Thursday, January 27, 2011

CAS 409 - Depreciation of Tangible Capital Assets

CAS 409 - Depreciation of Tangible Capital Assets. CAS 409 is the second half of the capitalization/depreciation standards. Yesterday we discussed CAS 404, Capitalization of Tangible Assets and today we discuss how those capital assets should be depreciated. This Standard came about in order to "enhance objectivity and consistency" in allocating depreciation costs to Government contracts. For companies with a significant number of capital assets, this standard will require extensive record-keeping.

The first thing the standard requires is that contractors estimate residual values for all assets (or groups of assets). Residual value is deducted from capitalized value to determine the depreciable cost base. The Standard generally prohibits contractors from depreciating assets below their residual value unless residual values are immaterial. .

The next thing contractors need to determine is how long the assets are going to last - the estimated service life. The estimated service life of the tangible capital asset, over which the depreciated cost is assigned, must reasonably approximate the actual period of usefulness to its current owner, considering such factors as obsolescence and required quality and quantity of output. Here's where it gets tedious. The standard requires contractors to maintain adequate records which identify the age of the asset or asset group at retirement or withdrawal from active use. These records should contain such information as asset acquisition/disposition dates, date asset was withdrawn from active service, and any other factors that directly influence asset lives.

If supporting records are not available on the date the contractor must first complywith the standard, the estimated service lives should be those used for financial accounting. However, the required supporting records must be developed by the end of the second fiscal year after that date and used as a basis for estimated service lives on assets subsequently acquired. When a new asset is acquired for which the contractor has no available data or prior experience, the estimated service life must be based on projection of the expected useful life using IRS Revenue Procedure Guidelines.

After determining residual values and useful lives, contractors must then determine the depreciation methodology. Contractors may select any appropriate method of depreciation which reflects the pattern of consumption of services over the life of the asset. For example, an accelerated method is appropriate where the expected consumption of services is greatest in the early years of the asset life. The method used for financial accounting is usually appropriate for contract costing unless it does not reasonably reflect expected consumption.  The method used for income tax purposes is almost never appropriate for contract costing purposes because it does not approximate the consumption of services over the life of the asset.

Depreciation costs are generally allocated as indirect costs to the cost objectives for which the assets provide service. They may be charged directly to cost objectives at average rates only if the charges are based on usage and the costs of all like assets used for similar purposes are also charged directly. Depreciation costs for assets included in service centers, where significant, must be charged to the service center.

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