*This is Part 3 of a 3-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- Part 1 addressed the general requirements/techniques, as well as those related to determining the estimated useful life of a tangible capital asset.
- Part 2 addressed the areas of depreciation methods and the determination of estimated residual values.
- This Part 3 addresses 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.
Gains & Losses
- In accordance with CAS 409-40(a)(4) and CAS 409-50(j)(1), a gain or loss on the disposition of an asset is assigned to the period in which the asset is disposed of.
EXAMPLE: A contractor whose fiscal year ends on December 31 sells an asset on December 19, 2014. The contractor does not receive payment for the sale until January 15, 2015. The contractor must record the sale of the asset in the period ending December 31, 2014, since this is the period the asset was disposed of (sold).
- CAS 409-50(j)(1) states that the gain or loss is the difference between the net amount realized and the undepreciated balance of the asset. The net amount realized includes insurance proceeds in the event of involuntary conversion.
EXAMPLE: A contractor sells a machine for $10,000. The book value of the machine is $11,000. The contractor must recognize a loss of $1,000 (the difference between the net amount realized of $10,000 and the undepreciated balance of $11,000).
- In accordance with CAS 409-50(j)(1), the amount of any gain cannot exceed the difference between the original acquisition cost of the asset and its undepreciated balance.
EXAMPLE: A contractor purchases an asset on July 1, 2012, for $20,000. The contractor depreciates the asset for two years, with depreciation charges totaling $6,000. The book value of the asset on July 1, 2014 is $14,000 ($20,000 purchase price less depreciation charges of $6,000). On July 1, 2014, the contractor sells the asset for $22,000. The difference between the net amount realized ($22,000) and the undepreciated balance of the asset ($14,000) is $8,000. However, the gain cannot exceed $6,000, which is the difference between the original acquisition cost ($20,000) and the undepreciated balance of the asset ($14,000). Therefore, for purposes of CAS 409, the contractor recognizes a gain of $6,000.
- CAS 409-50(j)(2)(i) states that gains and losses are not recognized at the time of disposition for assets that are grouped. Instead, gains and losses are processed through the accumulated depreciation account (the gains or losses are embedded within the accumulated depreciation account).
EXAMPLE: A contractor has an established policy that the purchase of small tools is grouped in a single asset account entitled “Small tools”. When the tools are disposed of, any amount received from the sale is processed as a reduction to the accumulated depreciation account. In accordance with CAS 409, the contractor does not recognize a gain or loss on disposition, since the disposition is processed through the accumulated depreciation account.
- In accordance with CAS 409-50(j)(2)(ii), when an asset is given in exchange as part of the purchase price of a similar asset, the contractor’s policy can provide for either (a) inclusion of the gain or loss in computing the depreciable cost of the new asset; or (b) recognition of the gain or loss on the old asset at the time of the exchange. When the contractor’s policy provides for inclusion of the gain or loss in computing the depreciable cost of the new asset, no gain or loss is not recognized at the time of asset exchange.
EXAMPLE (a): The contractor’s policy is to include the gain or loss in computing the depreciable cost of the new asset when there is in exchange. A contractor purchases a new truck for $20,000. In exchange for the new truck, the contractor pays $12,000 and its old truck. The book value of the old truck at the time of the exchange is $7,000. The contractor computes the depreciable cost of the new truck as follows:
Cash Payment for New Truck $12,000
Book Value of Old Truck 7,000
Depreciable Cost of New Truck $19,000
By using the book value of the old truck, the depreciable cost of the new truck includes the gain or loss. Therefore, in accordance with CAS 409, a separate gain or loss is not recognized for this transaction.
EXAMPLE (b): Assume the same facts as in Example (a) above, except that the contractor’s policy is to recognize the gain or loss on the old asset at the time of the exchange. If the contractor had recorded the new truck at its purchase price of $20,000, the contractor would have recognized a $1,000 gain on the sale of the old truck computed as follows:
Purchase Price of New Truck $20,000
Cash Payment 12,000
Trade-In Value of Old Truck 8,000
Book Value of Old Truck 7,000
Gain on Sale of Old Truck $ 1,000
- In accordance with CAS 409-50(j)(2), a gain or loss is not recognized when an asset is disposed of in an involuntary conversion and the asset is replaced by a similar asset, if the contractor’s policy is to include the gain or loss in computing the depreciable cost of the new asset. Conversely, if the contractor’s policy is to not recognize the gain or loss in computing the depreciable cost of the asset, then the gain or loss is recognized in the period of asset disposition. Under CAS, an involuntary conversion is the forced disposition of property due to a casualty, theft, condemnation, or threat of condemnation.
EXAMPLE (c): The contractor’s policy for involuntary conversions is to include the gain or loss in computing the depreciable cost of the new asset. A contractor delivery truck is stolen. The book value of the truck was $10,000. The contractor receives insurance proceeds of $8,000 and uses these proceeds, as well as an additional $4,000, to purchase a new truck for 12,000. The depreciable cost of the new truck is computed as follows:
Book Value of Old Truck $10,000
Additional Cash Paid for New Truck 4,000
Depreciable Cost of New Truck $14,000
Since the book value of the old truck has been included in the computation of the depreciable cost of the new asset, the contractor does not recognize a separate gain or loss on the involuntary conversion of the old truck.
EXAMPLE (d): Assume the same facts as in Example (c), except that the contractor’s policy for involuntary conversions is to not include the gain or loss in computing the depreciable cost of the new asset. In that case, the contractor records the depreciable cost of the new truck at the $14,000 purchase price. The contractor also records a $2,000 loss on the involuntary conversion of the old truck, computed as follows:
Proceeds Received from Involuntary Conversion $ 8,000
Book Value of Old Truck 10,000
Gain (Loss) on Involuntary Conversion $(2,000)
- CAS 409-50(j)(3) states that the Government and the contractor may agree to account for gains and losses from mass or extraordinary dispositions in a manner that will result in equitable treatment for all parties.
EXAMPLE: A contractor owns a plant that contains fifty pieces of equipment, including milling, fabricating, assembly, and printing machines. The contractor undergoes a major renovation of the plant, which includes the disposition of all fifty machines. The decision to renovate the plant was made on October 1, 2012, and the disposition occurred on December 20, 2012. The contractor has a fiscal year that ends on December 31. The loss on the disposition of the equipment is $5 million. Rather than recognize the entire loss in 2012, the Government and contractor agree to recognize $2 million in 2012 and $3 million in 2013. This agreement is in accordance with the provisions of CAS 409 for mass or extraordinary dispositions. Note that the contractor and Government must agree on how to account for the gain or loss. If the contractor and Government cannot agree, the gain or loss is recognized in the period the mass or extraordinary disposition occurs.
- CAS 409-50(j)(4) requires that gains or losses on disposition of tangible capital assets transferred in other than an arms-length transaction and disposed of within 12 months from the date of transfer must be assigned to the transferor.
EXAMPLE: On January 1, 2012, a contractor’s Government segment purchases a machine from a wholly-owned subsidiary for $20,000. From January 1, 2012 to July 1, 2012, the contractor records $1,000 depreciation cost on the machine. On July 1, 2012, the contractor disposes of the machine to an unrelated party, receiving $12,000 in proceeds. The contractor records a loss of $7,000, computed as follows:
Book Value ($20,000 – $1,000 Depreciation) $19,000
Loss $ 7,000
While the loss is computed at $7,000, CAS 409 prohibits the contractor from assigning that loss to the Government segment, but instead requires that it be assigned to the wholly-owned subsidiary.
- A gain or loss on the disposition of an asset is allocated to cost objectives in the same manner as the depreciation cost was or would have been. If the gain or loss is not material, the amount may be included in an indirect cost pool (CAS 409 40(b)(4)).
EXAMPLE: On the first day of its fiscal year, January 1, 2002, a contractor purchases a printing machine. During 2002, 2003, and 2004, the depreciation costs of the machine are charged to the overhead pool. On December 31, 2004, the contractor disposes of the machine, recognizing a gain of $5,000. The contractor must record the $5,000 gain in FY 2004 as a credit (reduction) in the overhead expense pool.
- Under CAS 409-40(b)(1), (2), and (3), depreciation is generally charged to an indirect cost pool. However, depreciation can be charged as a direct cost when (a) the depreciation is based on usage, or (b) the tangible capital assets are part of an organization that charges costs on the basis of a measurement of service (e.g., a service center).
EXAMPLE: A contractor purchases a forklift. The forklift will be used to load and unload materials on the loading dock. It is not practical to charge the depreciation costs based on usage, and the forklift is not part of a service center. Therefore, in accordance with CAS 409, the contractor must charge the depreciation costs of the forklift as an indirect cost.
- In accordance with CAS 409-50(k), when asset deprecation costs are charged direct to cost objectives on a usage basis, an average rate based on cost must be established for the use of such assets. Any variances between the total depreciation cost charged to cost objectives and the total depreciation cost for the cost accounting period must be accounted for in accordance with the contractor’s established practices for handling such variances.
EXAMPLE: A contractor has a machine that sews buttons on garments. The annual deprecation cost on the machine is $100,000. The contractor estimates that it will process 10,000 garments on the machine during the period. Therefore, the contractor charges $10 for each garment processed. The actual garments produced during the fiscal year are shown below:
|Contract||Garments Produced||Costs Charged|
The contractor has an established practice of charging any variances between estimated and actual costs for the garment machine to the overhead pool. Thus, at the end of the year, the contractor charges an additional $10,000 to the overhead pool, computed as follows:
Depreciation Costs $100,000
Charges to Users 90,000
Variance $ 10,000
The contractor’s method of accounting for depreciation costs of the garment machine is in compliance with CAS 409. The contractor computes an average rate for usage and has an established practice for disposing of the variances.
- Under CAS 409-40(b)(2), depreciation costs for tangible capital assets that are part of an organization that charges costs on the basis of a measurement of services (e.g., a service rate) shall be included in the computation of that rate.
EXAMPLE: A contractor has a number of copying and other printing machines that are part of its reproduction service center. The service center computes a total cost for the service center, which includes the depreciation costs for all the machines in the center. The service center uses these costs to develop various service rate (basic copying, color copying, binding, etc.), which is the basis for charges to users. The variance between the charges to users and the actual costs is charged pro-rata to all users at the end of the accounting period. This practice complies with CAS 409, since the machines are part of an organization that charges costs on the basis of a measurement of service.
Assets Acquired Prior to the Applicability of CAS 409
- In accordance with CAS 409-50(l), for assets acquired prior to the applicability of CAS 409, the contractor may continue to use prior practices for determining depreciation methods, estimated service lives and residual values provided those practices are acceptable under applicable procurement regulations. Any changes to those practices after the applicability date of CAS 409 must conform to the criteria in CAS 409.
EXAMPLE: A contractor owns a fleet of delivery vans. The contractor has been computing depreciation cost for Government contract costing, Federal income tax, and financial reporting purposes using an estimated life of five years, although its historical records indicate that the actual average historical life of the vans is eight years. CAS 409 becomes applicable to the contractor as of January 1, 2014. The contractor may continue using the five year historical life to depreciate the vans it owns as of December 31, 2013. However, any vans purchased on or after January 1, 2014 must be depreciated using an eight year life.