For the next couple of posts in our series about internal control processes, we figured it would be a good idea to address capitalization. Today we will be looking at some of the basics. Next time, we’ll dig a little bit deeper.
Why is the issue of capitalization important?
All bond expenditures must be for capitalized cost items. These same bond funds may only be used for direct project costs, so all allowable charges should be included. It is important for you to understand capitalization as you work through your building project.
What is a capitalized cost?
A capitalized cost is an expense that is added to the cost basis of a fixed asset on a balance sheet. These costs are incurred when building or financing fixed assets. They are not expensed during the period in which they were incurred, but are recognized over a period of time via depreciation or amortization. Capitalizing a cost allows a district to report that cost as an asset rather than an expense.
Since depreciation of a capital asset should not start until that capital asset is in use, capitalized costs should not be capitalized (listed as an asset) until all construction and direct costs are complete and the capital asset is being used.
The Foothill-De Anza Community College District’s policy for the capitalization of district property is the following:
“Expenditures incurred in construction such as materials, labor, engineering, supervision, legal, insurance, and overhead will be capitalized as ‘construction in progress’ until the project is completed and placed in service. No depreciation will be taken on construction in progress.”
Why is all of this important?
It is extremely important to ensure that you include all costs allowed for capitalization, but many direct charges are difficult to calculate for an individual project. These costs include consultants that do cost estimates early in the bond planning stage. Don’t forget about the construction management and project management that work on multiple projects at the same time and started during initial planning. Whatever method you use should be documented, whether percentage or another way.
In theory, if funds to offset depreciation are set aside each year, there will be enough funding to replace the asset when it has reached the end of its useful life — minus any escalation of the replacement cost, of course.
Next time, we’ll look at how a project should be accounted for before it is capitalized, and what should be included in capitalized costs.