Financial Management: Survey of Capitalization Threshold and Other Policies for Property, Plant, and Equipment
Released: 2002-10-15T00:00:00

Letter

Objectives, Scope, and Methodology

Our work was performed primarily using survey instruments to gather data on PP&E policies at 14 selected federal agencies and 12 private sector companies. Appendix II provides a list of all survey participants. We also held discussions with certain representatives of the participating federal agencies and private sector companies in developing the survey and in gathering follow-up information based upon the survey responses. We did not verify the accuracy of the data provided to us by the survey participants. We conducted our work from May 2001 through February 2002 in accordance with U.S. generally accepted government auditing standards. We requested comments on a draft of this report from the Department of the Treasury, OMB, all 14 federal agencies that participated in the survey, as well as the 12 private sector council member survey participants. Further details on our scope and methodology are included in appendix I.

Background

The Secretary of the Treasury, in coordination with the Director of OMB, is required to submit annually to the President and the Congress audited consolidated financial statements of the U.S. government beginning with those for fiscal year 1997. We are required to audit those statements. The principal financial statements required for federal agencies are the Balance Sheet, the Statement of Net Cost, the Statement of Changes in Net Position, the Statement of Budgetary Resources, and the Statement of Financing. These statements are to be prepared in accordance with U.S. generally accepted accounting principles. The balance sheet for the federal government presents the total balances of assets, liabilities, and net position as of a specific point in time. The government’s general PP&E, reported at almost $307 billion, net of accumulated depreciation as of September 30, 2001, represents approximately one-third of the assets on its balance sheet.

Federal Accounting Standards

Federal accounting standards, which agency CFOs use in preparing financial statements, are promulgated by the Federal Accounting Standards Advisory Board (FASAB). FASAB develops accounting standards after considering the financial and budgetary information needs of the Congress, executive agencies, other users of federal financial information, and the public. FASAB forwards the standards to the three principals—the Comptroller General, the Secretary of the Treasury, and the Director of OMB—for a review period, after which the standards are considered final, then published on FASAB’s Web site and in print. The American Institute of Certified Public Accountants recognizes the federal accounting standards promulgated by FASAB as being generally accepted accounting principles (GAAP) for the federal government. Currently, there are 22 SFFAS and three Statements of Federal Financial Accounting Concepts (SFFAC). The concepts and standards are the basis for OMB’s guidance to agencies on the form and content of their financial statements and the government’s consolidated financial statements.

FASAB significantly relied upon SFFAC No. 1, Objectives of Federal Financial Reporting, in drafting accounting standards for PP&E. The two principle reporting objectives relevant to PP&E are operating performance and stewardship. In developing PP&E standards to meet the operating performance objective, FASAB established the goal of measuring the cost associated with using PP&E and including that cost in entity operating results. In seeking to fulfill the stewardship objective, FASAB developed the PP&E accounting standards to result in reporting information on (1) asset condition, (2) changes in the amount and service potential of PP&E, (3) the cost of PP&E where applicable, and (4) spending for acquisition of PP&E versus noncapital spending.

Capitalization Thresholds and Estimated Useful Lives

Although FASAB established the reporting objectives framework in developing the PP&E accounting standards, it concluded that capitalization thresholds should be established by the federal entities themselves, based on their diversity in size and uses of PP&E. FASAB’s requirements in terms of establishing appropriate capitalization thresholds are that they be based on consideration of the entities’ financial and operational conditions, consistently applied, and disclosed in the financial reports. Before 1991, accounting principles, standards, and related requirements for executive agencies were published in appendix I of Title 2, “Accounting,” of the GAO Policy and Procedures Manual for Guidance of Federal Agencies, in accordance with 31 U.S.C. 3511. The capitalization threshold for federal agencies included in Title 2 was $5,000. In addition, under Federal Acquisition Regulations, government contractors are required to capitalize all assets costing $5,000 or more. Capitalization thresholds are tied to materiality as well, in that they generally are established at a level that would not omit a significant amount of assets from the balance sheet, which could materially misstate the financial statements of an entity or its components.

There is not an authoritative standard issued in the private sector specifically addressing capitalization threshold levels. However, the underlying GAAP state that all normal expenditures of purchasing or constructing an asset and readying it for use are capitalized, thereby achieving the matching principle by distributing the costs of such assets to the periods benefited through depreciation. Capitalization thresholds are set at levels that would not approach materiality in any foreseeable circumstances.

SFFAS No. 6 requires that depreciation expense be recognized on all general PP&E, except land and land rights of unlimited duration. Depreciation is the systematic and rational allocation of the costs of general PP&E to the operating periods benefiting from the asset, also referred to as the estimated useful life. FASAB again did not prescribe specific classifications of estimated useful lives. Instead, it requires that the useful life consider economic, environmental, and technological factors such as physical wear and tear and obsolescence.

In the private sector, GAAP state that depreciation method and rate depend upon such factors as time, usage, maintenance policies, and asset obsolescence, and recognize certain prescribed methods for allocating the cost to the periods benefited.

Federal PP&E

PP&E consists of tangible assets, including land, that have estimated useful lives of 2 years or more, are not intended for sale in the ordinary course of operation, and have been acquired or constructed with the intention of being used or being available for use by the entity. SFFAS No. 6, Accounting for Property, Plant, and Equipment, identifies four categories of PP&E: (1) general PP&E, (2) national defense PP&E, (3) heritage assets, and (4) stewardship land. General PP&E is used to provide general government services or goods and is reported on the balance sheet for federal financial reporting. National defense PP&E, heritage assets, and stewardship land are collectively referred to as stewardship PP&E and are reported in Supplementary Stewardship Information for federal financial reporting and are not included on the balance sheet or any other principal statement. FASAB has approved issuing a standard that would eliminate the category of national defense PP&E, and all items previously considered national defense PP&E would be classified as general PP&E. The focus of this report is on general PP&E, reported on the balance sheet of the U.S. government, which under current federal accounting standards does not include national defense PP&E.

General PP&E consists of items that (1) could be used for alternative purposes but are used by the federal entity to produce goods or services or to support the mission of the entity, (2) are used in business-type activities, or (3) are used by entities in activities whose costs can be compared to other entities. SFFAS No. 6 requires that all general PP&E be recorded at cost, which shall include all costs incurred to bring the PP&E to a form and location suitable for its intended use. General PP&E includes land acquired for or in connection with other general PP&E and heritage assets, whose predominant use is general government operations.

General PP&E is often classified into two main categories, personal and real property. Personal property includes vehicles, machinery, furniture, equipment, and software. Real property is land, buildings, and generally anything built or constructed on land, growing on land, or attached to the land.

Federal Agency Capitalization Thresholds Have Risen Significantly and Are Substantially Higher than Private Sector Capitalization Thresholds

Capitalization threshold levels at federal agencies have risen significantly over the past 5 years. Over 60 percent of the agencies surveyed have at least doubled their capitalization thresholds in the past 5 years. Further, federal capitalization threshold levels are significantly higher than those reported by the 12 private sector entities we surveyed. The maximum federal capitalization threshold levels reported for personal and real property were much higher than those reported by the private sector companies. Inappropriate or excessive capitalization thresholds have a significant impact on financial reporting and related oversight issues and may not comply with SFFAS No. 6 requirements.

Federal Capitalization Thresholds Have Risen Significantly in the Past 5 Years

Nine out of the 14 agencies surveyed reported that they had increased their capitalization thresholds in the past 5 years by 100 percent or more, for at least one category of property (excluding software). Figure 1 displays the increases by agency. Six agencies increased the capitalization threshold by 400 percent or more, 2 raising the threshold from $5,000 to $25,000, 2 raising the threshold from $5,000 to $100,000, 1 raising the threshold from $25,000 to $200,000, and 1 raising the threshold from $5,000 to $250,000. Appendix III provides detailed lists of the current capitalization level for both personal and real property by federal agency.

Reasons given by the surveyed federal agencies for changing the capitalization thresholds included materiality, implementation of federal accounting standards, management decision, or external auditor recommendation.

Twelve out of 14 federal agencies surveyed responded that they had performed some type of formal analyses or studies to develop or validate the capitalization threshold level. In some instances, the studies concluded that the threshold level was too low, prompting agency management to increase the capitalization threshold. Many agencies’ approaches to the capitalization threshold analyses involved applying varying threshold levels to PP&E balances to identify a capitalization level that resulted in a certain desired percentage of PP&E being captured on the balance sheet in relation to total PP&E. Although our survey asked for a brief description of the methodology used in the analyses, we did not request copies of the analyses from the federal agencies or assess the methodology or conclusions reached. We did note, however, that 5 of the 12 agencies solicited outside assistance in performing the analyses, and of those 5, 2 involved their respective offices of the inspector general.

Although DOD was not included in this review, the department holds a significant portion of federal PP&E. DOD’s reported general PP&E holdings for fiscal year 2001 were $113.8 billion, net of accumulated depreciation, representing approximately 37 percent of the federal government’s PP&E reported on the U.S. government’s consolidated balance sheet. DOD’s capitalization threshold has risen from $5,000 in 1994, to $50,000 in 1995, and to $100,000 in 1996, which remains the current level. DOD had contractors perform a study to validate its capitalization thresholds and useful life policies for personal and real property. We reviewed the contractors’ work and agreed that certain limitations they cited in their reports—such as that the databases they analyzed may not have been appropriate, complete, and accurate—could directly affect the assessment of the adequacy of the capitalization threshold and useful life policies. The contractor recommended that DOD undertake similar periodic analyses in future years.

Further, federal agency capitalization thresholds varied widely. They ranged from $0 to $250,000, excluding computer software, where the capitalization threshold ranged from $5,000 to $5 million. The lack of consistency in capitalization threshold levels among federal agencies could potentially lead to reporting problems in the U.S. government’s consolidated financial statements and performance measurement comparisons. For example, at some agencies major assets such as motor vehicles may be capitalized and at others they may not due to the varying capitalization threshold levels. As a result, the costs of vehicles used by certain agencies could be expensed in 1 fiscal year and not allocated to all the years benefiting from their use. Further, GAAP require that the capitalization threshold, including any changes in the threshold during the reporting period, be disclosed on the financial statements. Treasury has not disclosed the capitalization threshold used in the consolidated financial statements, or the fact that many reporting agencies have different capitalization thresholds.

Despite the sharp increase in the capitalization threshold, almost all of the surveyed agencies responded that they maintained property records for PP&E not capitalized on the balance sheet, for purposes of safeguarding PP&E, supporting agency operations, or fulfilling external reporting requirements. For example, all surveyed agencies indicated that they have policies and procedures in place, such as bar coding and periodic inventories, for safeguarding and maintaining accountability over pilferable and sensitive items. We did not evaluate the adequacy of the design of the agency policies and procedures or the effectiveness of the controls or their implementation. Even though 13 of the 14 federal agencies in our survey reported that they maintain property records for PP&E not capitalized on the balance sheet, most were unable to provide the cumulative value of PP&E recorded in property records but not capitalized on the balance sheet as of the end of fiscal year 2000. Only the National Aeronautics and Space Administration (NASA) and the Federal Aviation Administration (FAA) responded with the cumulative value of PP&E not reported on their balance sheets as of September 30, 2000—approximately $4.9 billion and $1.6 billion, respectively. However, we noted that NASA’s auditors for fiscal year 2001 reported a material weakness related to PP&E, so the amount NASA reported as being expensed may not be reliable.

Federal Capitalization Thresholds Differ Significantly from the Private Sector

Federal capitalization thresholds are significantly higher than those reported by the 12 private sector entities we surveyed. We found that the agency capitalization thresholds for personal property ranged from $3,000 to $200,000, and in some cases were 40 times higher than the maximum levels reported by the private sector participants. Table 1 compares the ranges of capitalization thresholds noted at the federal agencies surveyed to those of the private sector participants. Appendix IV provides the specific personal property responses for all survey participants by category.

As shown in table 1, private sector respondents’ threshold levels for personal property ranged from as low as $250 up to $5,000. Under these threshold levels, office equipment costing $20,000 with an estimated useful life of 5 to 7 years, would not be capitalized at more than half (9 out of 14) of the federal agencies surveyed, but would be capitalized at all of the private sector company participants.

Five of the surveyed federal agencies responded as having a separate capitalization threshold level for bulk purchases. A bulk purchase policy generally refers to capitalization guidelines when acquiring significant asset quantities in bulk at one time, where the individual unit price falls below the original threshold. For example, the National Oceanic and Atmospheric Administration’s (NOAA) policy is to capitalize a bulk procurement of $1 million or more for personal property with a unit price from $25,000 to its individual capitalization threshold of $200,000, if the items are identical. The Department of Education has a $500,000 bulk purchase policy, and the Social Security Administration (SSA) has a $10 million bulk purchase policy for computer hardware and software. Personal computers acquired individually would not be capitalized at many surveyed federal agencies under the current capitalization threshold levels, and bulk purchases of personal computers would have to rise to the capitalization threshold level, or higher at some agencies, as noted above, to be capitalized on the balance sheet. The remaining nine federal agencies responded that the capitalization threshold levels apply to both single item and bulk purchases of PP&E, as did the majority of the private sector companies surveyed. However, the few private sector respondents with bulk purchase policies indicate an emphasis on capitalizing assets and minimizing the impact on net income. For example, Pfizer responded that acquisitions of multiple like items would be capitalized if they exceed $10,000 in the aggregate, even though each item is under its $1,000 threshold level.

Certain federal agencies in our survey, as well as some private sector companies, reported capitalization thresholds specifically for software, classified as personal property on the balance sheet. The agencies’ capitalization thresholds for software ranged from $5,000 to $5 million, or 20 times higher than the maximum level reported by the private sector participants. The private sector respondents that reported specific capitalization threshold levels for software indicated ranges from $1,000 to $250,000. Figure 2 displays the percentages of surveyed federal agencies and private sector companies at each capitalization threshold level for software. As shown in figure 2, 92 percent of the federal agencies surveyed have threshold levels greater than $10,000 for software, compared to the private sector, with 25 percent of respondents in that category. The majority of the private sector software capitalization threshold levels were $10,000 and below. 75% SFFAS No. 10, Accounting for Internal Use Software, effective for reporting periods after September 30, 2000, was cited by several federal agencies as the basis for establishing a separate threshold just for software or increasing their capitalization threshold levels for software. SFFAS No. 10 requires the capitalization of the full cost (direct and indirect) of internal use software whether it is commercial-off-the-shelf, contractor developed, or internally developed. A specific capitalization threshold for software, separate from the threshold for all other personal property, may be warranted at many agencies due to the varying and incremental nature of the costs that go into software development, such as salaries. However, the threshold level for software also varies quite significantly among the federal agencies surveyed, which could result in the consolidation and comparison problems discussed previously. Appendix V provides the specific software responses for all survey participants.

Capitalization thresholds for real property ranged from zero, or no threshold, indicating that all such assets are capitalized on the balance sheet, to $250,000, which is 50 times the highest level reported by the private sector participants. Table 2 displays the capitalization threshold ranges for real property at the federal agencies surveyed compared to those in the private sector. Appendix VI provides the specific real property responses for all survey participants by category.

Private sector respondents’ threshold levels for real property ranged from $0 to $5,000. Under these threshold levels, a building costing $95,000 with an estimated useful life of 30 years would not be capitalized at some federal agencies surveyed, but would be capitalized at all of the private sector company participants. For example, Gillette, a large corporation with over $10 billion in assets, has a uniform threshold level of $2,500 for both real and personal property, with the exception of software.

As shown in tables 1 and 2, the threshold levels in the private sector for most personal property and real property are relatively low, and more consistent with the $5,000 capitalization threshold level previously established for federal agencies in Title 2 of the GAO Policy and Procedures Manual for Guidance of Federal Agencies, in accordance with 31 U.S.C. 3511. In addition, under Federal Acquisition Regulations, government contractors are required to capitalize all assets costing $5,000 or more.

Potential Impact of High Capitalization Thresholds on Financial Reporting

Our survey work was not designed to conclude on the reasonableness of the capitalization threshold levels being applied at the federal agencies or the private sector companies. However, the widely varying threshold levels among the federal agencies, the sharp increases in recent years, and the differences from private sector companies of considerable size in terms of reported PP&E and total assets raise some concerns. Inappropriate or excessive capitalization thresholds have a significant impact on financial reporting and related oversight issues and may not comply with SFFAS No. 6 requirements to capitalize all items that meet certain characteristics, such as a useful life of 2 years or more. FASAB believed that not specifying a threshold level, and allowing agencies broad latitude in establishing capitalization thresholds suited to their respective financial and operational conditions, would lead to a more cost-effective application of the accounting standard. However, objectives outlined by FASAB in the SFFAC No. 1, such as (1) stewardship responsibility, (2) capturing the full cost of operations, and (3) reliable financial reporting, may not be met as a result of the wide range and significant increase in threshold levels that we identified in our survey.

Excessively high capitalization thresholds reduce the amount of federal assets that are reported on the balance sheet, distorting financial reporting by potentially jeopardizing the matching of costs to the appropriate period of asset utilization. For example, in February 2000, we reported that an inappropriate capitalization threshold contributed to a material understatement in PP&E of approximately $1 billion, representing about 77 percent of the IRS’s total PP&E balances as of September 30, 1999. IRS had been following the Department of the Treasury’s standard $50,000 capitalization criterion, and now capitalizes most property and equipment regardless of the dollar amount, based upon the capitalization issues raised as a result of our financial audit of IRS.

Further, six of the agencies surveyed reported that they expensed a total of almost $2 billion in PP&E for the fiscal year ended September 30, 2000, and therefore did not report this amount on the U.S. government’s consolidated balance sheet as assets. While the $2 billion is a relatively small amount compared to the total PP&E or total assets reported on the consolidated financial statements of the U.S. government, this amount is incomplete, as the remaining eight agencies surveyed could not readily provide the amount expensed for the same period as a result of the PP&E acquisition costs not meeting the capitalization threshold. An assessment of whether the capitalization threshold has a material effect on financial reporting is difficult to make if agencies cannot provide the amount of assets that does not meet the capitalization threshold and is therefore expensed in a given year.

Interestingly, one of our surveyed federal entities, USPS, which sets its rates and fees to recover its costs, reported a $3,000 personal property capitalization threshold and $5,000 real property threshold, which is more in line with the surveyed private sector companies’ capitalization threshold levels. For example, Exxon Mobil Corporation, a global company with net PP&E of $90 billion as of December 31, 2000, also has a capitalization threshold of $3,000, excluding software. In fact, in looking at capitalization threshold levels for personal property in the private sector excluding software, all but 2 of the 12 participants had a threshold of $3,000 or less, and the remaining 2 had a $5,000 threshold.

As reported in our High-Risk Series, some federal entities do not yet have reliable financial and operational information to measure performance based on the costs of providing goods and services and therefore appear to have little incentive to maintain assets on the balance sheet through lower capitalization thresholds. For example, we reported in January 2001 that the Department of Agriculture (USDA) lacked financial accountability over billions of dollars of assets. FAA’s financial management was also designated as high risk because of serious and long-standing accounting and financial management weaknesses, including property system issues. Reliable information on the costs of federal programs and activities, of which PP&E is a major factor, is crucial for effective management of government operations.

Federal Agencies’ Estimated Useful Lives for Like Assets Are Similar

Useful lives for personal property ranged from 2 to 40 years among the surveyed federal agencies, but include a wide array of assets. Upon comparing the recovery periods for like assets, the range narrows. For example, the useful lives for motor vehicles ranged from 3 to 12 years in the federal agencies surveyed. Useful lives for real property at the surveyed federal agencies ranged from 5 to 100 years, which is a wide range that encompasses numerous and varying types of real property. The federal government’s real property is quite diverse, and includes items such as office buildings, dams, laboratories, courthouses, postal facilities, and embassies. However, when comparing the useful lives for similar buildings or structures across the federal government, the recovery periods are similar. For example, 12 out of the 14 surveyed federal agencies indicated useful life classifications for buildings of 30 to 40 years.

The useful life policies within the federal government were generally similar to those found in the private sector. No significant differences were noted between the federal government and the private sector survey respondents in the useful life policies for certain personal property categories such as equipment, furniture and fixtures, motor vehicles, and software. The ranges of useful life classifications for both federal and private sector company participants are shown in table 3 for personal property and in table 4 for real property. Appendixes VII and VIII detail the useful life ranges for personal and real property for each survey participant.

As noted above, the useful life ranges by category at the surveyed federal agencies are similar to those at the surveyed private sector companies. The high useful life of 40 years for equipment pertains to certain items at the Department of Energy (DOE), such as compressors and metal tanks. If such equipment were excluded, the maximum useful life classification for equipment at the surveyed federal agencies would be 25 years—identical to that in the private sector.

The few differences that we identified between federal agency and private sector useful lives are due to the different types of assets owned by the survey participants rather than any systemic differences in the useful life policies. For example, the maximum useful life classification for buildings was reported as 75 years by two surveyed agencies, the Department of the Interior’s Bureau of Reclamation and USPS. At the Bureau of Reclamation, the building useful life range of 30 to 75 years was reported for service facilities, which consist of houses, buildings, garages, and shops owned by the bureau and used in electric, irrigation, municipal and industrial, or multipurpose operations and are not included in the plant accounts of a specific project. At USPS, the 75-year building useful life was reported only for pre-July 1970 monumental (indicating stone or stone ornamentation) buildings. Other than these two specific classifications within the buildings category, the maximum useful life classification for buildings at the surveyed federal agencies would be 50 years, and identical to that in the private sector. Similarly, the 100-year useful life for other structures and facilities at the surveyed federal agencies was for dams and related property at the Bureau of Reclamation. The longest useful life reported by the private sector respondents is 40 years for other structures and facilities, but none of the private sector respondents reported an asset similar to a dam. We did not receive survey results from any private sector utility companies for comparison purposes because we were limited to the Private Sector Council (PSC) members that voluntarily participated in our survey.

Adequate useful life classifications also serve as a mechanism to achieve fair presentation of an entity’s financial position and results of operations in accordance with GAAP. New additions to PP&E that replace old or obsolete assets generally occur as the useful lives of the older assets are reaching completion, and the typical financial statement impact of the removal of an almost fully depreciated asset or a fully depreciated asset is minimal to none. However, if the useful life assigned to an asset or a class of assets does not reflect its actual service life, then the financial statement impact could be greater. For example, if an asset is assigned a useful life that exceeds its actual service life, the preliminary result would be an overstatement on the agency’s balance sheet and an understatement on its statement of net cost for a period. Conversely, if an asset’s designated useful life were lower than its actual service life, the preliminary result would be an understatement on the agency’s balance sheet and an overstatement on its statement of net cost for a period.

Observations

Our survey results identified widely varying capitalization threshold levels, sharp increases in recent years, and significant differences from private sector companies of comparable size. Because capitalization thresholds may have a significant effect on the consolidated financial statements of the U.S. government, this survey was designed as the first step in providing baseline information to analyze these significant PP&E policies and assess their impact on the financial reports of the U.S. government. In addition, agency management and auditors also have continuing responsibilities to ensure that established capitalization threshold levels are appropriate. These issues are especially critical for agencies that establish user fees based on actual costs and will become even more important as the government moves toward matching revenues and costs for performance measurement purposes. The information obtained as a result of our survey can be used as a tool for further analysis and assessment of these issues.

Comments and Our Evaluation

We provided a draft of this report to 14 federal agencies and 12 private sector companies that participated in our survey, as well as to the Department of the Treasury and OMB. We received comments from Treasury, OMB, and 4 of the 14 federal agencies surveyed, including USDA, the Department of the Interior (Bureau of Reclamation), NASA, and the Department of State (see appendixes XI through XV). Seven federal agencies, including the departments of Education, Energy, Justice (Bureau of Prisons (BOP)), Transportation (FAA), and Veterans Affairs (VA), as well as the Tennessee Valley Authority (TVA) and USPS, provided primarily editorial comments, which we have incorporated into the report as appropriate. The remaining 3 agencies, which include the Department of Commerce (NOAA), the General Services Administration (GSA), and SSA, reviewed a draft of this report and told us they had no comments. Three PSC members that participated in the survey, Allstate, McGraw-Hill, and PPG Industries, also provided primarily editorial comments, which we have incorporated into the report as appropriate.

The substantive comments we received from the Treasury, OMB, and federal entities had a common theme, in that they all generally took issue with comparing the capitalization threshold levels in the federal government to those in the private sector. For example, the Department of the Treasury stated that the private sector has income tax considerations that affect capitalization thresholds, but these are not an issue at federal agencies. In this regard, our private sector survey instrument (see appendix X) recognized this consideration by specifically asking for information regarding practices for financial reporting, or book purposes, and not for income tax reporting. USDA referred to inherent differences between the government and the private sector in reporting cost and income. NASA and the State Department commented that the report did not acknowledge the private sector’s profit objective, which they viewed as the main force behind its PP&E policies and practices, as distinctly different from the financial reporting objectives of the U.S. government.

Our views on asset capitalization are based upon two fundamental accounting concepts: the matching principle and materiality. The matching principle aims to assign costs to the proper period. In the case of capital assets, this is done through depreciation to recognize the use of the asset and can only occur if the asset is capitalized and not totally expensed when placed in service. The concept of materiality overlays the matching principle to provide relief from capitalizing and tracking assets that are immaterial to an entity’s financial statements. The establishment of a capitalization threshold policy must be supported by a detailed analysis, anchored by these two fundamental principles of matching and materiality. Furthermore, capitalization thresholds should be periodically reevaluated to help ensure their continuing relevance. Our report provides baseline data that we believe could be useful to federal agencies in analyzing capitalization thresholds. For example, NASA’s reported total assets as of September 30, 2000, were $34.5 billion, similar to Pfizer’s reported $33.5 billion at its fiscal year-end of December 31, 2000. NASA’s capitalization threshold for both real and personal property is $100,000 compared to Pfizer’s $1,000 threshold. Further, NOAA’s reported total assets at September 30, 2000, were $5.5 billion, similar to McGraw-Hill’s reported $4.9 billion at its fiscal year-end of December 31, 2000. NOAA’s capitalization threshold for both real and personal property is $200,000 compared to McGraw-Hill’s $2,000 threshold.

Our survey work was not designed to conclude on the reasonableness of the capitalization threshold levels being applied at the federal agencies or the private sector companies nor do we draw any conclusions. However, the widely varying threshold levels among the federal agencies, the sharp increases in recent years, and the large differences from private sector companies of considerable size in terms of reported PP&E and total assets are issues that we plan to review further. Inappropriate or excessive capitalization thresholds can have a significant impact on financial reporting by reducing the amount of federal assets that are reported on the balance sheet and by jeopardizing the matching of costs to the appropriate period of asset utilization.

While certainly differences exist between federal financial reporting objectives and those in the private sector, there are similarities as well. Both federal financial statements and those of private sector companies seek to provide reliable, useful, and timely information to their users. Similar to private sector companies’ responsibility to fairly state profits or net income, federal entities have a responsibility to fairly state the net cost of operations. This is also important in determining fees to be charged, in other efforts to recoup costs through any reimbursement arrangement, and in the ability to match costs with performance.

OMB’s comments also included similar concerns related to comparing federal capitalization threshold levels to those in the private sector. In addition, OMB noted that a comparison to the capitalization threshold levels of state and local governments would be informative, and referred to a recent survey of state comptrollers, done by the National Association of State Comptrollers (NASC). The results of the survey were reported in the July 2002 newsletter of the National Association of State Auditors, Comptrollers and Treasurers. While the NASC survey and its reported results appeared after we had completed our fieldwork, OMB felt strongly that the survey and its results should be mentioned in our report. Although a review of the NASC survey was not within the scope of our work, we noted that a significant portion of the states participating in the survey reported a $5,000 threshold, which is also the threshold required by the federal government for grant recipients’ recovery of costs under OMB Circular A-87. These thresholds, particularly those for personal property, are in line with those used by most of the private sector survey participants. Federal Acquisition Regulations also require federal government contractors to apply a capitalization threshold not to exceed $5,000.

OMB, Treasury, and the Bureau of Reclamation took issue with our statement that the lack of consistency in capitalization threshold levels among federal agencies could potentially lead to reporting problems in the U.S. government’s consolidated financial statements and performance measurement comparisons. As stated in our report, individual capitalization threshold levels are permissible under federal accounting standards, and because each federal agency was established with a specific mission, they may possess unique assets to achieve their respective goals. At the same time, consistent treatment of like assets is critical to accurate performance measurement and reliable, relevant consolidated financial reporting. Management has a responsibility to ensure that the financial statements are fairly stated, in all material respects, and the auditor’s role is to provide an opinion on that basic assertion, based on its work. As the auditor of the U.S. government’s financial statements, we must ensure that the varying capitalization thresholds do not result in or contribute to a material misstatement at the consolidated level. The results of our survey can provide useful baseline data to OMB and Treasury in their respective roles, and to agencies and their auditors as they continue to periodically assess the adequacy of the capitalization threshold in terms of material impact on financial reporting.

We are sending copies of this report to the Chairman and Ranking Minority Member, Senate Committee on Governmental Affairs; the Chairman and Ranking Minority Member, House Committee on Government Reform; the Chairman and Ranking Minority Member, Subcommittee on Government Efficiency, Financial Management and Intergovernmental Relations, House Committee on Government Reform; and other interested congressional committees. We are also sending copies to the Chief Financial Officers, the Inspectors General and other interested parties, including the survey participants, the Private Sector Council, and the Chairman of the Federal Accounting Standards Advisory Board. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you have any questions on this report, please contact me at (202) 512-9505 or Mary Arnold Mohiyuddin at (202) 512-3087.

Objectives, Scope, and Methodology

The objectives of this report were to determine (1) what are the federal government’s current capitalization threshold practices for PP&E and how such federal government policies compare to those practices being applied to PP&E in the private sector and (2) what are the useful life policies within the federal government and how they compare to those used in the private sector.

To fulfill these objectives, we developed two surveys, one for federal agencies and one for private sector companies. The surveys were used to collect information on capitalization thresholds and useful life policies, studies or analyses supporting those policies, and other related data that would assist us in determining the rationale for these PP&E policies as well as give us an indication of any differences or similarities between federal practices and private sector practices in the PP&E policy area.

For the federal government, we considered the 24 federal agencies responsible for annual audited financial statements as required under the CFO Act as expanded by the Government Management and Reform Act of 1994. We sent the survey to federal agencies with a reported $4 billion or more of net PP&E at September 30, 2000, except for DOD. For four agencies (Commerce, Interior, Justice, and Transportation), we surveyed a single component of the entire department due to the significant number of reporting components or because of the possibility of differing PP&E accounting policies for the various components. For each of those four agencies, we selected the component with the largest percentage of the total reported PP&E for that department. In addition, we randomly selected two federal agencies with net PP&E as of September 30, 2000, well below $4 billion to participate in the survey. We received completed surveys from all 14 federal agencies we contacted.

Although DOD is the largest holder of PP&E in the federal government, we chose not to include it in this survey. DOD had a study performed by contractors to validate its capitalization thresholds and useful life policies for personal and real property. We reviewed the contractors’ work and agreed that certain limitations they cited in their reports pertaining to the reliability and completeness of the data could directly affect the assessment of the adequacy of the capitalization threshold and useful life policies. Nonetheless, the reported value of net PP&E for federal survey participants represents over half of the federal government’s reported net PP&E as of September 30, 2000. Appendix II lists all agency survey participants.

We also surveyed member companies of the PSC, a nonprofit, nonpartisan public service organization committed to helping the federal government improve its efficiency, management, and productivity through cooperative sharing of knowledge. We sent our survey to all member companies, approximately 40, and received completed surveys from 12 PSC members. Appendix II contains the complete list of PSC survey participants.

We did not audit or verify the information provided by the federal agency or private sector survey participants in any way. We summarized the data collected from both survey groups, as reported to us by the respondents. We conducted telephone interviews with personnel at certain agencies and PSC members for follow-up questions or clarification purposes as needed.

The practical difficulties of conducting any survey may introduce errors, commonly referred to as nonsampling errors. For example, difficulties in how a particular question is interpreted, in the sources of information that are available to respondents, or in how the data are entered into a database can introduce unwanted variability into the survey results. We took steps in the development of the questionnaires, the data collection, and the data editing and analysis to minimize the nonsampling errors. For example, we pretested the questionnaires with a number of respondents to refine the survey instruments, we edited the surveys and called respondents to clarify answers, and we verified a sample of the survey data that was entered into our database for any keypunch errors.

We reviewed GAAP and concepts that related to PP&E accounting, as well as federal reporting guidelines issued by Treasury and OMB. In addition, we reviewed the financial statements and related notes to the financial statements of the federal agencies and private sector companies that participated in the survey.

We performed our work from May 2001 through February 2002 in accordance with generally accepted government auditing standards. We provided a draft of this report to 14 federal agencies and 12 private sector companies that participated in our survey, as well as to the Department of the Treasury and OMB. We received comments from Treasury, OMB, and 4 of the 14 federal agencies surveyed, including USDA, the Department of the Interior (Bureau of Reclamation), NASA, and the Department of State. Seven federal agencies, including the departments of Education, Energy, Justice (BOP), Transportation (FAA), and Veterans Affairs, as well as TVA and USPS, provided primarily editorial comments, which we have incorporated into the report as appropriate. The remaining 3, which include the Department of Commerce (NOAA), GSA, and SSA reviewed a draft of this report and told us they had no comments. Three PSC members that participated in the survey, Allstate, McGraw-Hill, and PPG Industries, also provided primarily editorial comments, which we have incorporated into the report as appropriate.

Survey Participants

Net PP&E/total assets (percentage)

Bureau of Prisons (DOJ)

Bureau of Reclamation (DOI)

Energy (except PMA PP&E)

FAA (DOT)

NOAA (Commerce)

Net PP&E/total assets (percentage)

Meredith Corp.

Capitalization Threshold Increases by Federal Agency

Capitalization threshold prior to current level not reported by agency, therefore no increase calculated.

Capitalization threshold prior to current level not reported by agency, therefore no increase calculated.

Capitalization Thresholds for Personal Property

TVA was not included in the above because it capitalizes entire projects instead of individual assets.

Meredith Corp.

Capitalization Thresholds for Software

TVA was not included in the above because it capitalizes entire projects instead of individual assets. Also, it has no specific software threshold.

Meredith Corp.

Capitalization Thresholds for Real Property

Federal agency did not report a capitalization threshold for this property category.

Meredith Corp.

Useful Life Ranges for Personal Property (in Years)

Meredith Corp.

Useful Life Ranges for Real Property (in Years)

Meredith Corp.

Federal Agency Survey

Private Sector Company Survey

Comments from the Department of Agriculture

Comments from the Department of the Interior

Comments from the National Aeronautics and Space Administration

Comments from the Department of State

Comments from the Department of the Treasury

GAO Contact and Staff Acknowledgments

GAO Contact

Acknowledgments

Staff members making key contributions to this report were Linda J. Brigham, Amy C. Chang, Francine M. DelVecchio, Cleggett S. Funkhouser, Stuart M. Kaufman, David C. Merrill, and Lisa M. Warde.

GAO’s Mission

The General Accounting Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony

The fastest and easiest way to obtain copies of GAO documents at no cost is through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full- text files of current reports and testimony and an expanding archive of older products. The Web site features a search engine to help you locate documents using key words and phrases. You can print these documents in their entirety, including charts and other graphics.

Each day, GAO issues a list of newly released reports, testimony, and correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site daily. The list contains links to the full-text document files. To have GAO e-mail this list to you every afternoon, go to www.gao.gov and select “Subscribe to daily E-mail alert for newly released products” under the GAO Reports heading.

Order by Mail or Phone

To Report Fraud, Waste, and Abuse in Federal Programs

Public Affairs

United States General Accounting Office Washington, D.C. 20548-0001