*This is Part 1 of a 3-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- This Part 1 addresses the general requirements/techniques, as well as those related to determining the estimated useful life of a tangible capital asset.
- Part 2 will address the area of depreciation methods and the determination of estimated residual values.
- Part 3 will address the accounting for gains/losses, cost allocation, and accounting for assets acquired prior to the applicability of CAS 409.
Background: This standard provides the criteria for assigning costs of tangible capital assets to cost accounting periods and for allocating such costs within such periods in an objective and consistent manner. The basic concept is that the amount assigned to each accounting period should be a reasonable measure of the expiration of the service potential of the tangible capital asset. The standard does not cover the amortization of intangible capital assets or the depletion of natural resources.
- CAS 409-40(a)(1) and 409-50(a) state that the depreciable cost of a tangible capital asset is its capitalized cost less its estimated residual value.
EXAMPLE: A contractor purchases an asset. Assume the capitalized cost in accordance with CAS 404 is $50,000, and the estimated residual value of the asset is $3,000. Based on these assumptions, the depreciable cost of the asset is $47,000 ($50,000 less $3,000).
- In accordance with CAS 409-50(a), the determination of the appropriate depreciation charges involves estimates of service life and the likely pattern on consumption of services. Factors to consider include the quantity and quality of expected output, costs of repair and maintenance, standby or incidental use, and technical and economic obsolescence of the asset.
EXAMPLE: A contractor purchases a machine for $1,000,000. In determining the appropriate depreciation charges, the contractor must estimate the service life and likely pattern of consumption, using the techniques for application contained in CAS 409.
- CAS 409-50(b) states that depreciation begins when the asset is ready for use in a normal or acceptable fashion. If partial use of an asset is identified with a specific operation, depreciation costs should be recorded for the portion of the asset that is used in performing the operation.
EXAMPLE: A contractor with a fiscal year that begins January 1 purchases a machine on October 30, 2012. The machine is delivered on December 28, 2012, and after installation is ready for use on February 1, 2013. The contractor must begin depreciating the machine in Fiscal Year 2013. The contractor may not depreciate any costs of the machine in Fiscal Year 2012, since the machine was not ready for use as of December 31, 2012.
- CAS 409-50(c) requires the contractor to follow a consistent policy in determining the depreciation cost when assets are placed in use or retired during an accounting period.
EXAMPLE: For purposes of computing depreciation, a contractor has a policy that places an asset in service as of the first day of the month after the asset is first ready for use. For example, if an asset is ready for use on January 14, for purposes of computing depreciation the asset is treated as if it was placed in service as of February 1. This method complies with CAS 409 provided the policy is consistently followed.
- Under CAS 409-50(d), assets may be accounted for as a single unit or by combining two or more assets into a single accounting unit, provided such treatment is consistently applied over the life of the asset or group of assets.
EXAMPLE: A contractor has a policy of grouping various machine tools into a single accounting unit. Historical records show that the average useful life for the machine tools is ten years, although the averages for individual tools vary between seven and twelve years. On January 1, 2013, the contractor purchases ten machine tools. Since the contractor has decided to group machine tools into a single accounting unit, all ten of the tools are depreciated over a period of ten years.
Estimated Service (Useful) Life
- CAS 409-40(a)(2) states that the estimated service life is used to determine which cost accounting periods the asset is assigned to.
EXAMPLE: A contractor that has a cost accounting period that ends on December 31 of each year purchases a truck on January 1, 2013. The truck has an estimated service life of five years. The depreciation costs of the truck are assigned to cost accounting periods 2013, 2014, 2015, 2016, and 2017.
- CAS 409-50(e) requires that the estimated service life of the asset be a reasonable approximation of the expected actual period of usefulness of the asset.
EXAMPLE: A contractor purchases a machine. The contractor uses an estimated service life of two years to depreciate the cost of the machine. The machine is expected to be operable for ten years. The contractor is in noncompliance with CAS 409. The estimated service life is ten years, which is the period of expected actual usefulness of the machine.
- CAS 409-50(e)(1) requires that estimated service lives be supported by records of past retirement or withdrawal from active use for like assets used in similar circumstances modified to reflect factors that will influence future lives. Factors that may reflect future lives include changes in quantity or quality of expected output, and changes in expected technological or economic obsolescence.
EXAMPLE: A contractor purchases a copying machine. Records of past retirements show that the copying machines usually last approximately three years. The contractor is unable to show that there are any factors that would justify modifying this past history. CAS 409 requires the estimated service life for the new copying machine be three years.
- Under CAS 409-50(e)(2), supporting records must show the age of the assets at retirement or withdrawal from active use for a sample of assets for each significant category.
EXAMPLE: A contractor maintains memorandum records that show the date of asset purchase and the date of asset disposition for each asset purchased by the contractor. The memorandum records also segregate the assets between the contractor’s major categories of tangible capital assets: machinery, buildings, computer equipment, automobiles, and trucks. The contractor’s practice complies with the requirements of CAS 409.
- CAS 409-50(e)(2) states that the burden is on the contractor to justify estimated service lives that are shorter than historical experience.
EXAMPLE: A contractor purchases a truck. Past history indicates that the truck has an estimated useful life of six years. The contractor uses an estimated life of four years because it does not believe they “make trucks like they used to.” The contractor is in noncompliance with CAS 409. The contractor has not provided sufficient justification to support the shorter useful life.
- When a contractor is initially required to comply with CAS 409, the contractor may not have adequate historical records to support estimated lives. In such cases, CAS 409 50(e)(3) requires the contractor to use estimated service lives used for financial accounting purposes, provided such lives are not unreasonable, until adequate supporting documentation is available. However, the contractor must develop current and historical asset records following the second fiscal year after CAS 409 becomes applicable.
EXAMPLE: A contractor has an applicability date for CAS 409 of January 1, 2013. The contractor has not maintained historical records to support estimated lives. For financial accounting purposes, the contractor uses five years for all computer equipment and automobiles, and 30 years for all buildings. The Cognizant Federal Agency Official believes these estimated lives are reasonable. The contractor may use these estimated service lives for FY 2013 and 2014. However, beginning January 1, 2015, the contractor must begin using historical records to support estimated lives.
- CAS 409-50(e)(4) requires that estimated service lives for assets the contractor has no available data or prior experience be based on a projection of the expected period of usefulness, but may not exceed the asset guideline periods used under Internal Revenue Procedures.
EXAMPLE: A contractor purchases a new fabrication machine. It is a revolutionary new state-of-the-art machine that has capabilities that go far beyond the prior models. In addition, the machine has been custom designed to fit the contractor’s unique processing requirements. The contractor has never owned a fabrication machine and is unable to find any comparable data to use in determining the estimated life of this machine. The IRS guidelines require that the machine be depreciated over a period that does not exceed twelve years. To comply with CAS 409, the useful life of the machine cannot exceed twelve years.
- In accordance with CAS 409-50(e)(5), the Government and the contractor may agree to use a shorter estimated service life than that specified in CAS 409 when the asset is used for a unique purpose or other special circumstances warrant a shorter estimated service life.
EXAMPLE: The contractor purchases a test facility with an estimated physical life of ten years. The test facility is to be used on a new Government program. It is expected that the program will be completed in six years. The test facility is not expected to be required for other products of the contractor. Although the facility will last ten years, the Cognizant Federal Agency Official and the contractor may agree to depreciate the facility over six years.
- CAS 409-50(g) requires that the estimated service life and depreciation method for an original complement of low-cost equipment be based on the expected consumption over the expected useful life of the complement as a whole. It is not based on the individual items that form the complement.
EXAMPLE: A contractor acquires a new lathe with an estimated service life of ten years. The contractor also acquires an original complement of equipment for the lathe that consists of a collection of tool holders, chucks, indexing heads, and wrenches. These individual items have an average life of six years. CAS 409 requires that the useful life of the complement equal the life of the lathe. Thus, an estimated service life of ten years must be used for the lathe and the original complement of equipment.