“They” say life is a bell curve. One of the best examples I can think of is walking. You start moving by being carried (by your parents) – crawling on your own – walking with support – walking without support – walking with support (or a walker/cane) – crawling in and out of bed – and then being carried (to the grave). An asset’s useful life is similar to this also. There is a learning curve, set up, assimilation into the process, and understanding the asset in order for it to reach its peak potential. Then there is the maintenance, repair, upgrade, and hoping it lasts just another month or so for it to reach the end of its useful life. In both cases, philosophically speaking, there is an allocation of useful life across the entire period. FAR 31.205-11, Depreciation, deals with the allowability of that allocation.
FAR 31.205-11, Depreciation
Depreciation is allowable for government contract costs, subject to limitations. Generally speaking, unless the depreciation for the asset would reduce the book value below $0 (zero) or the salvage/residual value, whichever is greater, the depreciation will be allowable as a contract cost. This is the point in the conversation where you wish you would have paid attention to your intro accounting professor.
As asset is defined, simply, as something the company owns. Depreciable assets are those with estimated useful lives normally beyond a year or the operating cycle, whichever is longer. The depreciation is based on cost minus salvage value. So, if an asset is acquired from the Government at no cost by the contractor, would the asset be depreciable? No – there is no cost on which to base the depreciation. I could continue the conversation about accounting for depreciation, but for purposes of the FAR, let’s get into the requirements a little more.
Whether or not the contract is subject to CAS, yet again there is a requirement to follow the standards and certain requirements of 404 and 409. First, 31.205-52 is required (and will be covered in this blog series at a later date). Impairments or sale and leaseback arrangements both affect the limitation on depreciation allowable as contract costs as do gains and losses. Also, a “capital lease” is also covered as a depreciable asset according to FAR. So, the costs associated with depreciating a capital lease are allowable.
There are some nuances to this principle I can’t imagine getting into, but in the end, it really comes down to a generally allowable charge with some limitations. Take good notes and carry on, all will be ok.