Establishing the exact level of detail that is appropriate for a particular business is difficult. It will also vary by asset categories. For some categories it would be particularly difficult to find a record-keeping basis that is meaningful to the individuals using them. A maintenance document prepared to record an employee’s time is self-policing. If a document is not filed, then the employee will not be paid. There is no reason not to include the asset that had maintenance performed on it on the employee’s record. Also, where repair parts must be requisitioned, that document can contain the identification of the assets worked on. However, when neither of these conditions exist, it may be necessary to have a document prepared that is only processed by the asset property record. Movement of assets from one location to another may not be connected with any other transaction. Creating documents just to maintain property record information will substantially increase the cost of record keeping. Being able to describe exactly the distinguishing characteristics of a base unit provides difficulties. In most cases it is necessary to create a list of property record items, assigned asset categories, and classifications. These are documented in the asset manual and are available for all who must produce asset documents. Documenting new purchases that are not yet included on these lists requires the involvement of the asset manager or accountant. These difficulties can be overcome by having the asset manager and accountant create lists of base units, assign property record classification, and include each item in the asset manual.
Policies established for capitalization and accounting for assets must be documented. Consistency in applying these policies is necessary to have meaningful records that allow for good asset management. Establishing policies that define the base unit within the property record can have a major impact on consistency.
For example: A building can be constructed as a shell with only bearing walls and permanent fixtures installed at time of construction. As each occupant moves in, they purchase drapes, blinds, and rugs and install walls, counters, and partitions. This method would have a different accounting treatment than if the building were constructed as a turnkey operation. When the construction project includes all elements of making the building ready to occupy, everything is included in the initial building capitalization.
Establishing base units reduces this problem and provides for a consistent property record being constructed under either scenario. Each of the major components of the building should be established as a base unit when it is valued at more than $1,000 and has a life expectancy beyond two years. Smaller, less expensive items should be included in a larger base unit. The base units will be the same if installed during the building construction phase or added later.
The following sections explore the example of a building, the base units to be established, and the policies that should define them.
Each separate parcel of land should be established as a separate base unit. If a parcel has a separate property tax bill from the taxing agency, it should have its own property record; but parcels can vary from a small lot to one that is thousands of acres in size. Included within the base unit of a land parcel are the costs of clearing and preparing the land for use. Permanent drainage facilities as well as utility improvements for sewer communications and power are included within the land base unit. Improvements such as parking lots, landscaping, and sprinkler systems where the value is greater than $1,000 should be separate base units in the building account. Each base unit will be separately recorded as an asset and a property record will be maintained. Items that require monitoring for appropriate maintenance and replacement should be included as a separate base unit and property record item. The land account should not include items that are subject to regular maintenance or replacement.
In establishing a base unit for buildings, thought must be given to whether each individual building is maintained separately or if auxiliary structures are to be part of the basic building. Generally, it is appropriate for each building to be a separate base unit, but where a large building exists with an adjacent ancillary structure, such as for power or grounds maintenance storage, the two structures could be included as one. In reviewing the building, however, remember that the building structure with routine painting and maintenance will last indefinitely, but components of that building such as heating, air conditioning, roofs, gutters, and drainage have a more finite life. When addressing the establishment of one base unit for the entire structure as opposed to having the roof or heating system as a separate base unit, look at the accounting that will occur over the life of the building as a result of establishing base units.
After the building has been in place for some time, maintenance and modifications to its systems will be necessary. If a new roof is required, is it appropriate to retire the old one and capitalize the new one?
Accounting practices call for retirement and recapitalization if it substantially increases the value of the asset or extends its life. The same is true with painting the structure. Normal wear and tear of the building will probably require some rooms to be painted on an annual basis. It is general practice to repaint offices and rooms when they are vacated due to a change of occupant. This does not extend the life of the building, however, it is less expensive to paint an empty room, and new occupants generally have their own pictures and appointments that do not always hide the scars of the previous tenant. When a heating or cooling motor or compressor needs replacement, is this routine maintenance or is it the replacement of a major item that should be capitalized?
The desirable outcome of the accounting policy is to ensure that the costs of assets and their maintenance be accounted for on a consistent basis and recovered from the periods that benefitted from their use.
It is also appropriate to keep records in an economic fashion. If every small item that was replaced in a building required capitalization and the original item retired, little benefit would occur to the management of the business; however, accounting costs would be increased. The purpose for establishing and documenting policies is to allow different people to arrive at the same accounting classification faced with similar facts.
Instead of capitalization and retirement of every item, establishing a consistent policy of base units allows the replacement of anything less than a base unit to be done on an expense basis. Therefore if the entire roof is established as the base unit, its replacement would be done on a retirement and capitalization basis. Similarly, with the heating and cooling unit, if the compressor or motor is a component of the heating system base unit, it would be expensed when replaced.
This would be true even if the component and compressor had lives in excess of two years and a value greater than $1,000. The rationale for expensing these components is that the total building is made up of numerous systems and on average each year of its total life, maintenance will be necessary. Although not the same cost, for each accounting period on average over the life of the asset its cost will approximate what would have occurred with each individual item capitalized and retired.
To fully understand this example, we look at a building built in 1990. It is reinforced, poured-concrete construction with metal door frames, doors, and windows. This basic structure will require little maintenance other than painting over the years. It will be established as a base unit. Another base unit is the roof, which, with our present construction techniques, will probably require major maintenance every ten years, with replacement in total at twenty to twenty-five years. Where tile or slate roofs are used, as in Europe, it will have a life as long as the building structure and be included in the building base unit. Rugs on the floors are separate base units and will require replacement every five to seven years. Paint on the building itself will be included as part of the building structure unit. The outside of the building, being basic concrete, will not require routine maintenance.
However, the landscaping around a park like building will require regular weekly gardening and some removal and replacement of trees and shrubs every five to ten years. The watering system for the grounds will also deteriorate and will require monthly maintenance after the first couple of years. The parking lot and roads will require resealing and repair as they deteriorate from cold winters, wet substrata, and heavy vehicles.
If these assets are not monitored and maintenance performed on a regular basis, the facility will generally deteriorate and lose its functional ability. If, at ten years, a major renovation of the building is done, catching up on all of this maintenance, the matching principle would require that the old units be retired and the new be capitalized. If maintenance is performed on a routine basis with a small portion done annually, the maintenance and replacement of less than a base unit would be expensed as incurred. Those replacements of an entire base unit, such as the replacement of a roof, would be capitalized and the original one retired. It can be seen, therefore, that the establishment of a base unit in the property record and the monitoring of its maintenance can affect accounting. By managing the asset and ensuring that maintenance occurs as it is required, the expense will be fairly uniform over the life of the building.
Establishing a base unit for equipment is more complicated than establishing a base unit for land or buildings. For example, take the case of a manufacturing production line. This could include a number of machines and associated conveyor structures. Each individual item can be one base unit or an entire assembly line can be considered one base unit. Policies must be written to clearly and consistently determine what a new base unit will be.