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5.3. ERMUSR 01-13-2004 December 18, 2003 TO: Bryan Adams, General Manager FROM: Patricia Hemza, Office Manager RE: GASB 34 Please find the attached Capital Asset Guide, which will be our document to comply with Governmental Accounting Standards Board (GASH) Statement 34. The document is the same as the Guide used by the Ciry of Elk River, with adaptation for specifics of the Utility. The depreciation schedules have remained the same, and some of our plant accounts have been combined for purposes of meeting thresholds, and for reporting. ERMU has in fact, been compliant in most cases for the past twenty years. All fixed assets of the electric and water for the ERMU have been tracked since inception, and depreciation properly recorded. In some cases, there will be expenses that do not meet the capital dollar amount threshold, which will have some impact on the P & L, but at this time it is unclear how much the effect will be. In any case, in four to five years, the depreciation expense, and the expensing of lower costs, once considered capital, and now maintenance, will even out. In conclusion, the changes are good, and will actually simplify certain accounting functions, with the clearly stated rules. The Elk River Municipal Utilities Commission will need to adopt the GASB 34 Policy. CAPITAL ASSET GUIDE Introduction For fiscal year ending December 31, 2003, Elk River Municipal Utilities will be required to implement Governmental Accounting Standards Board (GASB) Statement No. 34, Basic Financial Statements—and iLlanagement's Discussion and Analysis—for State and Local Governments. Statement No. 34 establishes new financial reporting requirements for state and local governments throughout the United States. When implemented, it will create new information and will restructure much of the information that governments have presented in their annual reports in the past. The intent of these new requirements is to make annual reports more comprehensive and easier to understand and use. Two key implementation challenges that the new reporting model presents are, infrastructure reporting and depreciation accounting. Statement No. 34 requires governments to report general infrastructure assets and depreciate general governmental capital assets over their estimated useful lives. While this document is not all encompassing, it has been prepared to provide general guidance on implementing the new reporting requirements in regards to capital assets for financial reporting purposes only. The primary objectives of financial reporting generally pertain to valuation, allocation, presentation and disclosure; therefore, this policy should not be used for property control purposes. This policy will take effect on: 1 Capital Assets and Capitalization Thresholds A capital asset is real or personal property that has a value equal to or greater than the capitalization threshold for the particular classification of the asset and has an estimated useful life greater than one year. The Utilities reports capital assets in the following categories: • Land/ land Improvements • Other improvements • Buildings building Improvements • Machinery and Equipment • Vehicles • Infrastructure • Construction in Progress For financial statement purposes only, a capitalization threshold is established for each capital asset category as follows: Capital Asset Category Capitalization Threshold Land/land improvements $10,000 Other improvements $25,000 Buildings and building improvements $25,000 Machinery and Equipment $5,000 Vehicles $5,000 Infrastructure $100,000 Construction in progress Accumulate all costs and capitalize if over $100,000 when completed Other Assets $5,000 Another criterion for recording capital assets is capital-related debt. Capital assets purchased with debt proceeds should be capitalized and depreciated over their estimated useful life. Capitalizing these assets would minimize the potential of negative net assets being reported in the statement of net assets. In most cases it would be expected that these assets would normally meet the thresholds and guidelines for recording as a capital asset. 2 Reporting Capital Assets Capital assets should be recorded and reported at their historical costs, which include the vendor's invoice (plus the value of any trade-in or allowance, if reflected on the invoice), plus sales tax, initial installation cost, attachments, accessories or apparatus necessary to make the asset usable and render it into service. Historical costs also include ancillary charges such as freight and transportation charges, site preparation costs, and professional fees. When the historical cost of a capital asset is not practicably determinable, the estimated historical cost of the asset should be determined by appropriate methods and recorded. Estimated historical cost should be so identified in the record and the basis of determination established in the responsible entity's public records. The basis of valuation for capital assets constructed by entity personnel should be the costs of material, direct labor and overhead costs identifiable to the project. An entity that owns capital assets is responsible for correctly reporting these assets at the date of acquisition. Donated capital assets should be reported at fair value I at the time of acquisition plus ancillary charges, if any. Donations are defined as voluntary contributions of resources to a governmental entity by a nongovernmental entity.2 Depreciating Capital Assets New to general governmental capital assets is the requirement to depreciate those assets over their estimated useful lives. Depreciation is the process of allocating the cost of an asset over the periods that asset is used for its intended purpose. Capital assets should be depreciated over their estimated useful lives unless they are: • Inexhaustible (i.e., land and land improvements, certain works of art and historical treasures), • Infrastructure assets reported using the modified approach, or • Construction work in progress 'Fair value is the amount at which an asset could be exchanged in a current transaction between willing parties A voluntary contribution of resources between governmental entities is not a donation. 3 For financial statement purposes, the straight-line method will be used to calculate depreciation for each capital asset recorded. Under the straight-line depreciation method, the basis of the asset is written off evenly over the useful life of the asset. The same amount of depreciation is taken each year. In general, the amount of annual depreciation is determined by dividing an asset's depreciable cost by its estimated life. The total amount depreciated can never exceed the asset's historic cost less salvage value. At the end of the asset's estimated life, the salvage value will remain. Improvements vs. Repairs/maintenance A significant issue when recording capital assets is the question of when is an expenditure capitalized as an improvement versus recorded as repairs or maintenance expense. Generally, the driving factors behind capitalizing cost are those related to significantly extending the useful life, increasing capacity, or improving the efficiency of capital assets. Capital asset improvement costs should be capitalized if: 1. The costs exceed the capitalization thresholds, and 2. One of the following criteria is met: a) The value of the asset or estimated life is increased by 25% of the original cost or life period b) The cost results in an increase in the capacity of the asset, or c) The efficiency of the asset is increased by more than 10% Otherwise, the cost should be recorded as a repair and maintenance expense within the appropriate expense function. The criteria are meant as a matter of policy and to be applied as guidance, not absolutes. It is likely that any of the above parameters could be adjusted based on the professional judgment of a qualified individual making the decision of whether to capitalize or expense a given cost. Determinations must be made on a case by case basis. Capital Asset Definitions and Categories Land/Land Improvements Land is the surface or crust of the earth, which can be used to support structures, and may be used to grow crops, grass, shrubs, and trees. Land is characterized as having an unlimited life (indefinite). Land improvements consist of betterments, site preparation, and site improvements that ready land for its intended use. The cost associated with land improvements is added to the cost of the land. 4 Land and land improvements are inexhaustible assets and do not depreciate over time. Examples of items to be capitalized as land and land improvements are: • Purchase price or fair market value at time of gift • Commissions • Professional fees (title searches, architect, legal. engineering, appraisal, surveying, environmental assessments, etc.) • Land excavation. fill grading. drainage • Demolition of existing buildings and improvements (less sal age) • Removal, relocation or reconstruction of property of others (railroad. telephone. and power lines). • Interest on mortgages accrued at date of purchase • Accrued and unpaid taxes at date of purchase • Other costs incurred in acquiring the land • Water wells (includes initial cost for drilling, the pump and its casing • Right-of-way (permanent) Other Improvements Assets built, installed or established to enhance the quality or facilitate the use of land for a particular purpose. Examples of items to be capitalized as other improvements are: • Fencing and gates • Landscaping • Parking lots/driveways/parking barriers • Outside sprinkler systems • Recreation areas and athletic fields (including bleachers) • Golf courses • Paths and trails • Septic systems • Stadiums • Swimming Pools, tennis courts, basketball courts • Fountains • Plazas and pavilions • Retaining walls Buildings/building improvements A building is a structure that is permanently attached to the land, has a roof, is partially or completely enclosed by walls, and is not intended to be transportable or moveable. A building is generally used to house persons, property, and fixtures attached to and forming a permanent part of such a structure. 5 Certain buildings or structures that are an ancillary part of infrastructure networks, such as rest area facilities and pumping station should be reported as infrastructure rather than as buildings. Building improvements are capital events that materially extend the useful life of a building or increase the value of the building, or both beyond one year. Examples of items to be capitalized as buildings and building improvements are: Purchased Buildings • Original purchase price • Expenses for remodeling, reconditioning or altering a purchased building to make it ready to use for the purpose for which it was acquired • Environmental compliance (i.e. asbestos abatement) • Professional fees (legal, architect, inspections, and title searches, etc.) • Payment of unpaid or accrued taxes on the building to date of purchase • Cancellation or buyout of existing leases • Other costs required to place or render the asset into operation Constructed Buildings • Completed project costs • Cost of excavation or grading or filling of land for a specific building • Expenses incurred for the preparation of plans, specifications, blueprints, etc. • • Cost of building permits • Professional fees (architect, engineer, management fees for design and supervision, legal) • Costs of temporary buildings used during construction • Unanticipated costs such as rock blasting, piling, or relocation of the channel of an underground stream • Permanently attached fixtures or machinery that cannot be removed without impairing the use of the building • Additions to buildings (expansions, extensions, or enlargements) Building Improvements • Conversions of attics, basements, etc. to usable office, clinic research or classroom space. • Structures attached to the building such as covered patios, sunrooms, garages, enclosed stairwells etc. • Installation or upgrade of heating and cooling systems, including ceiling fans and attic vents • Original installation or upgrade of wall or ceiling covering such as carpeting, tiles, paneling or parquet. • Structural changes such as reinforcement of floors or walls, installation or replacement of beams, rafters,joists, steel grids, or other interior framing. 6 _ • Installation or upgrade of window or door frame, upgrading of windows or doors, built-in closet and cabinets. • Interior renovation associated with casings, baseboards, light fixtures, ceiling trim, etc. • Exterior renovation such as installation or replacement of siding, roofing, masonry, etc. • Installation or upgrade of plumbing and electrical wiring • Installation or upgrade of phone or closed circuit television systems, networks, fiber optic cable. or wiring required in the installation of equipment (that will remain in the building) • Other costs associated with the above improvements Examples of items to be considered maintenance and repairs and not capitalized as buildings are: • Adding, removing and /or moving of walls relating to renovation projects that are not considered major rehabilitation projects and do not increase the value of the building. • Improvement projects of minimal or no added life expectancy and/or value to the building • Plumbing or electrical repairs • Cleaning, pest extermination, or other periodic maintenance • Interior decoration, such as draperies, blinds, curtain rods, wallpaper • Exterior decoration, such as detachable awnings, uncovered porches, decorative fences, etc. • Maintenance-type interior renovation such as repainting, touch-up plastering, replacement of carpet, tile , or panel sections; sink and fixture refinishing etc. • Maintenance-type exterior renovation such as repainting, replacement of deteriorated siding, roof, or masonry sections • Replacement of a part or component of a building with a new part of the same type and performance capabilities, such as replacement of an old boiler with a new one of the same type and performance capabilities • Any other maintenance-related expenditure which does not increase the value of the building. Equipment, Machinery, and Vehicles Fixed or movable tangible assets to be used for operations, the benefits of which extend beyond one year from date of receipt and rendered into service. Personal property paid for jointly by the Utilities and other governmental entities should be capitalized by the entity responsible for future maintenance. Examples of expenditures to be capitalized as equipment, machinery and vehicles: • Original contract or invoice price • Freight charges • Handling and storage charges • In-transit insurance charges 7 • Sales, use, and other taxes imposed on the acquisition • Installation charges • Charges for testing and preparation for use • Cost of reconditioning used items when purchased • Parts and labor associated with the construction of equipment • Some assets are allocated 75% electric, 25% water; the threshold will apply to the total Note: Cost of extended warranties and/or maintenance agreements. which can be separately identified from the cost of the equipment, should not be capitalized. Infrastructure Infrastructure assets are long-lived capital assets that normally are stationary in nature and can be preserved for a significantly greater number of years than most capital assets. Infrastructure assets are often linear and continuous in nature. Examples of expenditures to be capitalized as infrastructure: • Roads, streets, curbs, gutters, sidewalks • Dams and drainage systems • Water and sewer systems • Electric and gas (main lines and distribution lines) • Street lighting systems (traffic, outdoor, street, etc.) • Signage Infrastructure assets should be capitalized and depreciated. Improvements made to infrastructure assets that extend the useful lives or increase the value of the assets, or both should be capitalized. Other Capital Assets Computer software that is either purchased or developed for internal use should be capitalized as other fixed assets if the cost of the computer software exceeds the capitalization threshold and depreciated over the estimated useful lives of the assets. Capitalization of computer software includes software license fees if the total dollar amount of the fee divided by the numbers of units served (terminals) exceeds the threshold. Examples of expenditures to be capitalized as computer software: • External direct costs of materials and services (third party fees for services) • Costs to obtain software from third parties • Travel costs incurred by employees in their duties directly associated with development • Payroll and payroll-related costs of employees directly associated with or devoting time in coding, installing or testing. • Cost to develop or obtain software that allows for access or conversion of old data by new information systems. 8 Note: Upgrades and enhancements should be capitalized only to the extent that they increase the functionality of the product. Leased Equipment Equipment should be capitalized if the lease agreement meets any one of the following criteria: • The lease transfers ownership of the property to the lessee by the end of the lease term • The lease contains a bargain purchase option. • The lease term is equal to 75% or more of the estimated economic life of the leased property • The present value of the minimum lease payments at the inception of the lease, excluding executory costs, equals at least 90% of the fair value of the leased asset. Leases that do not meet any of the above requirements should be recorded as an operating lease and reported in the notes of the financial statements. 9 Capital Assets Estimated Useful Life Other improvements Fencing, gates 20 years Landscaping 10 years Parking Lots 15 years Outside sprinkler systems 20 years Paths and Trails 15 years Retaining Walls 20 years Outdoor lighting 20 years Building and building improvements Buildings-excavation, foundation, frame/structure 40 years Temporary/portable buildings 25 years Roof 20 years HVAC-Heating-ventilation, air conditioning 20 years Electrical 20 years Plumbing 20 years Sprinkler system 20 years Security fire alarm system 10 years Cabling 10 years Floor coverings (other than carpet) 15 years Carpeting 7 years Interior construction 15 years Interior renovation 10 years Elevators 20 years Equipment, machinery and vehicles Audio visual equipment 7 years Business machines/office equipment 7 years Radio, communications equipment 10 years Computer equipment/software 5 years Furniture 15 years Grounds equipment-mowers, tractors 10 years Kitchen equipment-appliances 10 years Lab equipment 10 years Machinery, tools and other equipment 5-10 years Custodial equipment 10 years 10 • Photocopiers 5 years Motor Vehicles: Cars, light trucks and vans (less than 13,000 lbs.) 3-8 years Heavy trucks (13,000 lbs or greater) 8-10 years Heavy equipment-front loaders, graders etc. 10-20 years Infrastructure Transmission & Distribution 10-33 years Plant Acquisition 10-50 years Landfill Gas Generation 10-50 years 11