retaining walls  Lighting systems  Water impoundment structures or attachments (dam, liner, other water control structures)

Buildings and Building Improvements

A building is defined as a structure that is permanently attached to the land, has a roof, is partially or completely enclosed by walls, and is not intended to be mobile.

Building improvements are defined as capital events that increase the value of a building, materially extend the useful life of a building, or both. A building improvement should be capitalized as a sub‐asset of the building and recorded as an addition of value to the existing building if the expenditure for the improvement is at the capitalization threshold and the expenditure increases the life or value of the building by 25 percent of the original life period or cost.

Examples of expenditures to be capitalized as buildings PURCHASED BUILDINGS

 Original purchase price  Expenses for remodeling, reconditioning or altering a purchased building to make it ready to use for the purpose for which it was acquired  Environmental compliance (i.e., asbestos abatement)  Professional fees (sales commission, legal, architect, inspection, appraisal, title search, etc.).  Payment of unpaid or accrued taxes on the building at the date of purchase

 Other costs associated with the above improvements

Building Maintenance Expense:

Maintenance costs allow an asset to continue to be used during its originally established useful life. Maintenance costs are expensed in the period incurred.

The following are examples of expenditures not to be capitalized as building improvements. Instead, these items should be recorded as repair and maintenance expense:

 Adding, removing and/or moving of walls relating to renovation projects that are not considered major rehabilitation projects and do not increase the value of the building  Improvement projects of minimal or no added life expectancy and/or value to the building  Plumbing or electrical repairs  Cleaning, pest extermination, or other periodic maintenance  Interior decoration, such as draperies, blinds, curtain rods, wallpaper  Exterior decoration, such as detachable awnings, uncovered porches, decorative fences, etc.  Maintenance‐type interior renovation, such as repainting, touch‐up plastering, replacement of carpet, tile, or panel sections; sink and fixture refinishing, etc.  Maintenance‐type exterior renovation such as repainting, replacement of deteriorated siding, roof, or masonry sections  Replacement of a part or component of a building with a new part of the same type and performance capabilities, such as replacement of an old boiler with a new one of the same type and performance capabilities  Any other maintenance‐related expenditure which does not increase the value of the building.

Repairs (Ordinary and Major):

Repairs maintain the asset in its original operating condition. Ordinary repairs are expenditures made to maintain plant assets in operating condition. Preventive maintenance, normal periodic repairs, replacement of parts, structural components, and other activities such as repainting, equipment adjustments, that are needed to maintain the asset so that it continues to provide normal services should not be capitalized but rather charged to an expense account. Ordinary repairs should be expensed. Examples of ordinary repairs include:  roof and/or flashing repairs  window repairs and glass replacement  tuck‐pointing  painting  masonry repairs  floor repairs Major repairs are relatively large expenditures that benefit more than one operating cycle or period. If a major repair, e.g., an overhaul, occurs that benefits several periods and/or extends the useful life of the asset, then the cost of the repair should be handled as an addition, improvement, or replacement, depending upon the type of repair made. Examples of major repairs include:

 roof replacement  window replacement  repairs to bring up to code (including ADA)

In some instances, implementation of this policy may be difficult due to the unique nature of the acquisition. In these cases, professional judgment should be exercised in determining whether the efforts outweigh the benefits derived from applying capitalization criteria.

Improvements and Replacements: The distinguishing feature between an improvement and a replacement is that an improvement is the substitution of a better asset ‐‐ having superior performance capabilities ‐‐ (e.g., a concrete floor for a wooden floor) for the one currently used, whereas a replacement is the substitution of a similar asset (a wooden floor for a wooden floor).

In both of these instances, agencies should determine whether the expenditure increases the future service potential of the asset, or merely maintains the existing level of service. When the future service level has been increased, the new cost is capitalized.

Additions and Improvements: For additions and improvements reported in the governmental or proprietary funds, the carrying amount of the old assets and associated accumulated depreciation, if applicable, should be removed from the accounting records, if the amount is known. The cost of the new asset should be capitalized. If the original cost and accumulated depreciation are not known, capitalize the additional cost.

Equipment

Equipment is defined as fixed or movable tangible assets to be used for operations. Improvements or additions to existing equipment that constitute a capital outlay or increase the value or life of the asset by 25 percent of the original cost or life should be capitalized and recorded as sub‐asset of the existing asset.

Examples of expenditures to be capitalized as equipment include:

 Original contract or invoice price  Freight charges  Import duties  Handling and storage charges  In‐transit insurance charges  Sales, use, and other taxes imposed on the acquisition  Installation charges  Charges for testing and preparation for use  Costs of reconditioning used items when purchased  Parts and labor associated with the construction of equipment

Note: If incidental items, such as extended warranties or maintenance agreements, are included with the capital asset upon receipt and are not listed as a line item on the purchase order or on the invoice, then the incidental charges are considered a part of the capital asset.

Infrastructure ‐ Long lived capital assets that normally are stationary in nature and normally can be preserved for a significantly greater number of years than most capital assets. Those assets with a cost greater than $1,500,000 must be reported to the CAFR Group.

Examples of expenditures to be capitalized as equipment include:

 Highway and rest areas  Roads, streets, curbs, gutters, sidewalks, fire hydrants  Bridges, railroads, trestles  Canals, waterways, wharf, docks, sea walls, bulkheads, boardwalks  Dam, drainage facility  Radio or television transmitting tower  Electric, water, and gas (main lines and distribution lines, tunnels, etc.)  Fiber optic and telephone distribution systems (between buildings)  Light system (traffic, outdoor, street, etc.)  Signage  Airport runway, strip, taxiway or apron

Modified Approach vs. Depreciation

The Modified Approach is an alternative to reporting depreciation for infrastructure assets that meet the following criteria:

 Assets are managed using a qualifying asset management system, and  Documentation shows that the assets are being preserved at or above a condition level established by the government.

Depreciation is not reported for infrastructure assets reported using the modified approach. Only infrastructure assets that comprise a network or subsystem of a network can be reported using the modified approach. The state highway system (excluding bridges), administered by WYDOT, is the only network reported by the state using the modified approach.

Capital Leases:

Capital leases transfer virtually all rewards and risks that accompany ownership of property to the lessee. A capital lease is a means of financing property acquisitions and has the same economic impact as a purchase made on an installment plan. Thus, the lessee in a capital lease must record the leased property as an asset and the lease obligation as a liability.

A lease agreement entered into by a State agency is a capital lease and should be capitalized only if the lease agreement meets one of the following criteria:

 The lease transfers ownership of the property to the lessee by the end of the lease term.  The lease contains a bargain purchase option.  The lease term is equal to 75 percent or more of the estimated economic life of the leased property.  The present value of the minimum lease payments at the inception of the lease, excluding administrative costs, equals at least 90 percent of the fair value of the leased property.

Leases that do not meet any of the proceeding criteria should be recorded as an operating lease and reported in the notes of the financial statements.

Asset under Construction:

Asset under construction reflects the economic construction activity status of buildings and other structures, infrastructure (highways, energy distribution systems, pipelines, etc.), additions, alterations, reconstruction, installation, and maintenance and repairs which are substantially incomplete.

Because an asset under construction is not complete or being used, depreciation shall not be recorded. The asset under construction should be capitalized to its appropriate capital asset category upon the earlier occurrence of substantial completion, occupancy, or when the asset is placed into service

Intangible Assets: Governments possess many different types of assets that may be considered intangible assets, including easements, water rights, timber rights, patents, trademarks, and computer software. Intangible assets, and more specifically easements, are referred to in the description of capital assets in

Miscellaneous Asset Issues

Software Licenses and Maintenance Agreements related to software licenses:

Maintenance agreements associated with technology hardware or software cannot be depreciated. Rather, such agreements are expensed over the period of benefit, and if paid upfront they are recorded as prepaid assets and amortized over the period of benefit, generally one or two years, as called for in the agreement. These software licenses and maintenance agreements are deemed to be a type of “operating lease.” The agreements generally do not confer any ownership rights nor does the State acquire any asset at the end of the agreement period. The State is simply obtaining a “right” to use the software and possibly receive any upgrades made to the software over time.