Has Anyone Ever Sat You Down and Really Explained the Process of Accounting for Capital Assets?
I know, you’re probably thinking “chained down” might be a better description of what it would take to get you through a lecture on capital assets accounting. However, if you would like to reduce, potentially to zero, the number of year-end audit adjustments that you are receiving in the area of capital assets, then follow me on this quick tour through Capital Assets Accounting 101.
Why Capital Assets Receive Special Treatment
Most Business Office personnel can automatically sense that really expensive items deserve some kind of special accounting treatment. And it’s true, high-dollar purchases of an organization do need to be set aside from the ranks of the ordinary expenditures and honored as capital assets. That’s because these items are expected to be used and have continued value well into future years. Through use of special account coding, these transactions find their way to the capital assets section of the Statement of Position where this value can be shown.
The Capitalization Policy
You may already know that in order to keep school districts on the same page, the Texas Education Agency has required in the Financial Accountability System Resource Guide (“FASRG”) that all Texas school districts use $5,000 as the threshold for determining whether or not an item should be capitalized. This is also the recommended threshold by the Government Finance Officers Association (GFOA) for governmental entities. Therefore, this is the criteria for test question number one: Is the item individually valued at $5,000 or more? And take special notice of the words individually valued in that question. Five computers purchased for $7,000 would not be individually valued at more than $5,000 each so this first test is failed already and you would not to capitalize.
Test question number two: Is the purchased item expected to have a useful life of more than one year? This of course will be a given for land, buildings, and most building improvements. Also, heavy equipment should easily pass this test question as well. School buses, maintenance vehicles, and cafeteria ovens will last longer than one year, and most likely will have passed the $5,000 test, so these items would be capitalized.
It’s the smaller equipment items where you really have to carefully apply the two test questions. Often, things like computers or band instruments, which seem like logical capital assets, will be purchased in bulk and therefore have a large invoice arrive in the mail. However, each individual item will most likely not be valued at $5,000 or more and therefore should not be capitalized.
By the way, if you are building something, accumulate all costs of the project together, regardless of amount, and then apply the $5,000 per individual item criteria. The project itself is considered the individual item under this scenario. Capital projects funds are used for large construction projects such as for school or city hall buildings. All costs recorded within these funds are generally capitalized.
Get the Account Coding Right to Begin with and You’re Halfway There Already
Correct account coding is crucial! And this can be said about all transactions flowing through an accounting system. With the daily bombardment of incoming invoices, each one must be funneled through an organized processing system, where the transaction is reviewed, assigned an account code, approved, keyed into the system, and filed away. If special care is taken at this point-of-entry for all transactions, the accounting system will be protected from potentially serious problems later on. Remember the classic saying “Garbage in, Garbage out”?
All personnel coding expenditures or approving the coding of expenditures in your organization must understand and apply the two pass/fail test questions for determining what should be coded as a capital asset. This is the only way to ensure that only items that should be capitalized gain access to those special codes of the accounting system.
For school districts, the FASRG tells us that capital assets are to be recorded to the 66XX object codes. (Remember, the object code is the third category of the standard 20 digit Texas school district account code structure) Specifically, land purchases and improvements are to be recorded to the 661X object codes, building purchases and improvements are to be recorded to the 662X object codes, and furniture and equipment are to be recorded to the 663X object codes. For cities and counties, your organization will most likely have pre-defined account codes within the chart of accounts for coding capital asset expenditures as well.
The Capital Assets Additions Schedule
If your organization is doing well with coding, then throughout the year the capital asset account codes should be getting filled with transactions. Depending on the size of the organization and the purchasing activities, these account codes could end up holding a large amount of capital assets by year end.
To properly close out the books at year end and to prepare for the annual financial audit, every item recorded to the capital asset account codes should be specifically identified and listed on a Capital Assets Additions Schedule. The process of preparing the Capital Assets Additions Schedule is a great way to verify that each transaction recorded to the capital asset account codes has been given appropriate treatment as a capital asset. For larger organizations or those with a lot of capital asset activity, the Capital Assets Additions Schedule should be updated monthly, not just at year end.
There could also be just as many items missing from the capital asset account codes that qualify as capital assets, and therefore could miss out on being capitalized. During the process of preparing the Capital Assets Additions Schedule, the overall general ledger of the organization should be reviewed to search for any miscoded capital asset transactions. The first place you should look for misplaced capital asset transactions is in the Repairs and Maintenance account codes. Making the distinction between whether a transaction is a repair or a capital asset is sometimes difficult, so definitely review the coding of the items in the Repairs and Maintenance accounts and make reclassifications if needed.
When you have completed the Capital Assets Additions Schedule, the total value shown for all assets on the schedule should agree to the total amount shown within the capital asset expenditure account codes. If you will go through this balancing process, and have correctly identified all capital asset transactions for the year, you will most likely have zero audit adjustments for the year arising from the area of capital assets.
The Capital Assets Deletions Schedule
Each year, capital assets that were added in prior years may become no longer usable, may have been sold, or traded-in against the purchase of new capital assets. As these items are removed from service during the year, they should be tracked and their method of disposal documented. These items should be listed in detail on a Capital Assets Deletions Schedule which is made available to the auditor during the year-end audit.
The Depreciation Schedule
A depreciation schedule is what is used to track the original value, the estimated useful life, the current year depreciation expense, the accumulated depreciation balance, and the net book value for each individual capital asset purchased in a prior year and still being used by the organization. The values from the depreciation schedule are then reported on the Statement of Position and Notes to the Financial Statements in a summary format by major capital asset category.
Many small to mid-size organizations utilize their audit firm for assistance in updating the depreciation schedule each year based on current year activity on the books. However, the update process is simply a matter of adding the assets shown on the Capital Assets Additions Schedule and showing as deletions those assets on the Capital Assets Deletions Schedule. Once the new assets are added to the depreciation schedule, an estimated useful life is assigned, and annual depreciation expense on the asset begins.
The Annual Financial Audit
During the year-end audit, the auditor will be concerned with verifying that the capitalization policy of the organization has been appropriately applied. This process will involve the auditor reviewing the transactions coded to the capital expenditure account codes to check them for accuracy and completeness. To check for the accuracy of what is already coded to the capital expenditure account codes, the auditor will request to see some of the actual invoices supporting those transactions. To check for completeness of the transactions coded to the capital expenditure account codes, the auditor will a search the account codes of other areas looking for possible miscoded capital assets.
Auditors often find themselves in the position of having to create the Capital Assets Addition schedule during the audit based on transactions coded to the capital expenditure accounts. This can be much like putting together a puzzle and add a great deal of time to the Capital Assets area of the audit. You can make your auditor smile by providing him or her with a Capital Assets Additions Schedule that already reconciles to the total of the capital expenditure account codes on your books.