With the condition of infrastructure serving as a point of national discussion, useful life estimates for capital assets make for a timely accounting topic. Governments must maintain support for the useful life estimates they use for assets, and have a process to reassess the estimates periodically. As auditors, there are times we find governments have not kept the documentation to support the estimates they used for reporting or have not performed a recent reassessment, making it difficult to determine whether the reporting is accurate. To further complicate the matter, long-lived assets such as infrastructure and buildings can prove challenging when estimating useful lives. If the useful life of an asset, or class of assets, appears questionable and a government cannot support the useful life estimate it used or has not reassessed that estimate in many years, then this can quickly become an area of audit concern.
Why is this important?
Ultimately, useful lives should be reasonably accurate to allow the financial statements’ users to accurately assess the government’s financial condition and to serve as a foundation for the government’s capital planning and budgeting. The allocation of asset costs affects annual operating expenses and operating income. The financial statements also convey information about the extent to which assets are depreciated. For example, an entity with assets that are nearly fully depreciated might need to replace those assets soon, which could reduce future cash flows. Although inaccuracies in assets’ useful life estimates might have a small effect on financial reporting or budgeting in the short term, the effects can grow to become significant over time.
How to estimate a useful life?
Ideally, a government should base useful life estimates on its actual experience and plans. However, if this information is not available, the government can look to industry guidelines for a starting estimate and then revise the estimate as additional information becomes known. Some factors from the Governmental Accounting Standards Board (GASB Comprehensive Implementation Guide 7.14.1) to consider when establishing or reassessing useful life include:
- The asset’s present condition
- The asset’s expected use
- Construction type
- Maintenance policy
- How long the asset is expected to meet service and technology demands
Reassessing useful life
Governments should reassess useful life periodically, as indicated by the Governmental Accounting Standards Board (GASB Comprehensive Implementation Guide 7.14.4). This would normally be part of the government’s periodic inventory and condition assessment procedures, according to the Budgeting, Accounting and Reporting System Manual (BARS 220.127.116.11). Some examples of situations that could lead to a change in useful life include:
- A government changes its funding policy regarding when it plans to replace assets.
- New information becomes known about the longevity of key materials used in the asset construction.
- Maintenance activities did not occur as planned.
- Condition assessments indicate that assets are deteriorating significantly more or less rapidly than expected.
During a reassessment, a government should involve operational staff directly responsible for managing and maintaining the assets, such as its engineers. It is also best to consider and incorporate information from capital asset planning processes about the timing of scheduled asset replacement. For audit purposes, we also recommend governments keep documentation to support the decisions reached.
Typically, adjustments should be made to future useful life estimates. However, there might be circumstances when an impairment expense or correction of an error for prior periods is appropriate. Our office is available for technical assistance if entities have questions on making corrections or adjustments of this nature.
The Performance Center will provide a series of articles on this topic to help local governments in this area of capital assets. To reach the Performance Center, call (360) 725-5621 or email firstname.lastname@example.org. Our Local Government Support team also provides accounting assistance and can be reached using the HelpDesk.