FOCUS: FINANCE AND BUDGETING

Managing and for Fixed

William C. Rivenbark

ixed assets represent a signifi- at their original historical and cant investment of public dol- remain at that value throughout Flars for local governments and their life. Fixed assets purchased by public authorities. Items that consti- “proprietary funds” (business-like tute fixed assets are tangible in na- funds, such as public utilities) are ture and normally have a useful life capitalized at their original histori- of at least two years. Commonly cal cost and depreciated over their used classifications of fixed assets are useful life. Items of insignificant land, buildings, equipment, and ve- value are simply expensed in their hicles. year of purchase. Maintaining control of fixed assets is Localities tend to capi- a function of the entire organization, talize assets at dollar values not just the accounting department. To much lower than needed, maintain financial control of fixed as- ✓ setting policy primarily to sets from an accounting perspective, a satisfy the internal control locality must properly report their value FIXED function rather than the fi- on its annual financial statements. To portant to staff, managers, nancial reporting function.2 They maintain internal control from a man- council members, investors, and should set the dollar value for capi- agement perspective (that is, to ensure creditors. External auditors issue a talization of assets with the objective of use of the assets for authorized pur- “qualified opinion” if they find accurately reporting the value of fixed poses and to prevent their misuse or that the financial statements are inad- assets on their annual financial state- theft), the locality must assign custodial equate in a material respect. Lack of ments. Internal control of fixed assets responsibility for fixed assets to the de- control over fixed assets is one of the should be addressed in the fixed assets partment and division managers who primary causes for receiving a qualified policy by more effective means than the employ them for service delivery. A audit opinion. For localities that receive capitalization threshold. fixed assets policy based on the recom- a qualified opinion concerning their ac- mended practices of the Government counting for fixed assets, the LGC will Legal, Administrative, and Finance Officers Association (GFOA) no longer authorize the issuance of GAAP Requirements and the Local Government Commis- long-term debt (bonds).1 sion (LGC) is essential to obtaining The purpose of this article is to en- The North Carolina General Statutes both types of control. courage localities to review their fixed (hereinafter G.S.) do not address the External auditors review fixed assets assets policies and to establish capitali- management of fixed assets in detail, records and internal controls during the zation thresholds based on criteria pro- providing flexibility for local govern- annual audit. They issue an “unquali- posed by the GFOA and the LGC. A ments. G.S. 159-26(a) states that “each fied audit opinion” if the general- “capitalization threshold” is the dollar local government or public authority purpose financial statements present value at which assets are “capitalized” shall establish and maintain an ac- fairly, in all material respects, the finan- (carried on the ) rather counting system designed to show in cial position of the organization. This than “expensed” (shown on the general detail its assets, liabilities, equities, rev- type of audit opinion is extremely im- ledger as a decrease in and an in- enues, and expenditures.” Additionally, crease in expenditures). Fixed assets G.S. 159-26(b)(8) requires that an ac- The author is an Institute of Government purchased by “governmental funds” counting system be designed to provide faculty member who specializes in local (public-purpose funds, such as public for “a ledger or group of accounts in government administration. safety and public works) are capitalized which to record the details relating to

spring 2000, popular government 35 the general fixed assets of the unit or External auditors zation threshold is likely to be lower public authority.” than needed, and fixed assets records The North Carolina Department of move toward a become difficult to manage. The finan- State Treasurer Policies Manual ex- qualified audit opinion cial reporting goal is to record the nec- pounds on G.S. 159-26(a) and G.S. essary information accurately when a 159-26(b)(8), providing detailed in- when fixed assets is acquired, maintain the in- structions on fixed assets management, records do not formation during the life of the asset, including the capitalization threshold. and delete the information after dis- It concludes that the dollar amount set materially reflect the posal of the asset. Localities can de- for capitalizing assets is a policy deci- value of fixed assets or crease the probability of a qualified au- sion of the governing board. dit opinion by following the recommen- Three of the twelve generally ac- when proper internal dations of the GFOA and the LGC. cepted accounting principles (GAAP) controls are not in place deal directly with managing and ac- to safeguard the assets. Capitalization Threshold counting for fixed assets.3 None of the principles, however, address what is a An effective fixed assets policy must be proper capitalization threshold, again guard the assets. Therefore, in develop- tailored to the individual needs of an leaving that to each locality to decide ing a fixed assets policy, local officials organization. Therefore the organiza- on the basis of its individual needs. should understand the audit process tion must reconcile the recommenda- and likely sources of problems. tions offered by the GFOA and the Fixed Assets Records The external auditors begin with an LGC with its own demands. examination of the organization’s fixed Estimating the useful life of assets. A and Audit Findings assets policy and procedures. At this fixed assets policy should begin by stat- point the auditors are determining ing its purpose and effective date. It Fixed assets records are used for a vari- whether adequate controls are in place then should define fixed assets. The ety of reasons and should be accurate and whether the organization is follow- LGC maintains that “fixed assets are and complete. They are periodically ing its policy and procedures. Auditors tangible in nature and have a useful life reconciled with departments’ actual typically intensify their examination of longer than one year. They are classified fixed assets to ensure fulfillment of the fixed assets records when they uncover as land, improvements other than departments’ custodial responsibility. problems during this initial review. buildings, buildings, operating plants, Risk management personnel use them Problems tend to emanate primarily equipment, and construction in prog- to ensure that the organization is prop- from one of the following areas: ress.”6 The GFOA promotes a similar erly protected with insurance cover- definition but states that “fixed assets age.4 Analysts often need fixed assets 1. Fixed assets already disposed of should be capitalized only if they have records when completing special as- still appear on the fixed assets list. an estimated useful life of at least two signments, and they are used to report This is the most common source of years following the date of acquisi- the beginning value, additions, dispos- audit problems. tion.”7 Normally a locality capitalizes als, and ending value of an entity’s fixed 2. Fixed assets recently purchased by assets with a useful life of at least two assets on the annual financial state- the organization are not listed on years unless special circumstances dic- ments. the fixed assets list. tate otherwise. External auditors move toward a 3. Fixed assets that appear on the Determining the threshold. The next qualified audit opinion when fixed as- fixed assets list are not valued cor- step is to establish the capitalization sets records do not materially reflect the rectly. threshold. In practice, land and build- value of fixed assets or when proper in- For at the end of ings always are capitalized, so the capi- ternal controls are not in place to safe- 1998, external auditors identified fixed talization threshold primarily applies to assets weaknesses as problems for ap- equipment and vehicles. The GFOA proximately 12.5 percent of North maintains that “as a general rule, capi- Carolina local governments and public talization thresholds should be de- authorities.5 If not corrected, these signed to encompass approximately problems can force an 80 percent of a government’s total FIXED to issue a qualified opinion for a lo- noninfrastructure assets”—that is, as- ASSET✗ cality’s financial statements. sets other than items like roads, bridges, One key to avoiding the major prob- and sidewalks.8 In addition, the GFOA lem areas is to avoid basing a capitaliza- recommends that a government never tion threshold solely on the in- use a capitalization threshold of less ternal control function. When than $1,000 for any individual item.9 concerns about internal control The LGC states that “equipment and dictate the dollar value for vehicles costing $500 or more should capitalizing assets, the capitali- be recorded as fixed assets.”10 To rec-

36 popular government, spring 2000 Internal Control Function tag and track these assets. This form of control can be more effective in pre- Although the capitalization threshold is venting misuse than a control mecha- primarily a financial reporting issue, a nism located in the accounting area. locality should address the internal con- The organization therefore should as- trol function during the development of sign custodial responsibility to indi- its fixed assets policy. Localities often viduals who can immediately detect need to track certain assets regardless of problems associated with fixed assets. value—weapons purchased by the po- For an additional control measure, the lice department, for example. The finance department should maintain LGC suggests that localities faced copies of all assets records. with this issue assign a value of Conducting periodic . one dollar to each asset and track The GFOA recommends conducting it accordingly.13 (Assigning a one- periodic inventories of capitalized fixed dollar value overcomes the prob- assets and supports a physical count FIXED lem that some accounting software based on a rotating method to ensure packages will not let the user enter as- that all fixed assets are accounted for ASSET 15 ? sets with a value of zero). at least once every five years. The Establishing multiple capitalization LGC recommends annual verification thresholds. The GFOA maintains that a of the existence and the condition of oncile the two recommendations, lo- “government may establish a single all fixed assets.16 The LGC recommen- calities should begin by applying the 80 capitalization threshold for all of its dation is more realistic for adequate percent rule. As for the actual dollar fixed assets or establish multiple capi- control but should be expanded to threshold for individual assets, a man- talization thresholds for different include certain assets that may fall be- ageable one would normally fall be- classes of fixed assets.”14 Localities low the capitalization threshold. For tween $1,000 and $5,000 for larger lo- should consider multiple thresholds to example, periodically, localities should calities.11 Smaller localities may have to control certain specialty items—for physically verify the existence of weap- employ a threshold of less than $1,000 example, data processing equipment. ons, computer equipment, and lawn- to reflect the value of fixed assets mate- Multiple capitalization thresholds maintenance equipment that are not rially. Localities should be extremely sometimes are appropriate, but locali- capitalized. cautious when adopting a capitaliza- ties should be careful not to expand ex- tion threshold of less than $500. A cessively the number of items that they Reporting of a Change in the lower threshold begins to compromise must record as fixed assets. Capitalization Threshold the accuracy of the fixed assets records Assigning custodial responsibility. because it results in the need to record The fixed assets policy should require When a locality increases its capitaliza- and track a large number of items. department and division managers to tion threshold, it must delete from the Applying the capitalization thresh- establish procedures that address the fixed assets list the items that fall below old. The fixed assets policy should ad- control not only of fixed assets but of the new dollar value. It also must adjust dress whether the capitalization thresh- assets that fall below the capitalization the notes to its financial statements17 old applies to individual assets or threshold. With a threshold of $1,000, (see Table 1 for an illustration of how groups of assets. The GFOA recom- for example, most lawn-maintenance to show this change for general fixed mends that capitalization thresholds equipment, like mowers and shredders, assets).18 apply to individual fixed assets only.12 would not be capitalized. However, de- Reporting the actual dollar amount The LGC approaches this issue slight- partment and division managers must of the new capitalization threshold is ly differently, giving localities the needed flexibility to record groups of Table 1. General Fixed Assets assets. For example, the value of in- dividual desks in local schools may June 30, 1999 Adjustments Additions Disposals June 30, 2000 fall well below the capitalization $$$$$ threshold. However, together the desks represent a significant investment and Land and improvements 1,000,000 –– 10,000 –– 1,010,000 may have a material impact on the over- all value of fixed assets if they are not Buildings 14,000,000 –– –– –– 14,000,000 capitalized. If a locality is going to capi- Furniture and talize groups of assets, its fixed assets equipment 5,000,000 (1,500,000) 500,000 (400,000) 3,600,000 policy should specify what groups and Vehicles 8,000,000 –– 1,000,000 (1,000,000) 8,000,000 why. The reason is to avoid ambiguity 28,000,000 (1,500,000) 1,510,000 (1,400,000) 26,610,000 that may cause problems during the au- dit process. Note: The $1,500,000 in adjustments reflects a change in the capitalization threshold.

spring 2000, popular government 37 of capital assets records (because 3. Principle 5 requires a clear distinc- capital assets records will contain tion between general fixed assets and fund more auditable information than fixed assets. Principle 6 requires the record- fixed assets records do). That in turn ing of all fixed assets at their will place additional impor- or at their estimated historical cost if their tance on establishing a man- actual cost cannot be determined. Principle 7 addresses the of fixed assets, ageable capitalization thresh- requiring that depreciation be recorded in old. proprietary funds and certain trust funds. Depreciation is not recorded in governmen- Conclusion tal funds, but accumulated depreciation may be recorded in the General Fixed Assets The capitalization thresh- Group (GFAAG), although few old and the internal governments currently choose this option. control function are See GOVERNMENTAL ACCOUNTING STANDARDS extremely important to BOARD, GOVERNMENTAL ACCOUNTING AND FI- ✓ a meaningful and NANCIAL REPORTING STANDARDS (Norwalk, FIXED manageable fixed as- Conn.: GASB, 1995). 4. ROBERT J. FREEMAN & CRAIG D. sets policy. Localities ASSET SHOULDERS, GOVERNMENTAL ACCOUNTING & also should address other FINANCIAL REPORTING (Lubbock: Center for optional. The purpose of the adjust- areas when constructing a fixed assets Professional Development, Texas Tech Uni- ments column is to avoid overstating policy, including the use of only capital versity, 1996). the disposal of fixed assets and to let the accounts to purchase fixed assets and 5. Telephone Interview with Cheryl J. reader know that a change has been the offering of annual training in the Spivey, Assistant Director of Fiscal Manage- made. In Table 1 the $1.5 million value management of fixed assets. Often ment, N.C. Local Government Commission decrease resulting from an increase in overlooked, annual training is an excel- (Oct. 14, 1999). the capitalization threshold is relatively lent way to expose employees regularly 6. DEPARTMENT OF STATE TREASURER, small compared with the overall total of to the idea that managing assets is a POLICIES MANUAL at § 20, p. 4. approximately $26.6 million. The ma- function of the entire organization, not 7. GFOA, RECOMMENDED PRACTICES at 15. jor impact of the change is the number just the accounting department. 8. GFOA, RECOMMENDED PRACTICES of items that have been removed from Local governments tend to capitalize at 15. the fixed assets list. assets at overly low dollar values. When 9. GFOA, RECOMMENDED PRACTICES. seen only in the context of control, this 10. DEPARTMENT OF STATE TREASURER, New Requirements for practice is explainable. Capitalization POLICIES MANUAL at § 20, p. 7. Recording Infrastructure and thresholds, however, are a function of 11. Current federal requirements pre- Depreciating Capital Assets financial reporting. The guidance pre- vent the use of capitalization thresholds sented by the GFOA and the LGC of- greater than $5,000 for purposes of grant The Governmental Accounting Stan- fers a logical approach for establishing reimbursement. dards Board’s recent passage of State- a meaningful and manageable capitali- 12. GFOA, RECOMMENDED PRACTICES. ment No. 34 has heightened the impor- zation threshold. Based on the need for 13. DEPARTMENT OF STATE TREASURER, 19 POLICIES MANUAL. tance of accurate fixed assets records. materially accurate financial state- 14. GFOA, RECOMMENDED PRACTICES The new pronouncement requires the ments, the guidelines are designed to recording and the tracking of infra- at 15. reduce the possibility of a qualified 15. GFOA, RECOMMENDED PRACTICES. structure along with customary fixed opinion stemming from lack of control 16. DEPARTMENT OF STATE TREASURER, assets. Further, because of its inclusion of fixed assets. Local government and POLICIES MANUAL. of infrastructure, the board has sub- public authority administrators, as well 17. GOVERNMENT FINANCE OFFICERS AS- stituted the term “capital assets” as council members, should be proac- SOCIATION, GOVERNMENTAL ACCOUNTING, AU- for “fixed assets.” The capitalization tive in constructing a comprehensive DITING AND FINANCIAL REPORTING (Chicago: threshold will not be a major issue in fixed assets policy. Accountability, GFOA, 1994). determining whether to record infra- credit quality, and time are at stake. 18. The change in capitalization levels is structure or not. Like land and build- a change in accounting policies. For propri- ings, infrastructure is almost always re- etary funds, fixed assets and accumulated corded as a capital asset. The issue is Notes depreciation are adjusted for the amounts with a new depreciation requirement removed, and the difference between the 1. NORTH CAROLINA DEPARTMENT OF two amounts is shown as an adjustment to for governmental funds. After the im- STATE TREASURER, POLICIES MANUAL (Raleigh, beginning retained earnings. plementation of Statement No. 34, N.C.: 1992). 19. GOVERNMENTAL ACCOUNTING STAN- capital assets, including equipment and 2. GOVERNMENT FINANCE OFFICERS AS- DARDS BOARD, BASIC FINANCIAL STATEMENTS— vehicles, will have to be depreciated. SOCIATION, RECOMMENDED PRACTICES FOR AND MANAGEMENT’S DISCUSSION AND ANALY- This requirement will force external STATE AND LOCAL GOVERNMENTS (Chicago: SIS—FOR STATE AND LOCAL GOVERNMENTS auditors to intensify their examination GFOA, 1999). (Norwalk, Conn.: GASB, 1999).

38 popular government, spring 2000