The situation is as follows. Under a Cost Reimbursable (CPFF) contract, the Government authorizes a contractor to purchase a piece of equipment (cost $8,000) as a direct charge to the contract. Rather than billing the entire purchase amount on a single invoice, the contractor elects to bill as a direct charge, only a portion of the cost (equal to the depreciated cost) on each monthly invoice over the useful life of the equipment. My questions are: 1) Am I correct to conclude that the Government retains title to this equipment? 2) What would motivate a company to bill in this manner?

By Beverly Wester on Monday, March 26, 2001 - 09:24 am:

Yes, in accordance with FAR Part 45. Maybe they did not want to cross fiscal years. It is hard to say, I have never heard of that type of billing. It would have been easier to submit the total invoice for the direct charge.

By Anonymous on Monday, March 26, 2001 - 09:57 am:

It appears that the company's accounting system is considering it as equipment purchased for their own use. Normally companies don't charge capital assets in one lump sum. Rather, they must amoritize the cost over the useful life by depreciating it. A prorated amount gets charged to each year.

By PWG on Monday, March 26, 2001 - 10:26 am:

I considered that but I was under the impression that in order to amoritize the depreciation expense over the useful life of the asset, it would need to be treated as an indirect cost rather than a direct cost.

To help my understanding of this concept, I pose this follow up question. Could it be an acceptable accounting practice for a company to treat depreciation expense as a direct cost rather than indirect?

By Anonymous on Monday, March 26, 2001 - 12:36 pm:

No, they couldn't. However, if for some reason they wanted to bill in partial increments, they could achieve the same results. For example, let's assume this equipment has a 5 year life with no residual value, and the company uses a straight-line method of depreciation. Therefore, the annual depreciation amount is 1/5th of $8,000, or $1,600. What the company now can do is bill the $1,600 as an annual installment purchase plan payment. Of course, this poses lots of other problems such as what happens in the event the government doesn't exercise the option to continue the contract, or who has responsible for replacement if loss or damages occur, etc.

By John Ford on Tuesday, March 27, 2001 - 12:13 pm:

PWG, in answer to your follow-up question, for government contract cost accounting a contractor could treat depreciation as a direct cost. Look at the tests for allocation of costs in FAR Part 31. If the depreciation benefits only one contract, then it can be charged as a direct cost of that contract. The same thing holds true for the CAS.
Going back to your original question, how long is the contract and what is the useful life of the property? It strikes me that the contractor is not billing for depreciation, but is simply spreading the acquisition cost of the property over the life of the contract. If that is the case, the contractor is not charging depreciation unless the useful life of the property and the length of the contract are the same.

By PWG on Wednesday, March 28, 2001 - 07:48 am:

John:

Thanks for your input about treating depreciation as a direct cost. In this instance, the useful life of the property exceeds the length of the contract and they are completely charging the total cost of the equipment so it would seem that the company is not really billing us for "depreciation" but is spreading the acquisition cost over the life of the contract. They are just calling it depreciation. Given that, I feel pretty comfortable concluding that the Government retains title to this equipment.

Hypothetical Question with regards to your response. If the contract term was five years, the useful life 3 years, and the company properly charged depreciation as a direct charge over those three years, who would have title (Government or contractor) once the equipment was fully depreciated? Assume a CPFF contract as in my actual situation.

By Anonymous on Wednesday, March 28, 2001 - 08:08 am:

I replied "no" above, providing a quick answer after asking a friend who is an auditor. He mentioned that FAR 31.205-52 (h) states "Depreciation should usually be allocated to the contract and other work as an indirect cost." In the case of an $8,000, treating it as a direct cost likely would be inconsistent with their normal practices. The "usually" part mentioned in the FAR gives some flexibility in special circumstances such as acquiring a significant purchase or a unique item that has no other use other than performing this one contract.

By Eric Ottinger on Wednesday, April 04, 2001 - 06:52 pm:

PWG and All,

Businesses usually have a consistent dollar threshold to distinguish items which are expensed from items which are capitalized and depreciated. For a rule of thumb this amount used to be $500 or $1,000. I would expect it to be more today.

See Item 5.6.0 in the CAS Disclosure Statement.

"Criteria for Capitalization. Enter (a) the minimum dollar amount of acquisition cost or expenditures for addition, alteration and improvement of depreciable assets captitalized, and (b) the minimum number of expected life years of capitalized assets. ... "

It might not be a good idea to provide an $8,000 item in light of FAR 45.302-1.

"(d) Government facilities with a unit cost of less than $10,000 shall not be provided to contractors unless --
(1) The contractor is a nonprofit institution of higher education or other nonprofit organization whose primary purpose is the conduct of scientific research;
(2) A contractor is operating a Government-owned plant on a cost-plus-fee basis;
(3) A contractor is performing on a Government establishment or installation;
(4) A contractor is performing under a contract specifying that it may acquire or fabricate special tooling, special test equipment, and components thereof subsequent to obtaining the approval of the contracting officer; or
(5) The facilities are unavailable from other than Government sources."

Professor Goetz at the "Ask A Professor" site is usually very cogent on these property related issues. I went back to look for an apropos Q&A. I found a good one, but it was severely truncated for some reason.

Eric

By Eric Ottinger on Friday, April 06, 2001 - 04:58 pm:

All,

I find that "Ask A Professor" addressed this specific question.

http://web2.deskbook.osd.mil/askaprof/normal/qdetail2.asp?cgiSubjectAreaID=14&cgiQuestionID=6252

Eric

By John Ford on Friday, April 06, 2001 - 09:52 pm:

Eric, this AAP link addresses the situation where the contractor is acquiring property to which it will retain title. This does not cover the situation where the government will obtain title to the property. If the government will obtain title to the property,as is the case in PWG's scenario, CAS 404 and the Depreciation cost principle would be inapplicable as they only contemplate how a contractor will account for property to which the contractor will retain title.

By Eric Ottinger on Tuesday, April 24, 2001 - 08:26 pm:

John,

I'm not sure that I understand you. Are you saying --

(a) all items should be expensed if the property is "government furnished property,"
(b) a different threshold should be used if the property is "government furnished property," or
(c) the contractor is expected to use a consistent threshold for contractor owned property, but there is no requirement to be consistent if the property is "government furnished property"?

I have no particular expertise in this area. I remember that the contractor was expected to use a consistent threshold to determine whether an item should be capitalized. Beyond that, I would defer to anyone with better information.

Eric

By John Ford on Wednesday, April 25, 2001 - 08:02 pm:

Eric, what I am saying is that if a contractor acquires property, title to which vests in the government, the contractor must expense that property. The government then pays the purchase price for the property and the government owns it. The contractor cannot capitalize property it does not own. In this case, CAS 404 does not apply because the contractor is not claiming depreciation cost on its property.
A contractor can only capitalize (depreciate) its own property. It usually includes this depreciation in its overhead, but is not always required to do so. CAS 404 governs the accounting treatment to be accorded depreciation on contractor owned capital equipment.