Cost Accounting Standard (CAS) 404 - Capitalization of Tangible Assets

CAS 404 provides the criteria for determining whether to assign the cost of a capital asset as a period expense when acquired or capitalize the item as a tangible asset and spread the cost over two or more accounting periods.

What are the Requirements of CAS 404?

The fundamental requirements of CAS 404 are:

• A written policy that is consistently applied;
• The establishment of a minimum service life and acquisition cost;
• Identification of asset accountability units;
• Designation of higher dollar limits for original complements of low-cost equipment and
• Costs that extend the life or productivity of an asset should be capitalized.

CAS 404 doesn’t address depreciation or the gain or loss on the sale of assets.

What if I Don’t Have Any Contracts Subject to Full CAS?

Contractors without contracts subject to CAS 404 would capitalize assets based on generally accepted accounting principles (GAAP), which we will discuss later. If FAR 31.205 does not address the treatment of a cost, FAR 31.201-2 addresses the allowability of cost, indicating that it has to be reasonable, allocable, comply with CAS, otherwise generally accepted accounting principles, and contract terms (emphasis added).

Let’s Discuss the Requirements of CAS 404

CAS 404 requires contractors to have a written policy on the acquisition cost of capital assets that is reasonable and consistently applied. In order to promote consistency for accounting for tangible assets, CAS 404 provides that assets with a useful life of over two years and an acquisition cost in excess of $5,000 are capitalized. The standard does provide latitude to establish a shorter useful life and/or lower acquisition cost. For example, if you purchase and capitalize assets with a minimum service life of two years and a value of $3,000 or greater, this practice would be compliant with CAS 404.

What is Included in the Acquisition Cost of an Asset?

CAS 404 defines the acquisition cost of an asset as the purchase price adjusted for discounts and any costs necessary to prepare the asset for use (e.g., installation costs, testing, etc.). Contractors can determine if they will capitalize or expense sales and use taxes and freight, as these costs are generally immaterial.

Contractors can also designate a higher dollar amount for low-cost equipment. Low-cost equipment is defined as a group of items acquired for the initial outfitting of a tangible capital asset. An example would be the purchase of a conference room table and chairs for a new conference room. CAS 404 does not provide a threshold for low-cost equipment; only the threshold needs to be reasonable.

What are the Requirements under FAR/GAAP for Acquisition Cost of Capital Assets?

Contractors not subject to CAS 404 will capitalize assets using GAAP as indicated in FAR 31.201-2. GAAP is very similar to CAS 404 as it requires fixed assets to be recorded at the historical value of the asset. This includes costs necessary to bring it to the condition and location for its intended use (e.g., installation costs, assembly, freight, warehousing, insurance, taxes, etc.). GAAP does not establish a specific dollar threshold for capitalization, only providing a useful life over one accounting period. While the FAR or GAAP does not specifically address written policies for the capitalization of fixed assets, we recommend contractors establish written policies as part of their internal control and for consistency in the application.

Self-Constructed Assets

When a company constructs an asset for its own use, CAS 404 requires the capitalized amount to include all allocable indirect costs. This includes G&A expenses and cost of money (CAS 417) when expenses are material in amount.

GAAP has similar requirements in that self-constructed assets include all costs (e.g., material, labor, a proportionate share of indirect costs, and interest) in the capitalized cost.

Business Combinations

CAS 404 addresses two methods of valuing tangible capital assets under a business combination: the purchase method and the pooling of interest method. However, in 2001, the Financial Accounting Standards Board (FASB) made a change that the pooling of interest method is no longer allowed, and all business combinations are accounted for using the purchase method of accounting. CAS has not been updated for this change. We are not addressing the pooling of interest method.

CAS 404 addresses how assets are valued under business combinations. The value of the assets is first dependent on whether depreciation was allocated to government contracts in the past, in which case the net book value of the assets is used. If depreciation was not allocated, the fair value of the assets is used but may have to be adjusted depending on whether the purchase price exceeds or is lower than the fair value of the assets. Although this sounds simple, it is a complex area, and contractors must perform a detailed analysis of the assets to value them properly.

Contractors that do not have contracts subject to CAS 404 are still required to follow FAR 31.205-52 Asset valuations resulting from business combinations, which incorporates CAS 404 when the purchase method of accounting for a business combination is used whether or not the contract or subcontract is subject to CAS.

Redstone GCI can assist your company in several ways. We can review your accounting of capital asset costs and assist with analyzing asset values in a merger or acquisition. Additionally, we can draft written policies and procedures, help you respond to DCAA noncompliance reports and ACO determinations of CAS 404 noncompliance, and provide training on Cost Accounting Standards through webinars or onsite sessions.