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Weekly UpdatesIn late 2006, the Governmental Accounting Standards Board (GASB) issued an exposure draft (ED) on Accounting and Financial Reporting for Intangible Assets. This article will briefly examine the key proposals put forward in the ED.
Background. Many state and local governments control intangible assets (e.g., easements, water rights, computer software). For more than 30 years, Accounting Principles Board (APB) Opinion No. 17, Intangible Assets, was the source of authoritative guidance on accounting and financial reporting for intangible assets. In 2001, the Financial Accounting Standards Board's (FASB) Statement No. 142, Goodwill and Other Intangibles, superseded APB Opinion No. 17 in the private sector. Meanwhile in 1999, the GASB issued Statement No. 34, Basic Financial Statements--and Management's Discussion and Analysis--for State and Local Governments, which expressly included intangibles as a subclass of capital assets.
It has not been clear to many financial statement preparers and auditors how these various standards apply to state and local governments. Some believe that APB Opinion No. 17 continues to be authoritative. Others contend that GASB Statement No. 34 effectively put an end to specialized accounting for intangibles, thereby effectively superseding APB Opinion No. 17. Still others hold that financial statement preparers and auditors should turn to FASB Statement No. 142 for authoritative guidance. The ED aims to put an end to this practical confusion.
Proposed Guidance. The ED takes the position that intangible assets are no more than a subclass of capital assets (per GASB Statement No. 34) and therefore should be subject to all of the display and disclosure requirements that apply to other types of capital assets.
The ED acknowledges that practical problems can arise in the case of internally generated assets (e.g., computer software), which would include items produced under contract with third parties, as well as existing items acquired from third parties that require "more than minimal effort" before they can achieve expected service capacity (e.g., commercial software). To minimize these potential problems, the ED proposes four criteria that must be met before any outlays can be capitalized in connection with an internally generated capital asset:
* It must have been determined that the objective of the project is to create a specific internally generated intangible asset;
* The nature of the service capacity expected upon completion must have been determined;
* The technical or technological feasibility of completing the project in such a way that expected service capacity is attained must have been demonstrated; and
* The government's intention, ability, and ongoing effort to continue to develop/complete the project must have been demonstrated.
Because of the significant costs that commonly arise in connection with internally developed software, the ED proposes specific capitalization guidelines based upon when outlays are incurred during the software development process.
* Preliminary Project Stage
* Description. Activities in this stage include the conceptual formulation and evaluation of alternatives, the determination of the existence of needed technology, and the final selection of alternatives for the development of the software.
* Proposed treatment. Report all outlays during this phase as expense or expenditure, do not capitalize.
* Application Development Stage
* Description. Activities in this stage include the design of the chosen path, including software configuration and software interfaces, coding, installation to hardware, and testing, including the parallel processing phase.
* Proposed treatment. Capitalize outlays, but only after completion of the preliminary project phase, and only if management authorizes and commits itself to funding the project for the current period, at least implicitly. Naturally, capitalization would cease no later than the point at which the software is substantially complete and ready for its intended use.
* Post-Implementation/Operation Stage
* Description. Activities in this stage include training and software maintenance.
* Proposed treatment. Report all outlays during this phase as expense or expenditure, do not capitalize.
The ED further explains that improvements (i.e.,"upgrades") would only be expected to be capitalized if they increased either the capacity or efficiency of the software.
As capital assets, intangibles are subject to the provisions of GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries. The ED proposes to amend that statement to expand the list of indicators of potential impairment in paragraph 9 to include a stoppage in the development of internally generated capital assets.
APB Opinion No. 17 had required that the cost of intangible assets be amortized over the useful life of the asset, but set a maximum amortization term of forty years, even for assets expected to provide service beyond that time. The ED also calls for the cost of intangible assets to be amortized over their expected useful life, but sets no maximum amortization period. It also explicitly recognizes that many intangible assets have an indefinite useful life (e.g., easements), in which case they should not be amortized at all.
Effective Date. The ED proposes implementation no later than for the fiscal year ending June 30, 2010. Note that implementation specifically would require retroactive reporting for previously unrecognized intangible assets. Because of the special challenge retroactive reporting could pose in the case of internally generated capital assets (e.g., computer software), the ED proposes to exempt such assets from the retroactive reporting requirement if it is considered impossible to determine or estimate historical costs "after making every reasonable effort"
STEPHEN J. GAUTHIER is director of the GFOA's Technical Services Center.
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