Discussion of Definition & Guidelines for Identifying Expenditures that Qualify as Capital Assets

Capital outlay expenditures are expenditures that qualify as capital assets. State law does not define capital outlay. GASB 34 paragraph 19 provides a definition of capital assets. "The term "capital assets" includes land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period".

I. Repairs and maintenance

One difficulty comes in deciding what expenditures qualify as improvements and which should be expensed as repairs and maintenance. Various legal cases and generally accepted accounting principles indicate that there are three main areas to assess. An improvement according to Gauthier page 36-38 "provides additional value. Such value is achieved by" one of the following:

"Lengthening a capital asset's useful life"
"Increasing a capital asset's ability to provide service through greater effectiveness" – that is increased capacity.
"Increasing a capital asset’s ability to provide service through greater efficiency"

In contrast to improvements, repairs and maintenance retain value rather than provide additional value.” “Care is sometimes needed to distinguish actions that lengthen the useful life of an asset from those that merely avoid shortening it. Assume, for example, that a new building is expected to have a useful life of 80 years, but will need to have its roof replaced in just half that time. Further assume that the cost of the roof is included in the cost of the building (i.e., rather than treated as a separate capital asset in its own right). It might be tempting to argue that since the building’s useful life would be just 40 years if the roof were not replaced, the replacement extends the building’s useful life and so qualifies as an improvement. In substance, however, the replacement of the roof does not lengthen the building’s originally estimated total useful life of 80 years, but simply avoids cutting it in half. That is, the roof replacement maintains rather than extends the originally estimated useful life of the building, and therefore should be treated as a repair (i.e., maintenance) rather than as a replacement”.

Later on page 77, Gauthier expands on this by discussing how components like a roof or HVAC might have different treatments in practice. These are:

"Treat the component as a separate capital asset." A new roof would be a replacement capital asset while the cost of the old roof would be removed from the capital assets."
"Include the component as an integral part of the larger capital asset and treat subsequent replacements as repairs".
"Include the component as an integral part of the larger capital asset and treat subsequent replacements as disposals. Each time the roof was replaced the undepreciated balance would be recognized as a loss on disposal and the cost of the new roof would be” added as a capital asset.

The first approach is the "conceptually preferable approach" although the others are used in practice.

As auditors, we realize that whether an item is a repair or a capital outlay is often a matter of judgment. Some of the factors that we consider are:

How frequently is this type of expenditure needed?
- For example, say we have a building with a useful life of 80 years. The interior must be painted every 5 years. Even though the cost of painting might be fairly large, it must be done a number of times over the life of the asset. We would therefore consider this a repair, not a capital outlay.
Has technology changed?
- If we add a piece of equipment to replace an old one that was much slower or more costly to operate that might be an indication of a capital outlay since we are making the system more efficient.
Are we adding capacity?
- If we replace an item with a larger item that might be an indication of a capital outlay since we are adding capacity. However, as a practical matter, if only a small portion is being replaced, that probably should be considered repairs rather than capital outlay.

II: Self-Constructed Assets

Another difficulty comes in deciding which internal costs are properly included as part of the cost of the capital assets. Gauthier page 28 outlines three principles:

"General and administrative costs should never be capitalized".
- "Overhead costs (e.g., use of office facilities, executive management, accounting, human resources) should always be reported as charges of the period in which incurred."
"Costs directly related to the acquisition of a specific asset should be capitalized."
- This includes the salaries and benefits of those who work directly on a given construction project.
"Costs clearly related to the acquisition of capital assets, but not to specific projects, should still be capitalized."
- For governments with multiple ongoing projects this involves allocating the costs to individual projects in some reasonable manner. We suggest pro rating based on total project costs or some other reasonable method.
- Those indirect costs could include costs associated with a project field office and “the administrative personnel that staff that office” and ”various office costs”.
- The important thing is that the costs must clearly relate to the projects.

These principles are consistent with the discussion in the 16th edition in 2007 of “Intermediate Accounting” by Stice, Stice, and Skousen.

III: Overall Principles

Deciding what is a capital outlay expenditure is a matter of judgment especially in tough economic times where state operating funds have been drastically reduced. A couple of important things to bear in mind when SPLOST funds are involved are:

What is the “spirit” of the law?
- Ask how the public with full knowledge of the details of the expenditure react.
- Would outsiders agree that this is a capital outlay or would they say it is a repair?
Is the expenditure related to a “specific capital outlay project” specified in the resolution calling for the imposition of the tax?
- As seen in the Cobb County Board of Education case related to laptops in their schools, the Georgia Supreme Court is taking a much narrower view of what these specified projects are. They have considered the internal list discussed by the BOE, the list of projects discussed in any public hearings, and items published in brochures or newspaper articles. This is something that should be discussed with the board’s attorney prior to the actual election so that there is clear guidance before a new round of SPLOST is commenced.

Quotes from

"Gauthier" are from "Accounting for Capital Assets" - A Guide for State and Local Governments” by Stephen J. Gauthier copyright 2008.
"GASB 34" are from GASB Statement 34, Basic Financial Statements and Management’s Discussion and Analysis for State and Local Governments.

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