Chapter 7. Capital Assets and Investments in Marketable Securities. Chapter 7 Granof-5e 1

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1 Chapter 7 Capital Assets and Investments in Marketable Securities Chapter 7 Granof-5e 1

2 Learning Objectives Accounting for GENERAL CAPTIAL ASSETS Accounting for DONATED ASSETS Trade-Ins Collectibles GASB s controversy on Infrastructure Assets Asset Impairments Investments in Marketable Securities Chapter 7 Granof-5e 2

3 General Capital Assets Associated with the government as a whole Non financial in character. Distinguished from other capital assets that are specifically associated with activities reported in proprietary and fiduciary funds. Examples: The City of Austin defines capital assets as assets with an initial individual cost of $1,000 or more and an estimated useful life of greater than one year. The City of Houston defines capital assets as assets with an initial cost of more than $5,000 (amount not rounded) and an estimated useful life in excess of four years. Chapter 7 Granof-5e 3

4 Common Classifications of GCAs Land Buildings Improvements other than Buildings Machinery and Equipment Construction in Progress Infrastructure (e.g., roads, streets, bridges) Intangible assets (GASB 51). Accounting and Financial Reporting for Intangible Assets, (2007). Chapter 7 Granof-5e 4

5 Acquisition and Common Financing Sources for GCAs & DCAs Acquisition: Purchase, Construction, Contributed/Donated (DCA), Annexed, Capital Leases, Foreclosure, Eminent domain, Escheat Financed: -Tax-supported bonds -Grants from other governmental units (e.g., Federal or state grants) -Transfers from other funds -Special assessment bonds or taxes -Capital leases Chapter 7 Granof-5e 5

6 Important Recommendation for GCAs & DCAs If funds received from governmental units, individuals, or organizations is restricted for the purchase or construction of specified capital assets it is recommended that a Capital Projects Fund be used. Chapter 7 Granof-5e 6

7 Government-wide Statements: Capitalized in the governmental activities column Depreciated Accounting for GCAs Fund Statements: Full Cost debited to Expenditures in the appropriate governmental fund when the assets are acquired. Chapter 7 Granof-5e 7

8 Accounting for GCAs - Example Example: The Sample city purchased office equipment for the Mayor s office and paid $50,000 cash from the General Fund. General Fund: Dr. Cr. Expenditures-Capital Outlay $50,000 Cash 50,000 Gov t wide (Gov tal Act.)*: Equipment $50,000 Net Assets, Invested in Cap Assets 50,000 *Note: This entry is not made on the books. It is only a conversion at eoy Chapter 7 Granof-5e 8

9 Placing a value (assigning costs) on GCAs For Purchased Assets Follow Cost Principle (subject to materiality threshold) Invoice cost or historical cost All other necessary and reasonable costs incurred to put an asset into use (less cash or other discounts and financing charges) For constructed assets: Direct labor and materials + overhead + architect fees + insurance premiums Capitalize interest on constructed assets per GASB Std. # 34 Chapter 7 Granof-5e 9

10 Placing Value (assigning costs) on GCAs (Miscellaneous items) Initially unrecorded assets (i.e. discovered assets or a new inventory of assets) --Record at estimated cost Foreclosures 1) Record at aggregate of accumulated taxes, interest, penalties, legal cost, OR 2)FMV whichever is lower Trade-Ins --Record at FMV of the new asset Chapter 7 Granof-5e 10

11 Placing Value (assigning costs) on DCAs Donated assets: reported at estimated fair market value. Exhaustible assets are depreciated over the remaining useful lives in their government-wide statements. Chapter 7 Granof-5e 11

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13 Depreciation included in Expenses Chapter 7 Granof-5e 13

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15 -No Capital Assets Chapter 7 Granof-5e 15

16 -No Depreciation -Expenditure for Whole Asset ( Capital Outlay ) Chapter 7 Granof-5e 16

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21 Infrastructure Infrastructure is: o Government s capital assets o Immovable, stationary in nature o Preserved for a longer period. Ex: roads, sidewalks, bridges, tunnels, drainage systems, water and sewer systems, dams, lighting systems etc. GASB 34: requires that infrastructure be accounted in the same manner as the capital assets.* o *Exception: They need not be depreciated if the government can demonstrate that they are being maintained/preserved at a specified condition level. o To avoid recording depreciation, governments must perform condition assessments at least every three years; have an up-to-date inventory of eligible assets estimate the amount to maintain and preserve the eligible assets. Chapter 7 Granof-5e 21

22 TWO Approaches for Infrastructure Accounting Traditional approach: Capitalize & Depreciate Modified approach: All expenditures incurred to maintain and preserve those assets should be expensed. Additions and improvements should be capitalized. Assessed condition of the assets and the basis of that assessment must be disclosed. Chapter 7 Granof-5e 22

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24 Expense for either: -Depreciation or - Maintenance Chapter 7 Granof-5e 24

25 Expenditure for either: -Maintenance or -Whole Asset ( Capital Outlay ) Chapter 7 Granof-5e 25

26 Criticisms of Statement No. 34's Approach to Infrastructure No indication that data on the historical cost of infrastructure would be used. No need to capitalize those assets because they cannot be stolen or misused. Comparison between measure of output (performance) and monetary value assigned to the assets is not meaningful. Infrastructure assets seldom have alternative uses. Past construction costs are of no significance. Chapter 7 Granof-5e 26

27 Transition -- Infrastructure Prospective reporting is required at effective statement date Retroactive reporting is required as follows: -Phase 1 governments: June 15, Phase 2 governments: June 15, Phase 3 governments: Never Retroactive reporting is required only for assets acquired after June 30, Illustration: For example, in 2008 the replacement cost of a road constructed in 1994 was $10 million. A road construction price level index was 90 for 1994 and 120 for The road would be recorded at an initial cost of $7.5 million ($10 million times 90/120). If the road had a useful life of 30 years, then at the end of 2008 (after 15 years, it would be 50% depreciated. Hence it would have a book value of 50% of $7.5 million -- $3.75 million. Chapter 7 Granof-5e 27

28 Accounting for Collectibles GASB No. 34 does not require capitalization of artworks if they are: 1) held for public exhibition or research AND 2) protected and preserved AND 3) the proceeds from sale of the collectibles are used to acquire other collectibles. Art and collectibles that do not meet these conditions must be capitalized. Capitalized --Revenue upon receipt of gifts should be recognized. Chapter 7 Granof-5e 28

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30 Accounting for Impaired Assets GAAP: GASB Std. # 42 Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries. Assets that have declined in their service utility significantly and unexpectedly are considered impaired. If impaired: a portion of the asset s historical cost representing the impairment must be written off. Impairment amount measured by 3 methods: -Restoration cost approach -Service Units approach -Deflated depreciated replacement cost approach. Chapter 7 Granof-5e 30

31 Marketable Securities - Overview GAAP is GASB Stmt #31 Accounting and Financial Reporting for Certain Investments and for External Investment Pools. 1) General Investment Governments either directly invest in stocks or bonds or small governments may participate in investment pools maintained by other governments. 2) Derivatives Governments typically engage in derivative transactions not to speculate but, rather, to reduce the overall investment risk. 3) Repurchase Agreement & Reverse Repurchase Agreement Repurchase agreement (Repo): short-term investment in which investor transfers cash in exchange for securities and the cash + plus interest is repaid in exchange for the same securities. Reverse Repurchase agreement (Reverse Repo): Here, government is the borrower rather than the investor. Chapter 7 Granof-5e 31

32 1) General Investments Example-Footnote The City of Austin, Tx in its CAFR for FY 2008 had the following footnote on investments. Investments Certain investments are required to be reported at fair value, based on quoted market prices. Realized gains or losses resulting from the sale of investments are determined by the specific cost of the securities sold. The City carries all of its investments in U.S. government and agency debt securities and money market mutual funds at fair value as of September 30, Investments in local government investment pools are carried at amortized cost, which approximates fair value. Chapter 7 Granof-5e 32

33 Disclosure Requirements Governments should organize disclosures by investment type Governments should disclose their vulnerability to specific types of risks o Credit risks o Concentration of credit risks o Interest rate risks o Foreign currency risks Chapter 7 Granof-5e 33

34 City of Houston: Notes on Investments These funds are managed internally by City personnel. The investments listed below do not include the City's three pension funds, which are described elsewhere in this report. 1. General Investment Pool 960 The General Investment Pool consists of all working capital, construction and debt service funds which are not subject to yield restriction under IRS arbitrage regulations. The funds of the City's enterprise systems, as well as the general fund are commingled in this pool in order to gain operational efficiency. Approximately 98.5% of the City's total investable funds are contained in this portfolio. Chapter 7 Granof-5e 34

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40 2) Derivatives GAAP is GASB Statement No. 53, Accounting and Financial Reporting for Derivative Instruments which addresses the recognition, measurement, and disclosure of information regarding derivative instruments entered into by state and local governments. Governments must explain the nature of derivative transactions including o Reasons to enter o Significant terms of the transactions o Vulnerability to specific types of risks Credit risks Concentration of credit risks Interest rate risks Foreign currency risks Chapter 7 Granof-5e 40

41 Definitions Custodial Credit Risk: Investments are exposed to custodial credit risk if the investments are uninsured, are not registered in the County s name and are held by the counterparty. Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations. Concentration of credit risk is the risk of loss attributed to the magnitude of an investment in a single issuer. Interest Rate Risk: All investments carry the risk that changes in market interest rates will adversely affect the fair value of an investment. Foreign Currency Risk: Foreign currency risk is the risk that fluctuations in the exchange rate will adversely affect the value of investments denominated in a currency other than the US dollar. Chapter 7 Granof-5e 41

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45 3) Repo & Reverse Repo Illustrative example is on the next ppt. slide Chapter 7 Granof-5e 45

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47 Summary Governments report general capital assets as expenditures when they construct or acquire them in their governmental fund statements which are accounted for on a modified accrual basis. Thus governments maintain the off the balance sheet record of these assets. GASB Std. # 34 requires that in Government-wide statements, governments capitalize capital assets and depreciate them over their economic lives. GASB Std. # 34 mandates that governments account for their infrastructure assets just as they do other capital assets. However governments are not required to depreciate infrastructure assets if they preserve them at a specified condition level. Investments made by governments are of concern because of the substantial risk that investors can incur through default, declines in value and even fraud. GASB through its standards requires disclosure of a wide range of investment information. Chapter 7 Granof-5e 47