Department of State Treasurer Policy Manual for Local Governments Revision Issued: August 2014
Table of Contents Executive Summary... 1 Part I Introduction... 3 A Purpose and Applicability... 3 B. Functions of the Capital Asset Accounting System... 3 Part II Classification and Recording... 5 A Classification... 5 1. Land... 5 2. Improvements Other Than Buildings... 5 3. Infrastructure... 5 4. Buildings... 5 5. Equipment... 5 6. Vehicles... 6 7. Construction in Progress... 6 8. Intangible Assets... 6 9. Works of Art and Historical Treasures... 7 B. Recording Capital Assets... 7 1. Capitalization Threshold Definition... 7 2. Capitalization Threshold Considerations... 7 a. Land... 8 b. Improvements Other Than Buildings... 8 c. Buildings... 8 d. Infrastructure... 8 e. Assets Acquired with Restricted Funds... 8 f. Small Items... 8 g. Equipment and Vehicles... 9 h. Construction in Progress... 9 i. Donated Assets... 9 j. Intangible Assets... 9 k. Internally Generated Intangible Assets... 9 3. Changing Capitalization Threshold... 9 4. Valuation of Capital Assets... 10 LGC Page i of iv. Revision Issued: August 2014
Table of Contents a. Cost... 10 b. Estimated Historical Cost... 11 c. Capitalization of Interest Cost... 11 d. Self-constructed Assets... 12 C. Internally Generated Computer Software... 12 D. Water Rights... 13 E. Right-of-Way Easements... 14 F. Annual Initial Inventory of Assets... 14 Part III Accounting for Capital Assets... 15 A. Introduction... 15 B. Acquisition of Capital Assets... 15 1. Installment Purchases... 15 2. Leases... 15 a. Operating Leases... 16 b. Capital Leases... 16 C. Acquisition with Federal Financial Assistance... 17 D. Disposals of Captial Assets... 19 1. Competitive Sale... 20 a. Advertisement for Sealed Bids (G.S. 160A -268)... 20 b. Negotiated Offer, Advertisement, and Upset Bids... 20 c. Public Auction... 21 2. Private Negotiation and Sale... 21 3. Exchange... 22 E. Impairment of Capital Assets... 22 Part IV Internal Control and Financial Reporting... 25 A. Introduction... 25 B. Internal Control Over Capital Assets... 25 C. Financial Reporting Considerations... 26 Part V Depreciation and Amortization... 29 A. Introduction... 29 1. Governmental Funds... 29 2. Proprietary Funds... 29 LGC Page ii of iv. Revision Issued: August 2014
Table of Contents B. Depreciation and Amortization Considerations... 30 1. Estimated Useful Life... 31 2. Expected Salvage Value... 31 C. Reporting Depreciation... 31 D. Amortization of Intangible Assets... 31 E. Selection of a Depreciation Method... 32 F. Straight-line Depreciation... 33 1. Computation... 33 2. Illustration... 33 G. Composite Depreciation... 33 Part VI Suggested Reading... 35 LGC Page iii of iv. Revision Issued: August 2014
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Executive Summary GASB Statement No. 34 defines capital assets as land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period. Capital assets and related depreciation expense are presented on the government-wide statements and are recorded in the accounts of proprietary funds, but are not recorded in the accounts of the governmental funds. Article V, Section 2(1) of the Constitution of the State of North Carolina requires funds generated by taxation to be spent only for public purposes. Local governments and public authorities are required by G.S. 159-26(b)(8) to maintain a ledger in which to record the details relating to the general capital assets of the unit or public authority. The establishment of the procedures and controls over capital assets are necessary to ensure that this constitutional provision, as well as laws and regulations, relating to the expenditure of public funds and the use of public property are being followed. A capital assets control system is important because it provides for effective property management and the safeguarding of a large public investment. The capital asset system needs to provide information not only for accounting and financial reporting but also for budgeting, for asset replacement and maintenance, and for insurance. It also can assist in making management decisions and prevent misstatements in the financial statements. To avoid recording assets for financial statement presentation with immaterial values, local governments should set minimum unit values, known as capitalization thresholds, below which an asset is not recorded in the capital assets records. The dollar amount set is a policy decision of the governing board. Each capital asset should be assigned a control number and all equipment tagged regardless of its cost. The existence, location and condition of all capital assets should be verified by taking an annual inventory. Capital assets should be accounted for at cost or estimated historical cost if actual cost is not available. Estimated costs can be calculated by using price deflator tables to discount replacement costs. Donated capital assets should be recorded at their estimated fair market value when received. Capital assets may be acquired with cash or through leases or other financing arrangements such as bonds, notes, and installment purchases. Regardless of the method of acquisition, when a local government obtains most of the benefits and risks of ownership of a property, the property must be recorded as a capital asset. GASB Statement No. 62 codifies the definition of a capital lease. A capital lease exists if at the inception of the lease it transfers ownership to the governmental unit by the end of the lease term, or it contains a bargain purchase option, or the lease term is 75% or more of the estimated economic life of the asset, or the present value of the minimum lease payments is at least 90% of the fair value of the property. With leases involving land, a lease must fulfill one of the first two above to be accounted for as a capital lease. For capital leases, a unit should record a capital asset and the related obligation. Unlike a capital lease, an operating lease does not transfer the benefits and risks of ownership to the local governmental unit. LGC Page 1 of 36 Pages. Revision Issued: August 2014
Executive Summary Under the North Carolina Constitution, a local government is generally required to dispose of property at its fair market value. However, in certain cases a conveyance with the receiving party (usually another government or nonprofit organization) to put the property to some public use constitutes sufficient consideration for the conveyance. Subject to certain limitations, a local government may dispose of real or personal property belonging to it by: 1) competitive sale; 2) private negotiation and sale; or 3) exchange. Before a department in a governmental unit disposes of any real or personal property, notice should be circulated to other departments that the property is considered surplus. Office of Management and Budget Circular A-102 sets out the requirements for the use and disposal of capital assets acquired with federal financial assistance. Depreciation expense should be recorded in the statement of activities, the accounts of proprietary funds and some fiduciary funds. Capital assets, net of accumulated depreciation, should be recorded on the statement of net position. Depreciation expense should not be recorded in the governmental fund statements. The objective of depreciation is to charge each accounting period for the estimated loss in economic value of the depreciable assets used during the period. Theoretically, a depreciation method should be selected that achieves the most realistic reflection of the loss in economic value of the asset. The most commonly used depreciation method is straight-line depreciation which provides a uniform rate of depreciation per period. Other depreciation methods available to units of local government include accelerated depreciation methods and composite depreciation, but these are rarely used. The recording of an impairment of capital assets is required by GASB Statement No. 42 for all long-lived assets when a decline in service utility of the capital asset is substantial and the event or change in circumstances is not part of the normal life cycle of the capital asset. LGC Page 2 of 36 Pages. Revision Issued: August 2014
Part I Introduction A. Purpose and Applicability Article V, Section 2(1) of the North Carolina State Constitution requires funds generated by taxation to be spent only for public purposes. The establishment of the procedures and controls over capital assets are necessary to ensure that this constitutional provision, as well as laws and regulations, relating to the expenditure of public funds and the use of public property are being followed. GASB Statement No. 34 at paragraph 19 defines capital assets to include land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period. Items of insignificant value, while they may meet the above criteria, are normally recorded as expenditures or expenses for financial reporting purposes instead of as capital assets. Local governments and public authorities are required by G.S. 159-26(b)(8) to maintain "a ledger in which to record the details relating to the general capital assets of the unit or public authority." Generally accepted accounting principles ( GAAP ) as specified in Governmental Accounting Standards Board ( GASB ) Statement 34 Basic Financial Statements and Management's Discussion and Analysis for State and Local Governments establish the primary reporting requirements for capital assets. Adequate capital asset records are necessary for the local government's auditor to render an unmodified opinion on the unit s financial statements. Governmental units having an unmodified opinion on their statements are viewed favorably by bond rating agencies and normally pay lower interest rates on their bonds. To meet GAAP and GASB 34 requirements, governmental units should record the capital assets at cost when historical records are available and at an estimated historical cost when no historical records exist. The LGC will not authorize the issuance of long-term debt for any units having a capital assets opinion modification. Capital assets information also is required for the unit s Comprehensive Annual Financial Report to qualify for the Government Finance Officers Association's Certificate of Achievement for Excellence in Financial Reporting. For most local governments and public authorities in North Carolina, meeting GASB 34 requirements involves extensive year-end adjusting entries to convert governmental funds from modified accrual to full accrual basis of accounting. Recording capital asset information throughout the year and using appropriate capital asset software makes the year-end conversion process much easier and may reduce audit cost. B. Functions of the Capital Asset Accounting System Establishing and maintaining complete and accurate accounting records for capital assets is important for several reasons. First, the value of capital assets for most governmental units and public authorities is significant. Therefore, adequate accounting procedures, internal controls and asset records are essential for effective property management LGC Page 3 of 36 Pages. Revision Issued: August 2014
including insurance and risk management. The capital assets records should provide adequate, detailed documentation of each asset capitalized including its description, serial number, location, cost, date acquired, vendor, depreciation, and other information. This information is necessary to determine the amount of property insurance required and to adequately document a claim in the event of damage or loss from an insurable event. The stewardship responsibility involved in safeguarding such a large public investment is of the utmost importance to sound financial administration. Adequate capital assets records can assist in making management decisions. Proper use of these records may prevent unneeded assets from being acquired. When budgeting for and preparing routine preventative maintenance and replacement schedules management may use these records to determine whether maintenance costs are too high for particular assets. Capital assets records also could be used to help clarify long-term capital budgeting needs. Finally, accurate and complete capital assets records can prevent the possible misstatement of a local government's financial statements. Otherwise, assets such as those acquired under capital leases and joint ventures could be overlooked or improperly reported. LGC Page 4 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording A. Classification Capital assets owned by the governmental unit and public authority should be recorded in the accounting records using the following general account classifications. Depreciable capital assets should be recorded separately from nondepreciable capital assets. More detailed, sub-classifications may be added as needed. The level of detail necessary at the ledger level should be sufficient to provide management adequate financial information but no more complex than necessary. Detail information for the individual assets should be available from the capital asset subsystems. 1. Land The land account includes the acquisition value of land and the rights to land owned by the governmental unit. It includes all land held in fee simple and all rights to land that have no termination date. 2. Improvements Other Than Buildings Improvements other than buildings reflect the acquisition value of permanent improvements (other than buildings) that add value to the land or improve the use of the land. Examples of such improvements are fences, retaining walls, drainage systems, sidewalks, parking lots, and driveways. Note that when used with capital assets, the terms improvement and betterment have different meanings. Improvements are capital assets permanently attached to land. Betterments are additions to or changes in existing depreciable assets intended to increase their efficiency or prolong their useful lives. 3. Infrastructure Infrastructure assets are defined by GASB Statement No. 34, paragraph 19, as longlived capital assets that normally are stationary in nature and normally can be preserved for a significantly greater number of years than most capital assets. Examples of infrastructure assets include roads, bridges, tunnels, drainage systems, water and sewer systems, dams, and lighting systems. Buildings, except those that are an ancillary part of a network of infrastructure assets, should not be considered infrastructure assets. 4. Buildings A capital assets account that reflects the acquisition value of permanent structures owned by the governmental unit and used to house persons and property. Permanently installed fixtures to or within these structures are considered parts of the structures. The costs of major improvements to structures are included in this account. 5. Equipment A capital assets account that reflects the value of tangible property not permanently affixed to real property and used in carrying out the operations of the governmental unit. Examples of equipment are machinery, furniture, and vehicles. Most local units include their computers in this category. LGC Page 5 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording 6. Vehicles A capital assets account that records the value of motor vehicles owned by the local government. 7. Construction in Progress A capital assets account used when a government reports amounts expended on an uncompleted building or other capital asset construction project. These subclasses such as buildings, improvements, and equipment might be used. When the project is complete and placed in service, the cumulative costs are transferred to the appropriate capital assets accounts. Depreciation expense is not recorded on the assets in this category. 8. Intangible Assets Intangible assets include assets such as easements, water rights, timber rights, patents, trademarks, and computer software. Paragraph 19 of GASB Statement No. 34, Basic Financial Statements-and Management s Discussion and Analysis-for State and Local Governments, states capital assets include intangible assets that are used in operations and have initial useful lives that extend beyond a single reporting period. Paragraph 21 of GASB Statement No. 34 explains that capital assets should be depreciated or amortized over their estimated useful lives and those inexhaustible capital assets such as land and land improvements should not be depreciated nor amortized. Paragraph 2 of GASB Statement No. 51 amends GASB Statement No. 34 and defines an intangible asset as possessing all of the following characteristics: Lack of physical substance. An asset may be contained in or on an item with physical substance, for example, a compact disc in the case of computer software. An asset also may be closely associated with another item that has physical substance, for example, the underlying land in the case of a right-of-way easement. These modes of containment and associated items should not be considered when determining whether or not an asset lacks physical substance. Nonfinancial nature. An asset with a nonfinancial nature is one that is not in a monetary form similar to cash and investment securities, and it represents neither a claim or right to assets in a monetary form similar to receivables, nor a prepayment for goods or services. Initial useful life extending beyond a single reporting period. Intangible assets that meet at least one of the following exemptions are excluded from the provisions of GASB Statement No. 51: Assets acquired or created primarily for the purpose of directly obtaining income or profit, Assets resulting from capital lease transactions reported by lessees, or Goodwill created through the combination of a government and another entity. (Paragraph 3, GASB Statement No. 51). LGC Page 6 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording Identifiable intangible assets that meet the above characteristics and are not exempt should be classified as capital assets and recognized as such on the financial statements. As capital assets, intangibles are subject to all existing guidance regarding capital assets. It is important to remember that they are reported as expenditures in the fund statements of governmental funds and not as assets. Intangible assets are identifiable when either of the following conditions is met: The asset is capable of being separated or divided from the government and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, asset, or liability, or The asset arises from contractual or other legal rights. 9. Works of Art and Historical Treasures Works of art, historical treasures and similar collections should be capitalized at their historical cost or estimated fair value at the date of donation. For a full discussion of accounting for and reporting works of art and historical treasures, see GASB Statement No. 34, paragraphs 27 29. B. Recording Capital Assets Governmental units may acquire capital assets by several methods. Possible acquisition methods include purchase, capital lease, installment purchase, construction, eminent domain, tax foreclosures, and gifts. Regardless of the method of acquisition, capital assets should be properly recorded on the unit s books and in subsidiary records that provide detailed information on each asset. 1. Capitalization Threshold Definition To avoid recording many assets with low values that do not, in the aggregate, amount to a material portion of the value of the capital assets, units should establish minimum asset values or a capitalization threshold below which the item is not capitalized for external financial reporting. However, adequate control must be maintained over all assets, not just high value assets. Internal control, insurance and security concerns, as well as legal compliance considerations, may require establishment of additional procedures for certain items that do not otherwise meet the capitalization threshold. Examples of such items include laptop computers and tablets, cell phones, assets acquired with restricted funds, and firearms. The internal control procedures for the capital assets not meeting the capitalization threshold should be designed to focus on the particular control issues related to these assets. The Government Finance Officers Association ( GFOA ) has issued Best Practice papers titled "Establishing Capitalization Thresholds for Capital Assets" and Maintaining Control Over Items That Are Not Capitalized that are available at their website, www.gfoa.org. 2. Capitalization Threshold Considerations To determine the capitalization threshold, the unit must identify the dollar amount that identifies an asset is of significant value for financial reporting. This is a policy decision for the governing board of the local government or public authority. Assets that equal or exceed the threshold value are capitalized; assets below that amount are LGC Page 7 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording recorded as expenditures or expenses. Local governments should establish a capitalization threshold level that reflects their financial conditions and may find it useful to establish different threshold values for different classes of capital assets. Generally, smaller units of government will use a lower dollar amount as a threshold for capitalizing assets than larger units. Generally, groups of items not individually meeting the capitalization threshold would not be capitalized. However, caution must be exercised in the application of the guidance to avoid a significant class of capital assets being understated. In its Comprehensive Implementation Guide ( CIG ), GASB recommends an appropriate balance between ensuring that all material capital assets, collectively, are capitalized and minimizing the cost of record keeping for capital assets. Some suggested capitalization thresholds and considerations follow. These amounts are optional and units of government may establish different thresholds. a. Land All land as well as easements and other permanent rights to land should be capitalized without regard to their value. b. Improvements Other Than Buildings A capitalization of $5,000 or more may be appropriate for improvements other than buildings. c. Buildings A capitalization of $5,000 or more may be appropriate for buildings, additions and betterments. All buildings should be recorded at acquisition cost which usually is well above the threshold. If a building is below the threshold, it should be expensed in the year of acquisition. Additions and betterments costing more than the capitalization threshold should be recorded as capital assets. d. Infrastructure A capitalization of $5,000 or more may be appropriate for infrastructure. e. Assets Acquired with Restricted Funds Assets costing less than the capitalization threshold for the class of property acquired with grant funds, with funds from bonded debt issuances or installment purchases, or with funds from other restricted sources should be capitalized in compliance with the grant contract, bond indenture or other agreement. In all instances, assets acquired with these funds should be specifically identified in the asset records to assure that these assets are used in compliance with all restrictions in the grant contract, bond indenture or other agreement. If necessary the assets may be recorded at $1 or other nominal amount to maintain the asset accounting record and assure proper internal control. f. Small Items Equipment costing less than $5,000 that the governmental unit desires to control may be capitalized at $1.00 for each separate asset record. (Examples: calculators, cell phones, computers and tablets, computer software, etc.) LGC Page 8 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording g. Equipment and Vehicles Equipment and vehicles costing $5,000 or more should be recorded as capital assets. Additions costing $2,500 or more to equipment and vehicles should be recorded as capital assets. Equipment and vehicles costing less than the above should not be recorded unless they meet the criteria for small items. h. Construction in Progress Construction in progress should be recorded at acquisition cost without regard to significant value. i. Donated Assets Since there is no cost for donated assets, the determination of whether to capitalize donated assets would be based on their fair market value at the time of acquisition plus additional charges related to the asset. j. Intangible Assets All intangible assets as well as easements and other permanent rights to land should be capitalized without regard to their value. k. Internally Generated Intangible Assets Intangible assets that are created or produced by the government or an entity contracted by the government would be considered internally generated. Assets acquired from a third party, but require more than minimal incremental efforts on the part of the government to begin achieving their expected level of service capacity, also are considered internally generated. Outlays that are incurred in the generation of internally generated intangible assets should be expensed until certain criteria are met. GASB Statement No. 51 paragraph 8, states that all three of the following requirements must occur before capitalization begins. Determination of the specific objective of the project and the nature of the service capacity that is expected to be provided by the intangible asset upon the completion of the project, Demonstration of the technical or technological feasibility for completing the project so the intangible asset will provide its expected service capacity, and Demonstration of the current intention, ability, and presence of effort to complete or, in the case of multiyear project, continued development of the intangible asset. 3. Changing Capitalization Threshold When a government decides to increase its threshold for capitalization, the new threshold is applied prospectively. Assets that have been capitalized under the preceding lower capitalization threshold are not removed from the capital asset records. GASB addressed the question of whether or not a restatement of beginning net position is required for a change in the capitalization threshold in the CIG, 7.22.17 (As amended for adoption of GASB 62). It concluded that no restatement of beginning assets is required indicating (u)se of a capitalization threshold is an application of accounting policy, and any change in capitalization threshold should appropriately LGC Page 9 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording ensure that all significant capital assets, collectively, are capitalized while considering the cost of record keeping for capital assets. 4. Valuation of Capital Assets Capital assets should be accounted for at cost or, if the cost is not practicably determinable, at estimated historical cost. Donated capital assets should be recorded at their estimated fair market value when received. a. Cost The cost of a capital asset includes the purchase price or construction cost and ancillary charges necessary to acquire the asset or to place it in the intended location and condition for use. Ancillary charges should be directly attributable to acquisition of the specific asset and include costs such as transportation charges, site preparation, professional fees including engineering and legal fees, and certain interest costs during construction. For equipment, the costs of any testing also should be capitalized. The costs of engineering studies on the feasibility of a project are sometimes properly expensed rather than capitalized at the time they are incurred if a decision on whether assets will be constructed has not been made. If these studies eventually lead to the acquisition or construction of assets, the unit should capitalize these costs if significant as part of a project. For example, engineering costs for the expansion of a water and sewer system may be expensed if there is no definite project. If the decision is made later to go through with the project, these costs should be capitalized and the expensed amount reversed. (1) Land When land is purchased, the costs includes the purchase price; legal fees including attorney s fees, closing cost and recording fees; filling, grading and excavation cost; and other costs directly related to the acquisition of the land and its preparation for use. Rights of way and easements are recorded at purchase cost plus legal costs. Removal cost for assets removed from the land increase the cost of the land; the net proceeds from the salvaging of any assets removed from the land reduce the cost, i.e. amounts received from the sale of the components of an existing building on the land. (2) Buildings, Improvements Other Than Buildings, and Construction in Progress If purchased or constructed, the valuation includes such costs as the purchase price, acquisition legal fees, permits, construction costs, and other professional fees related to design or construction. (3) Infrastructure If purchased or constructed, the valuation includes such costs as the purchase price, acquisition legal fees, and other professional fees related to design or construction. (4) Equipment The basis of valuation of purchased equipment includes the net contract price; transportation charges including insurance while in transit; the cost of assembly and installation of special devices or foundations; testing and calibration costs; and cost of other preparations required to ready the asset for its intended use. LGC Page 10 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording (5) Donated Assets For assets acquired by a gift, the valuation recorded should be the fair market value based on the appraised value at the time of acquisition plus ancillary charges, if any. b. Estimated Historical Cost Appropriate capital asset accounting records are essential for the fair presentation of financial statements prepared in accordance with GASB Statement 34. Prior standards and practices placed less emphasis on the capital assets as a whole, owned by the local government or public authority. Some units may find that their capital asset records are lacking in detail and completeness. In such situations, the original purchase documentation may not be available, or an inordinate expenditure of resources may be required to establish original asset costs precisely. Therefore, it may be necessary to estimate the original asset cost of such assets on the basis of documentary evidence available, including price levels at the time of acquisition, and to record these estimated costs in the appropriate capital asset accounts. In some units, the cost may not be known; but information and records may be available showing the year of acquisition. In this instance, historical appraisal cost can be used. Historical appraisal cost is defined for this purpose as the current appraised value adjusted to the year of acquisition using the appropriate construction indices, such as the Handy-Whitman Index (a subscription service available to utility companies) or The Engineering News-Record (a weekly technical magazine whose publisher issues a semiannual index upon request). If the exact date of acquisition and cost are not known, but a general time period of the acquisition and cost are known, an average year during the period and a reasonable estimated cost might be used. Information on the approximate time of asset acquisition can be obtained from such sources as building cornerstones and old newspaper clippings. The important concept is to obtain a reasonable estimated cost for use in recording the assets on the books and in establishing accountability. In order to have the auditor render an unmodified opinion, the capital assets values need to be materially correct. If the unit has documentation for assets that were recently acquired, this may represent the bulk of the dollar value of the unit's total capital assets. The depreciated carrying values for older assets should not be a large part of the total capital assets value. Using estimated costs does create some margin of error in the capital assets accounting records as compared to the proper recording at acquisition. However, such errors should be immaterial and will diminish over time as assets are retired and replaced, and estimated costs are replaced with actual costs. c. Capitalization of Interest Cost The cost of acquiring an asset in an enterprise fund includes the interest cost incurred during the period of construction as a result of outlays for the assets. GASB Statement No. 62 in paragraphs 5 22 discusses the capitalization of interest costs. Interest should be capitalized for qualifying assets, primarily assets constructed for the government s own use and should not be capitalized for inventories, assets acquired with gifts or grants restricted to the acquisition of the assets and certain other assets. The portion of interest cost incurred during LGC Page 11 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording construction that could have been avoided if the outlays had not been made is the amount that should be capitalized. d. Self-constructed assets At times a local government or public authority may construct an asset using its own staff. In this circumstance, the unit must identify the cost of the selfconstructed asset. Since there is no external transaction to provide the exchange price, this is more difficult than for a purchased asset and requires more detailed recordkeeping. Generally, the direct costs of materials and labor are easily captured. The difficulty is determining the amount of indirect cost associated with the construction. One approach is to include only those additional costs excluding any general or administrative expenses which are never capitalized that are incurred because of the decision to self-construct the asset, i.e. the incremental costs. Since depreciation and supervisor s salaries would be incurred if the asset was not selfconstructed, they are excluded when using this approach. C. Internally Generated Computer Software GASB Statement No. 51 recognizes computer software as internally generated if it is purchased or licensed by the government and modified with more than minimal incremental effort before putting into service. Websites also are considered in this group of assets, however keep in mind that there is a high hurdle here to exceed before capitalization is required. As with all other internally-generated intangible assets, computer software should be expensed until the requirements to capitalize are met. The requirements for capitalization of computer software are considered to be met when the following occur: The activities noted in the preliminary project stage are completed, and Management implicitly or explicitly authorizes and commits to funding, at least currently in the case of a multiyear project, the software project. Internally generated computer software is grouped into three stages: preliminary project, application development, and post-implementation. Only during the applicationdevelopment stage should outlays incurred be capitalized. Outlays associated with the preliminary and post implementation stages should be expensed as incurred. Preliminary-stage activities include: selecting a vendor, selecting a consultant to assist in development or installation, final selection of alternatives for development, making strategic decisions to allocated resources at a point in time, determining the performance requirements for the project, and determining the existence of needed technology. Training employees involved with the development of internally generated software, if the training does not contribute to putting the software in use, should also be expensed as incurred and not included in the application development stage. Included in the application-development stage are activities such as coding, software configuration, testing, installation to hardware, and data conversion. Tasks considered to be data conversion include purging or cleansing of existing data and reconciliation from the legacy system to the new system. Data conversion should only be included in the LGC Page 12 of 36 Pages. Revision Issued: August 2014
Part II Classification and Recording application development stage to the extent that it is necessary to make software operational. The CIG references a human resource software system as an example of when data conversion is needed for operational purposes. In a human resource system, payroll transactions are dependent on the transfer of information such as direct deposit information and tax deductions in order to pay employees. If the data conversion is deemed unnecessary for operation or more informational than essential, it should be included in the post-implementation stage. The same rule applies for data conversion activities associated with computer software that is not internally generated. Internal modification of existing software to make it able to interface with new software should be capitalized if it increases the functionality, efficiency or extends its useful life. Post-implementation stage activities include software maintenance and application training. Please note maintenance activities that do not improve efficiency, functionality or extend useful life would be considered post-implementation and should be expensed as incurred. The same rules apply for training activities when computer software is not considered internally generated. Outlays from business process reengineering activities that result during the development should not be considered a cost of development, but should be expensed. Commercially available computer software that is purchased or licensed by the government and placed into operation without modification, or requiring minimal incremental effort to modify is not considered internally generated. However, it will still meet the description of an intangible asset in GASB Statement No. 51. For example, a unit of government that acquires computer software through a five year licensing agreement requiring annual payments for the right to use should report the software as an intangible asset and record a long-term liability for the required annual payments. The government should not consider this software as internally generated. If the licensing agreement includes several components each component should be evaluated for capitalization. Similarly, an enterprise resource planning system with multiple modules, including procurement, human resources, and financial reporting, should have each module evaluated individually as to its stage in development. Maintenance agreements result in external modifications of the software that increase its functionality or improve the efficiency of the software should be capitalized as intangibles. Otherwise, maintenance agreements should be expensed. Theoretically the unit should split its maintenance agreement outlays into these two subsets. However, materiality should be considered in this decision the unit may as a matter of policy expense all maintenance agreements that are not specified to increase functionality or improve efficiency (CIG Z.51.23). D. Water Rights Water rights are not excluded from the provisions of GASB Statement No. 51 even if income or profit is generated through the sale of water. Question Z.51.5 in CIG states that water rights used in operations are not themselves directly generating income or profit. Income and profit are indirect results of ownership of the rights, therefore making water rights used in operations of water system an intangible asset. Water rights acquired for the purpose of trading those rights to obtain income are not intangible assets. LGC Page 13 of 36 Pages. Revision Issued: August 2014
E. Right-of-Way Easements Part II Classification and Recording Right-of-way easements are generally considered to be recordable intangible assets. A separate asset for the right-of-way easement should be reported at fair value at the time of acquisition in accordance with GASB Statement 34, paragraph 18. Determining the fair value is a challenge for right of way easements. The fair value of any asset is the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. In the case of right-of-way easements for roads, however, generally the only willing buyer is the government. The fair value can then be estimated to be the outlay the government would have incurred to acquire the easement in an exchange transaction. There also may be other reasonable methods for determining the fair value of a donated right-of-way easement. However, it is not appropriate to arbitrarily assign a nominal value to a donated easement. F. Annual Inventory of Assets The existence and condition of all capital assets should either be verified annually as a part of the year-end closing process or on a cycle basis during the year. If this task is challenging but manageable, then the capitalization threshold is probably appropriate for the local unit. Assets should be identified by the identification tag affixed to the asset, the asset description compared to the capital asset records, and its physical condition assessed. Any unrecorded acquisitions, additions or improvements made since the prior annual inventory should be identified and recorded. Capital asset records should be adjusted for any assets relocated since the prior inventory. Strict control must be maintained during the inventory-taking process to assure that uninventoried items are not moved to areas previously inventoried, or vice versa. LGC Page 14 of 36 Pages. Revision Issued: August 2014
Part III Accounting for Capital Assets A. Introduction Capital assets transactions arise primarily from acquisitions and disposals. These transactions appear first in the expenditure ledger as purchases or in the revenue ledger as revenues from the disposal of capital assets. The minutes of the governing board should be inspected for any transactions not recorded in the expenditure or revenue accounts, e.g., donated assets, assets received from another government entity, or assets not otherwise recorded. After the end of each month, the capital asset transactions for the month should be journalized and recorded. It is vital that capital asset subsidiary records also be maintained and kept up-to-date. It is recommended that the subsidiary records be updated on a monthly basis as well and reconciled to the general ledger. Subsidiary records should also be updated for capital assets transferred between departments at the unit. B. Acquisition of Capital Assets Local governmental units may acquire capital assets with cash or through leases or other financing arrangements such as bonds, notes, and installment purchases. The issuance of debt and the use of obligations similar to debt are allowed for counties, cities and certain other types of local governments but may require approval of the Local Government Commission to issue the debt. Regardless of the format of payment, if the local governmental unit acquires most of the benefits and risks of ownership of an asset, the asset must be recorded as a capital asset of the appropriate fund or in the statement of net position of the local governmental unit. Accordingly, the liability incurred to acquire the property also must be recorded as a liability of the appropriate fund or in the statement of net position of the local governmental unit. 1. Installment Purchases Installment contracts that create a security interest in some or all of the property purchased to secure payment of the purchase price to one advancing moneys or supplying financing for the purchase transaction are known as installment purchases and are authorized by G.S. 160A-20. Installment purchases that involve the construction or repair of fixtures or improvements on real property or that meet the standards set out in G.S. 159-148 require approval by the Local Government Commission. Capital assets purchased by incurring installment obligations must be capitalized. The basis of valuation of a capital asset purchased with an installment sales agreement is the lower of the market value of the capital asset or the net present value of the sales agreement plus the closing costs and the other costs of the purchase. The net present value of the installment sales agreement must be recorded as a long-term obligation in the appropriate fund or in the statement of net position. 2. Leases The standards of financial accounting and reporting for leases by lessees and lessors are set forth in paragraphs 211 271 of GASB Statement No. 62. The paragraphs LGC Page 15 of 36 Pages. Revision Issued: August 2014
Part III Accounting for Capital Assets define a lease an agreement conveying the right to use capital assets (land or other depreciable assets) usually for a stated period of time. This policy manual will only discuss the accounting by lessees, the party receiving the use and possession of the leased property. Capital assets do not always have to be constructed or purchased outright in order to be of benefit to a local government or public authority. Capital assets may be temporarily utilized through a rental agreement, known as an operating lease. In other situations, the utilization of leased capital assets may be such that the unit has in effect purchased the asset by virtue of the length of its use of the asset, or the amount of payments it has made to use the asset. This type of lease is known as a capital lease. a. Operating Leases A lease is an operating lease if it does not transfer the benefits and risks of ownership to the local governmental unit. Operating lease payments are recognized as expenses or expenditures to the local governmental unit when they become payable. The capital assets leased through operating leases are not capitalized; however, they should be inventoried and tagged for control purposes. Even if rental payments are not made on a straight-line basis, the rental expense or expenditure is recognized on a straight-line basis unless another systematic and rational basis is more representative of the pattern in which the benefits flow from the leased property. b. Capital Leases GASB Statement No. 62, paragraph 213, codifies the definition of a capital lease as follows: If at its inception a lease meets one or more of the following four criteria, the lease should be classified as a capital lease by the lessee. Otherwise, it should be classified as an operating lease. a. The lease transfers ownership of the property to the lessee by the end of the lease term. b. The lease contains a bargain purchase option. c. The lease term is equal to 75 percent or more of the estimated economic life of the leased property. However, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion should not be used for purposes of classifying the lease. d. The present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance and maintenance to be paid by the lessor, including any gain thereon, equals or exceeds 90 percent of the excess of the fair value of the leased property to the lessor at the inception of the lease over any related investment tax credit retained by and expected to be realized by the lessor. However, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion should not be used for purposes of classifying the lease. A lessor should compute the present value of the LGC Page 16 of 36 Pages. Revision Issued: August 2014
Part III Accounting for Capital Assets minimum lease payments using the interest rate implicit in the lease. A lessee should compute the present value of the minimum lease payments using its incremental borrowing rate, unless (1) it is practicable to obtain the implicit rate computed by the lessor and (2) the implicit rate computed by the lessor is less than the lessee s incremental borrowing rate. If both of those conditions are met, the lessee should use the implicit rate. The lessee records a capital lease as a capital asset and an obligation at an amount equal to the present value of the minimum lease payments excluding that portion representing certain costs. However, the present value as determined should not exceed the fair value of the leased property. The asset acquired under a capital lease should be amortized as follows: a. When the lease transfers ownership of the property to the lessee by the end of the lease term or contains a bargain purchase option, the asset should be amortized in a manner consistent with the lessee s normal depreciation policy for owned assets. Because ownership is expected to pass to the lessee, the portion of the asset recorded under the capital lease representing land would not be amortized. b. Otherwise, the period of amortization should be the lease term. Lease payments are allocated between a reduction of the obligation and interest expense or expenditure at a constant periodic rate of interest on the obligation. C. Acquisition with Federal Financial Assistance The federal government issued a recompilation OMB Circular A-102 (August 29, 1997), regarding uniform standards governing the utilization and disposal of property furnished by the federal government or acquired in whole or in part with federal funds by nonfederal political subdivisions. These requirements are set out in the common rule to OMB Circular A-102. Specific capital asset management information by federal department or agency may be reviewed through the following websites: www.whitehouse.gov/omb/circulars_a102 for the recompilation of Circular A-102 as amended, and www.whitehouse.gov/omb/grants/chart.html for Codification of the Government-wide Grants Requirements by Department. The capital asset management requirements may be summarized as follows. This summary is qualified by reference to the circular and relevant common rule. 1. Capital assets acquired with federal funds are restricted to the following uses: a. Real property - Unless otherwise provided by federal statutes, real property is to be used for the originally authorized purpose as long as needed for that purpose. Local governments are not to dispose of or encumber its title or other interests. LGC Page 17 of 36 Pages. Revision Issued: August 2014