Computer Equipment - Capitalization versus Expensing

We will be spending the next few days discussing an ASBCA decision involving incurred costs at Technology Systems, Inc. (TSI). DCAA issued a report on incurred cost for fiscal year 2007 noting a number of unallowable costs. The ACO (Administrative Contracting Officer) sustained many of the DCAA findings, issued a final decision, whereupon TCI appealed to the ASBCA.

This case touches on a number of issues not uncommon to small Government contractors and that is why we want to understand the issues and the bases for the decisions.

Today we will discuss the issue of capitalization/depreciation versus expensing capital equipment.

TSI expensed $26 thousand in computer supplies in 2007. The ACO (Administrative Contracting Officer) disallowed the expense based on her position that the amounts should have been capitalized and depreciated over several years.

TSI testified that some computers were for research and were taken apart, components soldered on, sensors added in and built into systems that would go out on a vehicle or boat for testing. They were heavily modified. After testing was complete the computers were of no further use to TSI and therefore expensed. The problem with TSI position however was that only one or a few of the computers in question were heavily modified. The rest were used in the day to day operations of the business. As the ASBCA decision states it:

As far as we can tell, TSI completely expensed every computer that it purchased in 2007 ... and explained its practice to the ACO by asserting that was a leading edge software Research and Development firm for which most computing equipment was obsolete within a year of purchase. In this communication, TSI made no mention of the heavy modifications that allegedly made the computes useless after a year. Based upon the evidence before us, we conclude that some of the computer equipment completely expenses by TSI was likely so modified that it could not be used beyond FY 2007, and that other computer equipment obtained in FY 2007 and also expensed by TSI was not so modified. Indeed, Mr. Fletcher's testimony is completely lacking with respect to explaining what efforts TSI undertook to identify which computer expenses went to the heavily modified computers consumed in research and which computer expenses went to computers more routinely used by the company.

The Board (Armed Services Board of Contract Appeals) rejected TSI's arguments. The Board found that TSI's depreciation practices in 2007 were inconsistent with its prior long-term practices and its rationales for the new approach to be unpersuasive: being a cutting edge technology company does not appreciably change the useful lives of desktop computers used for office work.

Moreover, TSI was unable to demonstrate the portion of computers that were modified. Finally, the IRS Code's allowance for earlier write-off, for tax purposes, does not have any effect on the proper depreciation for Government contracting purposes.

Computers and computer equipment are to be depreciated at the same rate as in prior years.