Wednesday, January 26, 2011

CAS 404 - Capitalization of Tangible Assets

CAS 404 - Capitalization of Tangible Assets. Cost Accounting Standard 404 establishes criteria for determining the acquisition costs of tangible assets which are to be capitalized. It does not cover depreciation or disposition of fixed assets. Depreciation and disposition is covered under CAS 409 which we will look at tomorrow.

This standard requires contractors to capitalize the acquisition cost of tangible assets in accordance with a written policy that is reasonable and consistently applied. There is an emphasis here and an expectation that the policy will be in writing. The written policy must include the following:
  1. A minimum service life criterion which shall not exceed two years but which may be a shorter period. This is logical. Companies "expense" rather than "capitalize" short-lived assets.
  2. A minimum acquisition cost criterion which shall not exceed $5 thousand but may be a smaller amount. The acquisition cost criterion is something that contractors should carefully consider and probably discuss with their IPAs (Independent Public Accountant). A $5 thousand capitalization threshold could significantly distort the financial statements of small businesses. Based on our experience, a $1 thousand capitalization threshold seems to be very common among small businesses.
  3. Identification of the asset accountability units to the maximum extent practical. An "asset accountability unit" is defined elsewhere in CAS 404 as a tangible capital asset which is a component of plant and equipment that is capitalized when acquired or whose replacement is capitalized when the unit is removed, transferred, sold, abandoned, demolished, or otherwise disposed of. Typically this applies when there are buildings or complex manufacturing equipment.
  4. Establishment of minimum dollar amounts for the capitalization of original complements of low cost equipment and for betterments and improvements.  "Original complement of low cost equipment means a group of items acquired for the initial outfitting of a tangible capital asset or an operational unit, or a new addition to either. The items in the group individually cost less than the minimum amount established by the contractor but in the aggregate, represent a material investment.

CAS 404 also requires that "acquisition costs" include not only the purchase price but all costs necessary to prepare the asset for use. This includes the cost of placing the asset in location and bringing the asset to a condition necessary for normal or expected use such as shipping, initial inspection and testing, installation, and similar expenses.

Thirdly, CAS 404 requires that costs incurred subsequent to the acquisition of a tangible capital asset which result in extending the life or increasing the productivity of that asset (e.g. betterments and improvements) shall be capitalized. Costs incurred for repairs and maintenance to a tangible capital asset which either restore the asset to, or maintain it at its normal or expected service life or production capacity shall be treated as costs of the current period. This is perhaps the most contentious aspect of the Standard because it requires the exercise of judgment. When does an expenditure extend the life or increase the productivity of the asset and when does the expenditure merely represent a repair cost?

CAS 404 is not highly technical but there have been a number of contractor noncompliances over the years. The ones that we have seen involve inadequate written policies and procedures (i.e. the written policies and procedures did not cover the minimum requirements) and a disagreement over the definition of "repair and maintenance" (it was too broad and included elements of "betterments and improvements").

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