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June 1999 Volume 1 Issue 2
UD’s Real Estate Assessment Cen- ter (REAC) is requiring all Public Housing Authorities (PHAs) to electronically file financial infor- mation that has been prepared in conformity with Generally Accepted Accounting Principles (GAAP). This is the second in a series of REAC documents called “GAAP Flyers” which are designed to assist PHAs in implementing these new requirements. This Flyer provides guid- ance on accounting for fixed assets and corre- sponding depreciation of those assets under GAAP. It has been prepared for REAC by the accounting firm of PricewaterhouseCoopers LLP.
FORMER HUD AC-
COUNTING
Cost is the basis for fixed assets. Formerly, HUD had preferred that not only costs associated with the actual purchase of capital assets and any major additions in the form of additional con- struction and improve- ments, known as “hard costs,” be capitalized (recorded as assets). Ad- ministrative and other costs that did not add value to the buildings, known as “soft costs”, associated with modern- ization and development, were accumulated into fixed asset accounts and capitalized. After these costs were captured, they remained in this ac- count and were not depreciated. This method of accounting for fixed assets is not in accordance with GAAP.
Under the former rules, the above costs were accumulated in property ledgers and the totals were then posted to the Development account, the Modernization account, or the Fixed Asset account in the general ledger. This means that the detail of the fixed assets is not in the general ledger accounts, but are summarized in the cost
ledgers. It also means that as new assets were added and, in many cases, the old ones were not removed, therefore the PHA effectively ac- counted for the same asset twice.
GAAP METHODOLOGY
HUD now requires that all accounting records, including those for fixed assets, be kept using GAAP accounting. The GAAP basis for the treatment of fixed assets for governmental and enterprise funds comes from NCGA Statement No. 1, Governmental Accounting and Financial Reporting Principles. This Statement says, in part, that fixed assets are recorded at cost in the fund accounts of an enterprise fund or in the General Fixed Asset Account Group (GFAAG), a memorandum group of ac- counts that is not a fund but that is used to account for fixed assets acquired by governmen- tal funds. REAC’s conclusion, as per GAAP Flyer Num- ber 1, is that the enterprise fund method of accounting should be utilized. Under either method, the basis for the fixed assets is cost or, if cost is not practica- bly determined, at esti- mated cost. Donated fixed assets should be recorded at their estimated fair value at the time received.
Determination of Costs to Capitalize
The first difference between GAAP and the former HUD accounting rules is in the determi- nation of those costs that should be capitalized. Under GAAP, only those costs actually relating to the purchase of new assets or the construction or improvement of a project should be capital- ized. These are basically the costs that formerly were referred to as “hard costs” which added value to the building. All other costs associated
ACCOUNTING FOR FIXED
ASSETS
“...the basis for the fixed assets is cost or, if cost is not practicably determined, at estimated cost. Donated fixed assets should be recorded at their estimated fair value at the time received.”
H
with these assets or projects should be expensed. This would also include all routine maintenance and repair.
This means that some costs previously capitalized now will be expensed. These are basically the costs formerly referred to above as “soft costs.” Some examples of soft costs are costs incurred for:
- Security officers
- Relocation costs
- Relocation specialists salaries
- Management improvements
- Mental health liaison
- Rent collection costs
- Emergency maintenance, to the extent that it is in fact re- pairs
When land is purchased for a construction of a building, its cost includes the amount paid for the land plus real estate commissions, escrow and legal fees, fees for examining and insuring the title, and any accrued property taxes paid by the purchaser. The cost of land improvements that pro- duce permanent benefits, such as landscaping, sewer installation, and special assessments by a government body for paying for paving and street lights, may all be included in the land account. Because land and land im- provements provide benefits indefi- nitely and an outside agency replaces and maintains such improvements, de- preciation is inappropriate. Con- versely, the cost of improvements that provide benefits over limited periods, such as fences and parking lots, and those items listed above that are not maintained by an outside agency, should be recorded separately in an improvements account and depreciated.
The cost of buildings should include not only the cost of the structure itself but also the costs of all permanent equipment and fixtures necessary for the intended use of the structure, such as boilers, furnaces, air conditioners, elevators, permanent floor covering, wiring, and lighting fixtures. All of the costs necessary to obtain the building and to get it into condition for its intended use should be included in the cost of the building. Additional costs incidental to the purchase, such as attorneys’ fees and building permits, should be capitalized along with the purchase cost. For enterprise funds, one of these additional costs is interest expense incurred during the construction of the asset.
Capitalization of Interest During Construction
The basic rules for interest capitalization are set forth in Statement of Financial Accounting Standards (SFAS) No. 34, Capitalization of Interest Cost. Under this statement, interest incurred throughout the construction period of a project should be included as part of the cost of the asset under construction rather than reported as an expense of the period. The construc- tion period extends from the initial preconstruction activities (e.g., obtaining necessary permits) until an asset is ready to be placed into service.
The amount of interest to be capitalized is calculated by mul- tiplying the interest rate on the related borrowings (debt in- curred for construction pur- poses) by the weighted average of the expenditures for the pe- riod. For example, assume that the entity borrowed $10,000, at 5 percent and began construc- tion at the beginning of the pe- riod. Also, assume that the weighted average of the entity’s spending for construction throughout the year was $7,000,000. In this example, the capi- talized interest would be $350, ($7,000,000 X 5%).
SFAS No. 34 also requires capitaliza- tion of interest even when the entity did not have specific borrowings for a particular construction project but had other unpaid outstanding debt and used its existing funds for construction instead of repaying the existing debt. In this case, the interest rate used in the calcula- tion would be the weighted average interest rate on the entity’s outstanding debt.
SFAS No. 62, Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants modifies the provisions of SFAS No. 34 for tax-exempt debt that is externally restricted for the acquisition of specified assets. Under SFAS No. 62, the amount of interest to be capitalized is the difference between total interest ex- pense on the total amount borrowed (in this example $10,000,000) and total interest earned on the proceeds of the debt that have been temporarily invested. Using our example above, we would assume that the average investment of bor- rowed funds was $3,000,000 earning 6%. Therefore, the interest capitalized (ignoring the tax effects of rebatable arbi- trage) is illustrated at Exhibit 1 :
“The cost of buildings should include not only the cost of the structure itself but also the costs of all permanent equipment and fixtures necessary for the intended use of the structure, such as boilers, furnaces, air conditioners, elevators, permanent floor covering, wiring, and lighting fixtures.”
As a practical matter, since most assets are fully depreciated when sold or traded-in, there would be no gain or loss to record.
In some instances, an old asset is traded- in on a new asset and the resulting charge to the entity is the difference in value between the new and the old assets (book or recorded value). This is commonly the situation when PHAs purchase a new vehicle to replace an old one. Assume that the entity had a vehicle originally costing $15,000 and had recorded accumulated depreciation of $12,000. The new vehi- cle can be purchased by trading-in the old vehicle and cash in the amount of $18,000. The entry to record this transaction in the enterprise fund is illustrated at Exhibit 4 :
The entry to record this transaction in a governmental fund is illustrated at Exhibit 5 :
The above entries for the enterprise fund would generate a new vehicle with a depreciable basis of $21,000 (Cash in the amount of $18,000 plus the undepre- ciated basis of the old vehicle of $3, ($15,000 -$12,000)).
Account Numbers
The Financial Data Schedule Line Definitions and Crosswalk Guide issued by HUD on December 4, 1998 recommends that the costs for all fixed assets, as discussed above, be recorded into the following accounts and account numbers to facilitate the associated reporting on the Financial Data Schedule:
Exhibit 3: Asset Disposal and Replacement - Governmental Fund Accounting
(GFAAG) DR CR
Accumulated depreciation 35, Investment in general fixed assets 5, Building 40, To remove the old asset
(GFAAG)
Building 70, Investment in general fixed assets 70, To record the new asset
(Capital Projects Fund) Expenditure-capital outly 70, Cash-unrestricted 70, To record paying for the asset
Exhibit 4: Old Asset Traded-in On A New Asset - Enterprise Fund Accounting
DR CR Accumulated depreciation 12, Furniture, equipment and machinery 21, Furniture, equipment and machinery 15, Cash-unrestricted 18, To record trade-in of asset
Exhibit 5: Old Asset Traded-in On A New Asset - Governmental Fund Accounting
(GFAAG) DR CR
Accumulated deprreciation 12, Furniture, equipment and machinery 21, Furniture, equipment and machinery 15, Investment in general fixed assets 18, To record trade-in of asset
(Capital Projects Fund) Expenditure-capital outlay 18, Cash-unrestricted 18, To record paying for the asset
“As a practical matter, since most assets are fully depreciated when sold or traded-in, there would be no gain or loss to record..”
Exhibit 6: HUD Recommended Fixed Asset Accounts
1400.6 Land 1400.7 Buildings 1400.8 Furniture, equipment and machinery – dwellings 1400.9 Furniture, equipment and machinery – administration 1400.10 Leasehold improvements 1400.5 Accumulated depreciation structures and equipment
ASSET CONVERSION
The PHA should currently have detailed records of all of its fixed assets recorded in its fixed asset accounts as formerly required by HUD. The existence of property ledger records is not a new requirement resulting from the conversion to GAAP, but rather a management of assets compliance issue because under ALL HUD agreements the PHAs are supposed to main- tain property records in accordance with the requirements of Public and Indian Housing Low-Rent Technical Accounting Guide, 7510, dated January 1996. (^) The absence of property records should have generated a compliance finding in the OMB Circular A-133 compliance report. If these records do not exist, we will discuss guidance in obtaining this information later.
Examination of Current Fixed As-
set Records
The first step in the conversion process should be to determine what fixed assets the PHA currently has in its property records. These assets should be sorted into the following classifications:
♦ Land ♦ Buildings ♦ Building improvements ♦ Furniture and fixtures - Dwelling ♦ Furniture and fixtures – Administration ♦ Equipment – Dwelling ♦ Equipment - Administration
This process may be accomplished by obtaining the original development cost certificates and the modernization cost cer- tificates and any other grant-related closeout documents. These documents can then be used to segregate the costs that should be capitalized from those that now should be expensed, i.e. “soft costs.” A simple procedure to use would be to accumulate all costs on a spreadsheet with columns categorized for cost to be capitalized, per the guidance above, and costs that should be expensed, also per above, for each asset. This allocation should equal the “hard” and “soft” costs for each asset as originally accumulated. This would assist in accumu- lating sufficient cost information to generate subsequent con- version entries. The totals of these columns, both hard and soft costs, should agree with the total costs for fixed assets as shown on the PHAs existing accounting records under the former HUD accounting.
Allocation of Costs
This allocation of costs between those to be capitalized and those to be expensed should only be required for the costs
relating to buildings and building improvements. The former concept of “hard costs” and “soft costs” did not normally apply to assets other than buildings and building improvements.
As the information is accumulated for the cost of the assets, the dates that each asset was put into service must also be deter- mined. This date will be required to compute the amount of accumulated depreciation to be recorded for the depreciation that should have been recorded in prior periods in accordance with GAAP. Therefore, the easiest way to capture this infor- mation may be to break this information down on the spread- sheet by year that the assets were placed into service.
Estimation of Costs When Historical Costs Are Un-
known
If there are assets for which costs cannot be determined, then estimated costs should be used. These estimated costs are best determined by the use of appraisals and having the appraiser determine the fair value at the dates the assets were origi- nally put into service. Insured values can be used as a guide for estimation purposes but are nor- mally at replacement cost (today’s value) and not original cost.
If replacement cost is the only cost, which can be determined, then the effect of general inflation since the asset was acquired should be removed. This can accom- plished by obtaining the current year and acquisition year Consumer Price Index (CPI) which can be requested from the U. S. Department of Labor. These indexes are easily accessible on the internet in a number of locations by searching for the Consumer Price Index. An example of this would be to assume an asset with a current replacement cost of $100,000 and an acquisition date of 1981. Based on the general CPI for 1981 and 1996, 1981 costs are 57.9 percent of 1996 costs. Therefore the estimated historical cost of the asset is $57,900 ($100,000 X 57.9%).
More Complex Situations
Certain seemingly complicated situations can arise related to the allocation of costs. Some of these would be scattered site housing and large developments that are completed in phases over several accounting periods. By utilizing the cost princi- ples detailed above related to capitalizing costs, and applying simple, systematic and consistent methods, these projects can be reduced to basic calculations.. PHAs should look to OMB Circular A-87 for guidance on allocating costs. In addition, while not applicable to governmental entities, Part 31.200 of the Federal Acquisition Regulation, provides excellent detail instructions on allocating costs. The overriding theme through- out FAR Part 31.200, is utilizing a systemic and consistent allocation method.
“The PHA should currently have detailed records of all of its fixed assets recorded in its fixed asset accounts as formerly required by HUD.”
Using the concepts enumerated above, REAC requests that the PHA, in conjunction with its CPA, put forth a “Best Efforts” attempt to accumulate its fixed asset records. This should not become a MAJOR undertaking. REAC would like the best prior year records that can be documented or estimated, but the
PHAs focus should be on maintaining proper GAAP fixed assets records prospectively.
DEPRECIATION
The second difference between GAAP and the former HUD accounting is that GAAP requires depreciation in enterprise funds and allows, but does not require, depreciation in the GFAAG. REAC’s conclusion, as per GAAP Flyer Number 1, is that the enterprise fund method should be utilized, which requires depreciation. However, if the GFAAF method is used, then REAC would prefer depreciation be recorded.
Depreciation is the measure of the wearing out, consumption or other reduction in the useful economic life of a fixed asset whether arising from use, affluxion of time or obsolescence through technological or market changes.
Depreciation is a system of accounting that aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not valuation.
Depreciation Methods
The most commonly used methods of depreciation are the straight-line and accelerated methods. Use of the straight-line method is quite simple. After reducing the cost basis by estimated salvage value at the end of the asset’s life, if any, the remaining balance is divided by the number of years of estimated life. This amount is then recorded as depreciation each year in amounts that are dependent on the method of depreciation selected. The straight-line method is almost always used for buildings and building improvements, however it is more than acceptable for use with all depreciable assets. This method is normally exclusively used in situations where the determination of net income is not of paramount importance.
Straight-Line Depreciation Method
HUD recommends the use of the straight-line method of depreciation for simplicity purposes. This method of allocating depreciation is a function of the passage of time and recognizes equal periodic charges over the service life of the asset. The depreciation expense allocated to each year is determined by dividing the depreciable base by the estimated useful life of the asset in years:
Acquisition cost – Estimated salvage value = Depreciation expense Estimated useful life
Assume that on the first day of the year, the entity acquires an asset for $70,000 cash. The estimated useful life is five years, and the estimated salvage value is $10,000. Depreciation expense under the straight-line method would be $12,000 per
Exhibit 10: Entries to Record Cost of Fixed Assets - Continued
For Enterprise Funds
DR CR
Land 25, Buildings 30, Furniture, equipment and machinery – dwellings 10, Furniture, equipment and machinery – administration 10, Cash-unrestricted 75, To record purchase of fixed assets
O ther administrative expense* 25, Cash-unrestricted 25, To expense costs not capitalized
For Governmental Funds:
( General and/or Capital Projects Funds) Cash-unrestricted 100, Revenue – HUD PHA grant 100, To record HUD grant
(GFAAG) Land 25, Buildings 30, Furniture, equipment and machinery – dwellings 10, Furniture, equipment and machinery – administration 10, Cash-unrestricted 75, To record purchase of fixed assets
(Capital Projects Fund) Expenditures-capital outlay 100, Cash-unrestricted 100, To expense costs reimbursed from grant Funds
(General Fund) Other administrative expense* 25, Cash 25, To expense costs not capitalized
* This item could be any expense category in which Expended modernization costs are classified.
lives of identical assets.
More often than not, economic factors are the limiting factors in the determination of useful life. Economic factors include obsolescence, inadequacy, and changing economic conditions.
Obsolescence refers to the process by which an existing asset becomes outmoded as improved, more efficient substitutes become available. For example, consider the continuing development of new generations of computers, making the previous generation obsolete. In many cases, to remain competitive, an entity must continually replace its assets with the most up-to-date resources available, even though the replaced asset may not be near the end of their physical lives.
Assets may become inadequate as a result of growth. A growth entity reaches a point where its existing assets simply cannot perform the work required. Therefore, the firm must replace them with more efficient assets.
Changing economic conditions can cause an asset to lose its potential; such economic changes include inflation, energy crises, and changes in consumer tastes. For example, much of the equipment used in the manufacture of large cars, such as body molds, is no longer useful even though its physical life still may be substantial.
Suggested Range of Depreciable Lives
Useful lives in practice for broad general categories are normally as follows. Please note these are suggested, not mandatory, useful lives:
♦ Buildings 20 to 40 years ♦ (^) Building improvements 10 to 40 years ♦ Furniture and fixtures 5 to 10 years ♦ Equipment 3 to 10 years
For some more specific items, the following may be suggested lives: ♦ Telephones 5 years ♦ Tools 5 years ♦ Appliances 7 years ♦ Furniture 10 years ♦ Computers 3 years ♦ Roofs 10 years ♦ (^) Leasehold improvements - 15 years or the life of the lease ♦ Land, and permanent improvements to land, are not depreciated.
The determination of the estimated life requires consideration of all of the factors listed above. Building improvements
year, calculated as follows:
$70,000 -$10,000 = $12, 5 years
Note that we also may express the annual depreciation expense as a rate, in this case, 1/5 = 20 percent. Also, generally, salvage value will be minimal and in most cases can be disregarded.
Often, plant assets are acquired and disposed of at times other than the beginning or end of an accounting period. Therefore, entities must adopt some logical and consistent means of allocating depreciation to the period of acquisition and to the period of disposition. Using the example of depreciation above, assume the purchase of the $70,000 asset was on April 1 and that the entity’s accounting year is the calendar year. Since the asset provided service potential for only nine months in the year of acquisition, the entity would only charge three-fourths of the first year’s depreciation, or $9,000, on the asset to the first accounting period. If the entity uses the asset for five years, as it expects to do, each of the next four years will absorb depreciation charges for a full 12 months, or $12,000, and in the fifth year, the entity would only record three months, or $3,000, of depreciation expense
Determination of Depreciable
Lives
The fixed assets are to be depreciated over their estimated useful lives. The useful life of an asset is the period of time during which the entity expects to use the asset for its intended purpose. It should be clear that the useful life of an asset to an entity couldn’t exceed the asset’s physical life. Several different entities may use an asset during its physical life.
The cost of maintaining an asset in efficient operating condition is usually very high during the latter years of its physical life. This is the one reason that an asset’s useful life is often shorter than its physical life because the asset would have to be abandoned or replaced because of the high cost to maintain. Thus, we must consider both physical and economic factors in estimating the useful life of an asset. Also, an entity’s experience with previous assets provides some basis for estimating the useful life of a similar asset that is newly acquired.
Physical factors affecting useful life are the normal wear and tear that result from use and the passage of time. With the exception of land, the service potential of an asset expires as an entity uses the asset. Because repair and maintenance policies vary among entities, so do the estimated useful and physical
“The useful life of an asset is the period of time during which the entity expects to use the asset for its intended purpose.”
RECAP AND ILLUSTRATION
To recap the discussion above, the following are the basic steps the PHA would normally follow to enable it to convert its fixed assets records to GAAP:
- Gather the fixed asset records, which would include the Cost Certificates, which support the general ledger bal- ances, and any other records necessary.
- Using a spreadsheet, breakout the costs from the Cost Certificates into the categories of assets.
- Still using the spreadsheet, spread the costs into the two categories, hard costs and soft costs.
- Take an inventory of fixed assets.
- Add any assets determined to be in existence but not on the general ledger to the spreadsheet.
- Establish for all hard costs:
- Cost basis
- Date placed in service
- Useful lives
- Calculate accumulated depreciation and current depreciation expense.
- Prepare journal entries for items that affect current operations and to restate fund balance.
- Prepare balance sheet and income using the new GAAP records.
To illustrate the above steps, we will make certain assumptions as we proceed through the above steps.
Step 1:
Assume that the fixed asset general ledger shows a building in the amount of $1,460,000 and we have a detailed property ledger with the same total ($1,460,000). We will call this building A. Also we will assume that this building was built and furnished with HUD Capital Funds (DEV, CIAP, CGP).
Steps 2 and 3:
Assume that the spreadsheet looks like the one shown at Exhibit 14.
Step 4:
Assume that the PHA has another building, Building B that is not on the fixed asset general ledger and was not built and furnished with HUD Capital Funds. Also, assume that Building B was put into service on January 1, 1980.
Step 5:
Since there are no soft costs involved, the costs as determined in the next step would be added to the spreadsheet as hard costs.
Step 6:
Assume that Building A was put into service on January 1, 1993 and that the PHA’s fiscal year end is December 31, 1998. The costs to depreciate are shown as hard costs in the above spreadsheet. Additionally, assume that we determine that the useful life of Building A to be 25 years and the useful life of the fixtures to be 10 years.
Assume that Building B has received an appraisal of $1,000,000 for the building, $100,000 for the land and $20, for the fixtures. Assume that we determine the useful lives to be the same as for Building A, 25 years, and the its fixtures, 10 years. Additionally assume that the CPI for 1980 is 40% of
- Therefore the cost basis for GAAP purposes would be $400,000 for the building ($1,000,000 X 40%), $40,000 for land ($100,000 X 40%), and $8,000 for fixtures ($20,000 X 40%).
Step 7:
Depreciation and accumulated depreciation would be com-
Hard Costs Soft Costs Total
Cost of constructing Building 1,000,000 1,000, Land 200,000 200,
Fixtures 100,000 100,
Emergency main- tence (replace roof- $100,000 and fix toilets-$40,000) 100,00 40,000 140, Relocation of tenants 20,000 20,
Total 1,400,000 60,000 1,460,
Exhibit 14 - Building a Property Ledger
Asset Cost Basis Useful Life
Annual Deprecia- tion
Years Before 1998
Accumulated De- preciation 1-1-
Current Year Depreciation
Building A: Building 1,000,000 25 40,000 7 280,000 40, Roof 100,000 10 10,000 7 70,000 10, Fixtures 100,000 10 10,000 7 70,000 10,
Total Building A 1,200,000 60,000 420,000 60,
Building B: Building 400,000 25 16,000 17 272,000 16, Fixtures 8,000 10 800 17 8,000 0
Total Building B 408,000 16,800 280,000 16,
Total A & B 1,608,000 76,800 700,000 76,
Exhibit 15 - Calculation of Depreciation
puted as illustrated in Exhibit 15.
Step 8:
The journal entries to record the data in Exhibit 15 are illus- trated in Exhibit 16.
Exhibit 16: Entries to Record Depreciation
DR CR Enterprise Funds:
HUD PHA Contribution 60, Fixed assets 60, To write off soft costs from Building A purchased with HUD Capital Funds (DEV, CIAP, CGP)
Buildings (Roof is included) 1,100, Land 200, Furniture & fixtures 100, Fixed assets 1,400, To reallocate Building A hard costs to proper accounts
Building 400, Land 40, Furniture & fixtures 8, Retained earnings 448, To set up Building B not previously recorded as a fixed asset and financed with other than HUD Capital Funds
Exhibit 16: Entries to Record Depreciation - Continued
DR CR
Enterprise Funds - Continued:
HUD PHA Contribution 420, Accumulated depreciation 420, To record depreciation related to prior years for Building A
Retained earnings 280, Accumulated depreciation 280, To record depreciation related to prior years for Building B
Depreciation expense 76, Accumulated depreciation 76, To record current year depreciation for all fixed assets
HUD PHA Contribution 60, Retained earnings 60, To record the add-back of depreciation relating to assets purchased with HUD Capital Funds
THE FUTURE – GASBs NEW REPORTING
MODEL
Beginning with year 2002, a new reporting model will be phased in by governmental entities (GASB Statement No. 34). Among other matters, it eliminates the GFAAG. The effort to convert to the new fixed assets requirements of the new model is not expected to be significant for PHAs.
