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HomeMy WebLinkAbout4 Capitalization Policy Agenda Item # l Memorandum To: Board of Directors From: Kim Szczurek, Finance & Accounting Manager Through: Mary Chapman, Administrative Service Manager Peter Holzmeister, General Manager Date: July 28, 2006 Subject: CAPITALIZATION POLICY 1. WHY THIS MATTER IS BEFORE THE BOARD Accepted accounting policies and procedures for local government entities include the adoption and implementation of a Capitalization Policy for Fixed Assets. 2. HISTORY The Board has not adopted a policy regarding the capitalization limits for fixed asset purchase or construction. It is standard practice to adopt such a policy and to describe that policy in the footnotes to the financial statements in accordance with GASB 34. A capitalization policy is meant to clarify financial reporting issues so that the information presented in the District's financial statements is accurate and consistent with Generally Accepted Accounting Principles. It also helps, in some cases, to clarify and streamline the record keeping for District purchases. Our outside auditors, Virchow Krause noted to staff and in their verbal report to the Board on the 2005 financial statements that the District should consider the adoption of a capitalization policy. 3. NEW INFORMATION Attached is a draft policy establishing capitalization procedures for your review and discussion. The capitalization amounts set forth in the draft policy are somewhat higher than the amounts we are currently using. The idea is to make the dollar amount of items to be capitalized reflect an appropriate value. We suggest our current capitalization value is too low. I have also included as an attachment the Government Finance Officer's Recommended Practice concerning capitalization thresholds for your reference. 4. RECOMMENDATION That the Board adopt the resolution setting a Policy for Capitalization of Fixed Assets f CKEE DONNER Public Utility District R' solu ion No. 2006 - )UOC POLICY FOR CAPITALIZATION OF FIXED ASSETS WHEREAS, the Board of Directors of the Truckee Donner Public Utility District wishes to set forth the procedures to be followed in determining which purchases should be capitalized or expensed in the year purchased in accordance with generally accepted accounting practices. NOW, THEREFORE, IT IS HEREBY RESOLVED, that the following procedure be followed in determining if a purchase meets the necessary requirements for capitalization: ASSET CLASS MINIMUM COST Office Equipment $2,500.00 Tools $2,500.00 Equipment $5,000.00 Structures and Land Improvements $7,500.00 Construction and Remodel Projects $7,500.00 All of the following criteria shall also be used: 1. The normal useful life of the item is at least two years from date of purchase. 2. The item has an acquisition cost(including freight and installation)of at least the amounts listed above in each asset class. 3. The item will not be substantially reduced in value by immediate use. 4. In case of repair, the outlay will substantially prolong the life of an existing fixed asset or increase its productivity significantly, rather than merely returning the asset to a functioning unit or making repairs of a routine nature. 5. Land purchases must always be capitalized. PASSED AND ADOPTED by the Board of Directors of the Truckee Donner Public Utility District in a meeting duly called and held within said District on the 2"dday of August, 2006. AYES: NOES: ABSTAIN: ABSENT: TRUCKEE DONNER PUBLIC UTILITY DISTRICT J. Ron Hemig, President ATTEST: Peter L. Hoizmeister, District Clerk RECOMMENDED PRACTICE Establishing Appropriate Capitalization Thresholds for Capital Assets (1997 2001 and 2006) (CAAFR) Backeround.The term capital assets is used to describe assets that are used in operations and that have initial lives extending beyond a single reporting period. Capital assets may be either intangible (e.g.,easements,water rights)or tangible(e.g., land,buildings,building improvements,vehicles, machinery, equipment and infrastructure). It is incumbent upon public-sector managers to maintain adequate control over all of a government's resources,including capital assets,to minimize the risk of loss or misuse. As a practical application of the materiality principle,not all tangible capital-type items with useful lives extending beyond a single reporting period are required to be reported in a government's statement of position. Items with extremely short useful lives(e.g.,less than 2 years)or of small monetary value are properly reported as an"expense" or"expenditure" in the period in which they are acquired. When outlays for capital-type items are, in fact,reported on the statement of position, they are said to be capitalized. The monetary criterion used to determine whether a given capital asset should be reported on the balance sheet is known as the capitalization threshold. A government may establish a single capitalization threshold for all of its capital assets, or it may establish different capitalization thresholds for different classes of capital assets. Capitalization is, of its nature,primarily a financial reporting issue. That is, a government's principal concern in establishing specific capitalization thresholds ought to be the anticipated information needs of the users of the government's external financial reports.While it is essential to maintain control over all potentially capitalizable items,there exist much more efficient means than capitalization for accomplishing this objective in the case of a government's smaller tangible capital-type items.' Furthermore,practice has demonstrated that capital asset management systems that attempt to incorporate data on numerous smaller items are often costly and difficult to maintain and operate. Recommendation.The Government Finance Officers Association(GFOA)recommends that state and local governments consider the following guidelines in establishing capitalization thresholds: • Potentially capitalizable items should only be capitalized only if they have an estimated useful life of at least two years following the date of acquisition; • Capitalization thresholds are best applied to individual items rather than to groups of similar items(e.g., desks and tables),unless the effect of doing so would be to eliminate a significant portion of total capital assets(e.g.,books of a library district); • in no case should a government establish a capitalization threshold of less than $5,000 for any individual item; See GFOA's recommended practice on"Ensuring Control over Noncapitalized Items"(2006). j In establishing capitalization thresholds, governments that are recipients of federal awards should be aware of federal requirements that prevent the use of capitalization thresholds in excess of certain specified maximum amounts(i.e., currently$5,000) for purposes of federal reimbursement; and Governments should exercise control over potentially capitalizable items that fall under the operative capitalization threshold. Approved by the GFOA's Executive Board,February 24,2006. 2 See GFOA's recommended practice on"Ensuring Control over Noncapitalized Items"(2006).