The state’s capitalization policy is as follows:

• All land, including land use rights with indefinite lives acquired with the purchase of the underlying land, and ancillary costs.

• The state highway system operated by the Department of Transportation.

• Infrastructure, other than the state highway system, with a cost of $100,000 or greater.

• Buildings, building improvements, improvements other than buildings, and leasehold improvements with a cost of $100,000 or greater.

• Intangible assets other than lease assets, such as internally developed software, patents, and trademarks, with a cost of $1,000,000 or more that are “identifiable” by meeting either of the following conditions:
  
  
  • The asset is capable of being separated or divided  and sold, transferred, licensed, rented, or exchanged; or
    
    
  • The asset arises from contractual or other legal rights, regardless of whether those rights are transferable or separable.

• Lease assets with total payments over the lease term of $500,000 or greater.
  
  
• All other capital assets with a unit cost (including ancillary costs) of $5,000 or greater, or collections with a total cost of $5,000 or greater, unless otherwise noted.
  
  
• All capital assets acquired with Certificates of Participation (COP).

For capital assets acquired by and used in the operations of governmental fund type accounts, record the value of the assets in the General Capital Assets Subsidiary Account (Account 997). Refer to Subsection 85.60.30.a.

For capital assets acquired by and used in proprietary and trust fund type accounts, record the value of the assets in the account itself. Refer to Subsection 85.60.30.b.

Although small and attractive assets do not meet the state’s capitalization policy above, they are considered capital assets for purposes of marking and identifying capital assets (refer to Section 30.30), inventory records requirements (refer to Section 30.40), and physical inventory counts (refer to Section 30.45).

Close out the construction in progress and capitalize the costs into the appropriate asset classification when a project is substantially complete, accepted, and placed into service. Refer to Subsection 85.65.64.

New acquisitions. Capitalize new acquisitions that meet the state's capitalization policy as stated above. Additions, improvements, repairs, or replacements to existing capital assets are not considered new acquisitions and are discussed below.

Additions. Capitalize expansions of or extensions to an existing capital asset when the cost of the addition meets the state's capitalization policy above.

Extraordinary repairs, betterments, or improvements – Capitalize outlays that increase future benefits from an existing capital asset beyond its previously assessed standard of performance if the outlays meet the state's capitalization policy as stated above. Increased future benefits typically include:

• An extension in the estimated useful life of the asset.
• An increase in the capacity or efficiency of an existing capital asset.
• A substantial improvement in the quality of output or a reduction in previously assessed operating costs.

Leasehold improvements that meet the state's capitalization policy are recorded to General Ledger Code 2350 "Leasehold Improvements."

Replacements. For building and improvements other than buildings, capitalize the cost of outlays that replace a part of another capital asset when the cost of the replacement is $100,000 or more and at least 10 percent of replacement value of the asset.

Example: A $120,000 replacement of a heating system in a building having a replacement value of $1.5 million would not be capitalized. In this case $120,000 is not at least 10 percent of the building's replacement value. Had the building's replacement value been less than $1.2 million, the $120,000 heating system replacement would have been capitalized.

Exceptions to this policy are:

• Replacement roof coverings are not capitalized (whether or not the replacement is with superior materials) unless the replacement extends the useful life of the building.

• Replacement floor coverings and window coverings are not capitalized.

• Costs to remodel (convert) a building to a different use are not capitalized, where the remodeling does not extend the useful life of the structure itself, unless the conversion increases the capacity or efficiency of the existing asset.

Remove the capitalized value and the associated accumulated depreciation of the replaced capital asset or original building component from the accounting records if the amounts are determinable and capitalize the cost of the replacement. Refer to Subsection 85.60.50.

Bulk purchase. For proprietary fund type accounts, bulk purchases of like capital assets with unit costs of less than $5,000 may be capitalized as a group where the allocation of costs for the bulk assets over time is matched to the corresponding revenue generated by the bulk assets. For other fund type accounts, bulk purchases are capitalized when the purchase is made using the Office of the State Treasurer’s (OST) Certificate of Participation (COP) program. Refer to Subsection 30.20.50.

Collection. Capitalize art collections, library reserve collections, and museum and historical collections when the conditions described in Subsection 30.20.22 are not met. Agencies meeting these conditions have the option of capitalizing their collections. Library resources are capitalized and may be carried on the agency’s property records as a single item.

Art collections, library reserve collections, and museum and historical collections that are considered inexhaustible, in that their value does not diminish over time, are not required to be capitalized if all of the following conditions are met:

• The collection is held for public exhibition, education, or research in furtherance of public service, rather than financial gain.
• The collection is protected, kept unencumbered, cared for, and preserved.
• The collection is subject to an agency policy that requires the proceeds from sales of collection items to be used to acquire other items for the collections.

Agencies must be able to provide descriptions of the collections and the reasons the collections are not capitalized.

While these collections are not required to be capitalized, they are to be catalogued per Subsection 30.40.10.

Right-to-use Lease Agreements. A lease is a contract that conveys control of the right to use another entity’s capital asset for a specific period of time in an exchange or exchange-like transaction.

A contract conveys control of the right to use the asset if the lessee has both of the following:

• The right to obtain the present service capacity from use of the asset.

• The right to determine the nature and manner of use of the asset.

Lease-to-own Agreements. A contract that transfers ownership of the underlying asset to the lessee by the end of the contract and does not contain termination options, should be reported as a financed purchase of the underlying asset by the lessee and a sale of the asset by the lessor. Refer to Subsection 30.20.40.

Short-term Leases. Any item with a maximum possible lease term of less than 12 months cannot be capitalized. Record these lease payments as a current period expenditure/expense when the state is the lessee or revenue when the state is the lessor.

Rolling month-to-month leases and leases that continue into a holdover period until a new lease contract is signed should be treated as short-term leases.

Lease Term. The lease term is the period during which a lessee has a noncancelable right to use an underlying asset, including any periods covered by:

• The option to extend the lease if it is reasonably certain that option will be exercised.

• The option to terminate the lease if it is reasonably certain that option will not be exercised.

Periods for which both the lessee and the lessor have an option to terminate the lease without permission from the other party (or if both parties have to agree to extend) are cancelable periods and are excluded from the lease term, regardless of whether it is reasonably certain that option will be exercised. For example, if the lease contains a clause that allows both the lessee or the lessor to cancel with 60 days notice, then the maximum term is 60 days and the lease should be accounted for as a short-term lease.

Fiscal funding or cancellation clauses should be ignored. These clauses allow lessees to cancel a lease, typically on an annual basis, if the government does not appropriate funds for the lease payments.

Leased assets that meet the state's capitalization policy (refer to Subsection 30.20.20) that are leased from (state is lessee) or to (state is lessor) individuals or organizations external to the state must be capitalized (refer to Subsections 30.20.35.b for lessee accounting and 30.20.35.c for lessor accounting).

Leases between state agencies and leases that do not meet the capitalization threshold should be recognized as a current period expenditure/expense by the lessee and/or revenue by the lessor.

Lessees should account for a lease as an acquisition of a lease and the incurrence of a liability.

At lease inception, the lease liability should be recorded at the present value of payments expected to be made during the lease term, including the following:

• Fixed payments
• Variable payments that depend on an index or a rate (such as the Consumer Price Index or a market rate), measured using the index or rate as of the commencement of the lease term
• Variable payments that are fixed in substance
• Amounts that are reasonably certain to be paid under residual value guarantees
• The exercise price of a purchase option if reasonably certain that the option will be exercised
• Payments for termination penalties if it is reasonably certain that option will be exercised
• Any lease incentives receivable from the lessor
• Any other payments that are reasonably certain of being required

The future lease payments should be discounted using the interest rate the lessor charges the lessee. If the rate is not readily determinable, the lessee’s incremental borrowing rate should be used, that is the interest rate the state would be charged to finance a similar asset.

Variable payments based on future performance of the lessee or usage of the underlying asset, such as charges based on hours equipment was used, should not be included in the measurement of the lease liability. Rather, those variable payments should be recognized as an expenditure/expense in the period in which the obligation for those payments is incurred.

The intangible right-to-use lease asset should be recorded at the sum of the lease liability, any ancillary charges, and lease payments made to the lessor at or before the commencement of the lease term, less any lease incentives received from the lessor at or before the commencement of the lease term.

Refer to Subsections 85.60.70 and 85.72.30 for more details on how to account for leases and illustrative entries.

Lessors should recognize a lease receivable and a deferred inflow of resources at the commencement of the lease term. The lessor should continue to recognize the capital asset.

At lease inception, the lease receivable should be recorded at the present value of payments expected to be received during the lease term, including the following:

• Fixed payments
• Variable payments that depend on an index or a rate (such as the Consumer Price Index or a market rate), measured using the index or rate as of the commencement of the lease term
• Variable payments that are fixed in substance
• Residual value guarantee payments that are fixed in substance
• Less any lease incentives payable to the lessee

The future lease payments should be discounted using the interest rate the lessor charges the lessee, which may be the interest rate implicit in the lease. If the rate is not readily determinable, the lessee’s incremental borrowing rate should be used, that is the interest rate the state would be charged to finance a similar asset.

Variable payments based on future performance of the lessee or usage of the underlying asset should not be included in the measurement of the lease receivable. Rather, those variable payments should be recognized as revenue in the period to which those payments relate.

The deferred inflow of resources is equal to the sum of the lease receivable, lease payments received from the lessee at or before the commencement of the lease term that relate to future periods (for example, the final month’s rent), less any lease incentives paid to, or on behalf of, the lessee at or before the commencement of the lease term.

The lease receivable and deferred inflow of resources should be reduced by any provision for estimated uncollectible amounts.

Refer to Subsections 85.54.41 and 85.65.37 for more details on how to account for leases and illustrative entries.

Contracts with Multiple Assets or Components and Multiple Contracts. In general, the capitalization threshold should be applied to each lease contract (rather than each asset within the contract). Lease contracts entered into under a master vendor agreement are separate contracts. However, if multiple contracts are negotiated as a package with a single objective, then the contracts should be combined and considered a single contract.

If a contract contains both a lease component (such as the right to use a building) and a nonlease component (such as maintenance services for the building), the lease and nonlease components should be treated as separate contracts. The lease component is subject to all SAAM requirements for leases. Whereas, the nonlease component should be recognized as a current period expenditure/expense by the lessee and/or revenue by the lessor.

If a lease involves multiple underlying assets with different lease terms, each asset or group of assets with a different lease term should be treated as a separate contract. If a lease involves multiple underlying assets that are in different major classes (i.e., building and land), each asset class should be treated as a separate lease contract.

If a contract does not include prices for individual components or assets, an estimate should be used to allocate the contract price to those components. However, if a reasonable estimate cannot be determined, then the contract should be treated as a single lease contract.

A contract that transfers ownership of the underlying asset to the state by the end of the contract and does not contain termination options should be recorded as a financed purchase.

When the state's capitalization policy (refer to Subsection 30.20.20) is met, account for a lease that transfers ownership as an acquisition of a capital asset and the incurrence of a liability. If a lease involves the acquisition of more than one asset, each asset is capitalizable if its fair value meets the state's capitalization threshold. Refer to Subsections 85.60.70 and 85.72.30.

Record a lease-to-own agreement between state agencies as follows:

• The lessor agency is to treat the lease as a sales type lease (record a sale on account and remove the asset from inventory).

• The lessee agency is to treat the lease as a lease-to-own agreement (record the acquisition of a capital asset and the incurrence of a liability)

Lease-to-own agreements are to be used only to acquire capital assets. Refer to Subsection 30.20.20.

Capital assets acquired through OST’s Certificate of Participation (COP) program are to be capitalized. Refer to Subsections 30.20.20.e, 85.60.80, and 85.72.40.

In accordance with the Governmental Accounting Standards Board Statement Number 34, acquisitions of capital assets defined as infrastructure, which meet the state's capitalization policy, are to be capitalized.

The state highway system operated by the Department of Transportation is classified by the state as Transportation Infrastructure-Modified Approach. Refer to Subsection 30.20.80.

All transportation-related infrastructure not included in Subsection 30.20.60.b and all non-transportation infrastructure assets are required to be depreciated. Refer to Subsection 30.20.70.

Calculate and record depreciation or amortization for all depreciable capital assets refer to Subsection 85.60.40.

Non-depreciable capital assets include:

• Land
• The state highway system operated by the Department of Transportation, which is classified as Transportation Infrastructure-Modified Approach (refer to Subsection 30.20.80)
• Art collections, library reserve collections, and museum and historical collections that are inexhaustible (refer to Subsection 30.20.22)
• Construction in progress
  
  
• Intangible assets with indefinite useful lives
  
  

Depreciation normally begins when an asset is purchased or completed and accepted. However, if it is not placed into service immediately, depreciation should begin when the asset begins to lose value. Either option should be applied consistently and should be reasonable in the circumstance. Depreciation may be calculated using either the straight-line or composite method.

• To calculate depreciation using the straight-line method:

Annual Depreciation =	Cost - Salvage Value
	Asset Useful Life

Salvage value is an estimate of the amount that will be realized at the end of the useful life of a depreciable asset.

• Calculate the composite method based on weighted average estimated lives or an estimate of the useful life of the grouping of assets; such as library resources. The assessment could be based on condition assessments or experience with the useful lives of the groupings of assets. A consistent composite depreciation rate should generally be used throughout the life of the grouping of assets, but the rate should be recalculated if the composition of the assets or estimate of the useful lives changes significantly.

For example, if the average useful life of library resources, or portion thereof, was estimated to be 25 years, an annual depreciation rate of 4 percent would be used. The annual depreciation expense would be calculated by multiplying the annual depreciation rate by the cost of the collection.

Amortization on right-to-use lease assets begins on the lease start date. Amortization must be calculated using the straight-line method, by dividing the value of the lease asset by the lesser of the lease term or the asset’s useful life. If it is reasonably certain that a purchase option will be exercised, the asset’s useful life must be used.

Useful life for capital assets – Agencies are required to use the useful life shown in Schedule A, Capital Asset Class Code List and Useful Life Schedule (Subsection 30.50.10.a) for capital assets acquired in new condition. For energy efficiency equipment and products, refer to the Addendum to Schedule A (Subsection 30.50.10.b).

However, a shorter or longer estimated life may be used depending on factual circumstances, replacement policies, or industry practices. Proposed deviation in useful life from Schedule A requires prior written approval from the OFM Accounting Division.

When establishing an asset’s useful life:

• Agencies are responsible for establishing and utilizing an appropriate useful life for assets acquired in less than new condition.

• The useful life for leasehold improvements is the estimated service life of the leasehold improvements, or the remaining term of the lease, whichever is shorter.
  
  
• The useful life for intangible assets acquired by contract generally should not exceed the period of the contract.

For depreciation purposes, the useful life of assets should be reviewed to ensure it has remained the same. Impairment of assets or changes in contractual provisions may impact the useful life and remaining depreciation.

The state capitalizes the state highway system as a class of infrastructure assets and reports these assets using the "modified approach" to depreciation. Under the modified approach, these infrastructure assets are not depreciated as long as two requirements are met:

• The assets are managed in an asset management system, which includes keeping an up-to-date inventory of assets, performing condition assessments of the assets and summarizing the results, and estimating the annual amount to maintain and preserve the assets.
• The state documents that the assets are being preserved approximately at or above the condition level established and disclosed previously by the state.

A capital asset is considered to be impaired if the asset experiences a significant and unexpected decline in its service utility. The service utility of a capital asset is the expected usable capacity at acquisition. A capital asset may be impaired due to events or changes in circumstances, such as physical damage, obsolescence or changes in technology, enactment or approval of laws or regulations or other changes in environmental factors, a change in manner or duration of use, or a construction stoppage.

A capital asset that becomes impaired is to be revalued to reflect its decline in service utility. Refer to Subsection 85.60.45.

Insurance recoveries related to impaired assets are reported net of the related loss when the recovery is realized or realizable in the same fiscal year as the loss. Otherwise, restoration or replacement costs of an impaired capital asset are reported as a separate transaction from the related insurance recovery. Contact your assigned OFM Accounting Consultant when you have a material impairment.