Base unit definition is the necessary element of a consistent capitalization policy. Once a base unit is established it should not be changed, unless there is a significant reason. In establishing the formal policy, two main factors should be considered:
Record-keeping costs—very small base units will necessitate large numbers of assets records. This will increase the cost of maintaining that accounting system.
Value of the detailed information—value can be measured in many different ways. The value of an asset can be the replacement cost. It can also be the cost if the equipment breaks down because preventative maintenance was not performed or if legally required maintenance must be accomplished at a time when the asset is needed on line.
An example of this would be an aircraft that must have maintenance checks each 100 hours. It is important to schedule this when the craft is not needed for a scheduled flight. Another cost is having an item in the right place when required. Construction equipment such as cranes or graders have a large carrying cost. If the one needed on a construction job in one city or state is at another location, considerable expense can be incurred while a crew waits for it to be delivered. All of these costs should be considered in determining not only the information to be maintained in the property record, but also establishment of a base unit. The base unit definition will determine what items are given individual property record identification and control. In the case of an aircraft, engines also have required major maintenance intervals. Normally, spare engines are maintained. At the appropriate maintenance interval, engines are swapped, and the aircraft continues on with a new engine while the one removed is overhauled. It is important in this case to actually maintain the engine as the base unit and control it as an individual item.
The ability to control an asset, in many cases, provides much more benefit than the cost of maintaining an additional record. However, the cost of control is not just the computer record.
The major cost is in ensuring that the record is maintained. The location of a major piece of construction equipment must be reported each time it is moved, if information on its whereabouts is to be available. The cost of making such a report, and following up to ensure the report is made, could be of greater cost than the value of the information produced. If a company owns only one or two cranes and they have a single operator, other means of ensuring that equipment is in the right location are possible.
The operator can be given the schedule of when and where the equipment should be available. However, for a company that has a number of pieces that must be juggled between jobs—not by the operator, but by project managers—the cost of keeping the file updated will be negligible in comparison to not having equipment at a location when it is needed.
Maintaining adequate asset records for tax purposes is necessary. Tax depreciation may be different from that required for accounting books. Sufficient detail should be maintained so that the tax return can be prepared from the information in the property record. In establishing a base unit, consideration of tax rules is important.
A building might be established as a single base unit with its furnishings separately identified. However, tax depreciation will be different for the building itself than for heating and air conditioning units, as well as lighting, refrigeration, and other built-in systems. The tax rules are established to accomplish government policies not based on any accounting logic. Periodically, the government establishes investment tax credits to encourage businesses to purchase assets. These credits allow profitable companies to reduce the cost of their assets through a reduction in taxes. Typically, the rules apply to assets with lives greater than five years. Consideration of making individual items that have in the past or may in the future be eligible for investment tax credits is an appropriate exercise in establishing a base unit. Underlying accounting principles also will affect the definition of base units.
We should not spend money to keep records that would not alter decisions. In the past, assets have not received much management attention. They are receiving more attention today because of the high cost of debt. The past practice of ignoring assets is now material. Many companies, in addition to government entities, have taken the attitude in the past of purchasing assets, installing them, and ignoring them. Now, companies need to make up for deferred maintenance. The replacement of assets all at the same time is becoming a material concern.
The reduction in cost of maintaining records with the introduction of personal computers was significant. Asset software is now catching up with the computer improvements and there are accounting systems that can be purchased relatively inexpensively for integrated asset modules within complete accounting systems. Similarly, the reduction of cost of maintaining those records through “one write” systems that capture changes in assets through routine accounting entries has reduced record-keeping costs. Asset databases are now updated from purchase and maintenance documents that are required for other than asset record-keeping purposes.
Reports must be produced on a comparable basis. To accomplish this, transactions of a similar nature must be handled in the same way even by different people and in different time periods. For this to happen, written policies must be produced and must be taken into consideration in defining base units. The designation of a base unit and its property record class must be easily discernable by different people. What is easily discernable by an asset manager or accountant may not be understood by purchasing agents, mechanics, and managers.
The information presented in reports must include everything an informed reader needs to arrive at a conclusion. Nothing of substance should be concealed or omitted. Establishment of base units has an impact on the material that can be produced. Leverage buyouts that have had such an impact on our economy during the 1980s were, in many cases, made possible by the lack of disclosure regarding assets. Financial statements only contained the depreciated historical cost. Present management had no idea of their current market value. Establishment of very large base units in terms of dollars can perpetuate the lack of disclosure. This principle is also cited as a reason why historical cost is not an adequate measure of the value of assets. In determining what is a base unit, consideration should be given to separating items that will have material future value versus those that do not. An example might be a light utility pickup.
The future value of the pickup will be based on the depreciated value in the used marketplace; however, a utility bed, generator, or hydraulic crane attached to the pickup may have a considerably different value based on future utility. Separate base units should be established based on the expected life of an item in addition to its expected value at the end of that period.
Another example is in furniture: Hardwood furniture not subject to damage may have greater market value in twenty years than it had at the time of purchase. A service organization, such as a real estate firm, may have a significantly higher market value in fully depreciated office furniture. Furniture in a department store or an office environment where it is subject to considerable wear and tear will not have much future value. In many businesses, furniture will be an item to lump together, with little reason for spending the cost of maintaining individual property records.
Full disclosure is appropriate when viewing financial statements as a whole. Statements that contain so much detail as to be overwhelming to the reader are of no use. They also increase costs beyond any benefit. This is a significant reason for not capitalizing each small item used for a period longer than one year.
A written set of decision rules for classification of each transaction is necessary. The person making the classification decision must be able to follow these rules and arrive at the same conclusions regarding similar assets in different time periods. These rules must also allow different people to arrive at the same conclusion.
Further worth reading for Establishing Base Unit Of Asset:
Accounting10 years ago
Check Payment Issues Letter [Email] Templates
Accounting11 years ago
What is Journal Entry For Foreign Currency Transactions
Accounting7 years ago
Accounting for Business Acquisition Using Purchase Method
Accounting11 years ago
Journal Entry for Correction Of Errors and Counterbalancing