Chapter 3. Property and Equipment

30.01 General

This chapter discusses property and equipment accounts. These accounts consist of the five accounts listed in the Bank Premises section of the FR 34 balance sheet, the Furniture and Equipment account and its related allowance for depreciation account, and the Other Real Estate account listed in the Other Assets section of the FR 34. This chapter also gives instructions concerning leasehold improvements and software which are discussed in Deferred Charges (see also paragraph 4.20).

Property and equipment, also referred to as fixed assets, are used in the production and distribution of services by all Federal Reserve Banks. Fixed assets have three primary characteristics:

1. Acquired and held for use in operations, (i.e., not held for sale).
2. Long-term in nature (greater than 1 year) and
3. Possess physical substance.

Generally Accepted Accounting Principles (GAAP) generally require fixed assets to be recorded at their cost, including all normal expenditures to bring the asset to a location and condition for its intended use.

Full acquisition cost for fixed assets (except software--see Appendix D) includes all expenditures necessary to bring the asset to a location and condition in which it is usable for the purpose intended. Acquisition cost includes:

• installation costs
• assembly
• freight
• warehousing
• insurance
• taxes

Full acquisition cost should also include trade-in allowances (i.e., the amount capitalized when an asset is traded-in for a new asset should equal the cash outlay for the new asset plus the lesser of (1) the net book value of the asset traded-in or (2) the allowance provided for the trade-in. Further information on trade-ins is found in paragraph 30.90.

Installation costs should include external costs of services, such as consultants who are contracted to work on the installation project, and salary and related benefits of staff and travel expenses incurred by staff or consultants who are directly involved with the installation project. Integration costs that are related to the installation of equipment should also be capitalized. Capitalized installation costs of equipment should include the cost of initial programming if (1) the cost is included in and is indistinguishable from the price of the purchased equipment, (2) the programming is an integral part of the equipment and is not the type that could be performed in-house, and (3) there is no readily determinable fair value for the software. Internal use computer software with an acquisition cost of $100,000 or greater should be capitalized as a deferred charge. (See paragraph 4.20 for further information.)

The capitalized cost of an asset is written off periodically, or depreciated, in a manner that is systematic and rational after consideration of any salvage values (see paragraph 30.75). Allocating the cost of a long-lived asset over the accounting periods which the asset is used matches its cost with revenue generated throughout its useful life. The Federal Reserve System uses the straight-line method for depreciating fixed assets.

In general, assets should be capitalized using the individual asset method, which is based on the individual asset unit. Asset units should be readily identifiable (subject to verification of existence without disassembly) and provide economic benefit through distinct, substantive functionality. Thus, in some instances, an asset may be an integrated unit made up of components that individually do not provide functionality without connection to the other components.

An alternate method of capitalization, the pooled method, must be used when capitalizing Furniture/Furnishings/Fixtures. The pooled method may be used to capitalize a bulk purchase of low-cost equipment, at the Reserve Bank's option, when the RBOPS Accounting Policy and Operations Section has been notified.. The pooled asset method is described in paragraphs 30.47 and 30.55-30.58. All other paragraphs relate to individual asset accounting. The useful lives and capitalization thresholds discussed in the following paragraphs reflect minimum accounting requirements for Reserve Banks. Based on local experience or practice, Reserve Banks may establish policies authorizing shorter useful lives or lower capitalization thresholds. Such policies must be in writing, applied consistently within the District, and provided as information to the RBOPS Accounting Policy and Operations Section.

30.05 Historical Information

The accounting rules for capitalizing and depreciating property and equipment have remained the same over the years with only minor departures for special circumstances. Prior to 1922, for example, several offices were authorized to charge larger amounts of depreciation against earnings because of inflated construction costs during and after World War I, and in 1922 FRB-Minneapolis was authorized to write off $500,000 to reduce the book value of its quarters to the approximate market value.

In 1995, the Federal Reserve Banks began recognizing impairment losses consistent with FASB ASC Topic 840-30; formerly SFAS No. 121, which was superseded by FASB ASC Topic 360-10; formerly SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, write-downs of property and equipment occur periodically as a result of adjusting assets to their estimated fair values. (See paragraph 30.95.)

Prior to 1996, construction costs for improvements or additions to a building were capitalized as part of the original building only if the addition or improvement significantly increased the useful life of the building beyond the current depreciation schedule or added functionality or space, in accordance with generally accepted accounting principles. In practice, ensuring accounting consistency for large improvement projects became burdensome, especially as some buildings approached the end of their initial useful lives. Since 1996, improvements to existing buildings are evaluated, capitalized, and depreciated as separate assets as a practical expedient. Accordingly, underlying asset values are not adjusted for capitalized improvements regardless of when the underlying asset was acquired. Improvement assets and accumulated depreciation, however, are adjusted if replaced or modified by a subsequent capitalized improvement and charged to depreciation expense.

Accounting for Asset Retirement Obligations (FASB ASC Topic 410-20; formerly SFAS 143, as interpreted by FIN 47, requires recording an asset and related liability for conditional asset retirement obligations, such as the legal requirement to remediate environmental hazards in land and buildings (for example, asbestos). Application of these standards can be complex, and Reserve Bank staff must obtain approval from the RBOPS Accounting Policy and Operations Section prior to making any accounting entries.

30.06 Publication of Property and Equipment Information

Property and equipment information is published weekly, monthly and annually in various publications as described in paragraphs 60.15, 60.20, and 60.35. A detailed table showing costs and net book values, by office, for land, buildings, building machinery and equipment, construction, and other real estate also appears in the Board's Annual Report.¹

30.10 Land

This account includes all expenditures to acquire a site (such as purchase price, closing costs, and attorney/recording fees), and costs to prepare a site for construction (such as the removal of existing structures, draining, filling, and clearing).² The account should be debited when property is purchased for immediate Bank use or when a property that was previously carried in Other Real Estate is approved for construction. Land is carried on the Reserve Bank's books at cost and is not depreciated.

If the property includes a building or other structure which is intended to be used for banking purposes, the portion to be charged to Land should be based on the assigned value in the purchase document or, in the absence of such specific information, on the appraised value. When appraised values are used and are different from the purchase price, the cost should be distributed on a pro-rata basis in the same proportion as the value of Land, Building, and Building Machinery and Equipment bears to total appraised value. If the purchased property includes a building or other structure, which is to be razed, the entire purchase price should be allocated to the account. The cost of removing such structures should be charged to the account and the proceeds from the sale of salvaged materials should be credited. Incidental costs of demolishing the building (such as liability insurance, measures taken to maintain adjacent property during operation, reinforcement of walls of adjacent buildings, other repairs made for safety, and reconnection or construction of sewers) should also be included in this account.

30.15 Land Improvements

The Land Improvements account is used to record costs incurred for capital land improvements which have limited lives (e.g., sidewalks, fountains, and fences). Land improvements that cost $100,000 or more must be capitalized. The Land Improvements account is reported as a sub-account to Land. The allowance for depreciation for land improvements is reported as a sub-account to the bank premises allowance for depreciation.

The cost of each improvement should be recorded in a subsidiary ledger within the Land Improvements sub-account and depreciated over its own unique estimated useful life. Depreciation is recorded by debiting depreciation expense and crediting Accumulated Depreciation for Land Improvements. The maximum useful life for land improvements is 20 years.

30.20 Building

This account is used to record costs of acquiring or constructing a building to be used by the Bank. The cost of a building should include all expenditures related directly to its acquisition or construction. Generally, all costs incurred beginning with excavation through completion of construction, are considered part of the building costs. The cost of the building should not include the cost of land, land improvements, or fixed machinery and equipment.

This account should be charged when a building is purchased for immediate Bank use or when the Construction account is closed upon completion of a project. Thereafter, only major alterations, renovations and improvements may be added to the capitalized cost of the building.³ Building improvements must be capitalized if the cost is $100,000 or more, and if the improvements meet the capitalization criteria defined in paragraph 30.70.

Such major improvements should be recorded and depreciated individually in the Bank's subsidiary records. The account should be credited only when the building or major improvement is sold, demolished, or otherwise retired, such as by transfer to the Other Real Estate account.

Projects such as repairing, painting or refurbishing should be charged to expense unless they meet the capitalization tests for improvements as defined in section 30.70. The maximum useful life of a building is 50 years. Improvements should be assigned unique useful lives, not to exceed 50 years.

30.25 Building Machinery and Equipment

This account comprises stand-alone or supplemental equipment with a shorter expected life than the building but that would remain as part of a building upon its sale or abandonment by the Reserve Bank. The account should be debited when a building is purchased or when the Construction account is closed out upon completion of a project. The account should be credited when the equipment is disposed of, or when the building to which it pertains is sold or transferred to the Other Real Estate account. Subsequent purchases or capitalizable improvements to building machinery and equipment will be recorded by increasing the Building Machinery and Equipment asset account (see paragraph 30.70). Building machinery should be capitalized if the full acquisition cost (paragraph 30.01) is $50,000 or more and meets the capitalization criteria defined in paragraph 30.70.

When property is purchased for immediate use, the estimated amount of machinery and equipment that is included in the building should also be included in this account. If the purchased property includes building machinery and equipment which is to be dismantled, the proportionate cost allocable to such machinery and equipment should be charged to the asset account Land. If the building or other structures are to be held for future Bank use, no allocation will be necessary since the entire cost of the property will be charged to Other Real Estate. The maximum useful life of building machinery and equipment is 20 years. Improvements may be assigned unique useful lives, not to exceed 20 years.

30.30 Construction Account

This account is used to accumulate all capitalizable costs relating to a building or renovation project, and is closed out following completion of the project. This account should be charged for all costs of a new building, the purchase price of a building to be held for future use pending renovation, and all renovation and improvement costs. Receipts from the sale for such items as scrap or recoveries of building costs for such items as change orders and insurance should be deducted from the amount of the project to be capitalized.

Upon completion of a given project, amounts that were accumulated in this account should be analyzed and capitalized in accordance with the provisions contained in this chapter. Construction projects should be capitalized in a timely fashion (i.e. when the project is substantially complete) and, if necessary, in portions. Resolution of punch list items and billing disputes should not delay capitalization unless their nature is so significant that the asset(s) are rendered virtually unusable until resolution. Reserve Banks may capitalize and depreciate salaries of employees directly engaged in construction projects if they are performing functions that an outside contractor or consultant would be retained to perform if the internal staff were not available or did not have the necessary expertise. Personnel costs associated with management oversight should not be capitalized if they are of an administrative nature. See 30.40 for examples of capitalized items.

As costs are incurred, they should be analyzed for propriety as capital costs related to the project. Expense items should not be carried in this account except as necessary when commingled with other costs. When such expense items are finally determined, they should normally be applied to the current year's expenses. Similarly, costs related to building and construction projects, such as consulting fees and survey costs, that have not been and are not likely to be approved by the Board in the near future should be expensed when incurred, rather than included in this account.

30.40 Examples of Classification of Capitalized Bank Premises Assets

The following are examples of disbursements, which are to be capitalized as land, land improvements, building, and machinery and equipment. The list is intended to suggest the scope of the Bank Premises accounts and is not exhaustive.

30.45 Furniture and Equipment

Furniture and equipment includes computing equipment, automotive equipment, furniture/furnishings/fixtures, operating equipment, and artwork.

30.46 Examples of Classification of Capitalized Furniture and Equipment Assets

The following are examples of expenditures that are to be capitalized as furniture and equipment. The list is intended to suggest the scope of the furniture and equipment accounts, and is not exhaustive.

30.47 Methods of Capitalization--Furniture and Equipment

Two accounting methods are followed in capitalizing and depreciating these assets--the "individual asset" method (as is used for all other asset categories) and the "pooled asset" method.

Assets classified as Furniture/Furnishings/Fixtures must be capitalized and depreciated using the pooled asset method, as described in paragraph 30.55 below. In addition to purchased furniture, a Reserve Bank may, at its option, capitalize and depreciate salaries and the outside cost of materials that are consumed in the construction of furniture and equipment by Reserve Bank personnel. These costs are also capitalized and depreciated using the pooled asset method.

Equipment with a cost of $5,000 or more must be capitalized using the individual asset method. Equipment with a purchase cost below $5,000 should be expensed. If equipment costs less than $5,000 for an individual item but significant quantities are acquired, and the total purchase exceeds $100,000, then the purchase may be capitalized and recorded with notification to the RBOPS Accounting Policy and Operations Section, which has 10 business days to object to the accounting treatment.

The pooled asset method of capitalizing, depreciating, and handling improvements is discussed in paragraphs 30.55-30.58. All other paragraphs in this chapter relate to the individual asset accounting method. Maximum useful lives for furniture and equipment asset groupings under both the individual asset and pooled asset method are found in table 30.78.

30.50 Equipment

Equipment (with the exception of those items that are pooled) should be capitalized on an individual item basis and recorded within the appropriate asset account. This account should be charged for the full acquisition cost as described in paragraph 30.01 and care should be taken to ensure asset and liability accounts are properly reflected at the time the asset is received.

30.55 Pooled Asset Method

The pooled asset method is used to account for furniture, furnishings, and fixtures. Pooling allows small dollar/large quantity assets to be appropriately reflected on the financial statements without imposing the unnecessary tracking of each asset individually as a practical expedient. Under the pooled asset accounting concept, no individual item has a recorded and separately identifiable book value. Rather, it is the group (pool) account that carries a book value. Accordingly, as will be noted from the following instructions, once a pool account has been established, the amount in the pool account remains unchanged for as long as the pool account remains in existence (until it is fully depreciated).

All purchases handled under the pooled asset method are to be capitalized into pooled accounts at full acquisition cost, including, where applicable, such items as outside installation costs, furniture assembly, freight charges, warehousing, insurance, and taxes. Each calendar year will be considered as a separate pool and all purchases made within a given calendar year will be considered a part of that pool account.

If a Reserve Bank has been granted approval to capitalize a particular bulk purchase of low-cost equipment, that purchase will be handled similarly to pooled assets, in that the items will not be individually tracked or have separately identifiable book values.

30.56 Pooled Asset Depreciation

Depreciation will be calculated monthly on the gross amount of each pool account, using the "straight-line method." Depreciation on each furniture pool account will begin in the first month following the end of the pool year (calendar year). Guidelines on useful lives of pooled assets are found in table 30.78. Depreciation will continue until the allowance for depreciation equals the amount of the pool account, at which time the pool account will be credited and the related allowance for depreciation will be debited for the amount of the pool account (effectively removing these accounts from the balance sheet).

30.57 Pooled Improvements (or Betterments)

The costs paid to an outside vendor for significant improvements or betterments made to furniture, furnishings, and fixtures will be capitalized. When such expenditures are made, the amount will be added or capitalized in the appropriate pooled asset account for the year in which the expenditures are made. Such capitalized improvement or betterment costs will be treated as a purchase made during the year and will be depreciated, along with the other purchased assets in the pool, over the life of that particular pool account.

30.58 Disposals and Trade-ins of Pooled Asset Items

The following is the treatment to be used when any item carried in a pooled asset account is (a) sold, the salvage received from the sale should be credited against the appropriate current year pool; (b) traded in on a new item which also is to be carried in a pooled asset account, the appropriate pooled asset account for the current year is to be debited with the net purchase price (full acquisition cost less trade-in) of the new asset. If the new item (for which the pooled item was traded in) will not be pooled, it should be expensed at the net purchase price; (c) lost, stolen or junked, with no salvage or trade-in value received, no entries are to be made for Balance Sheet accounting and reporting purposes.

30.70 Expenditures for Existing Buildings and Equipment

Expenditures for existing buildings and equipment consist of the cost of additions, improvements, and major replacements to an asset (see descriptions below). These expenditures should be analyzed to determine if they should be capitalized or charged to expense in the current accounting period. Generally, expenditures for existing assets that meet the capitalization threshold of the Reserve Bank for similar assets are considered capitalizable if at least one of the following criteria is met:

1. The useful life of the existing asset is increased by more than one year.
2. The quantity of output or operating efficiency of the asset is significantly increased.
3. The quality of output is significantly increased.

The cost incurred for any asset that does not meet the criteria described above or the capitalization threshold for similar assets should be expensed in the period incurred. Repairs and maintenance costs incurred to maintain an asset at its current level of operation are not capitalizable and should be charged to expense.

Additions:

Additions are the increases to, or extensions of an existing building or equipment. Additions that meet one or more of the criteria described above should be recorded in a separate subsidiary account of the Buildings or Equipment account and generally depreciated over the remaining life of the principal asset. If the addition is considered to have an independent service life of its own, depreciation is recognized over the service life of the addition.

Improvements:

Improvements (or betterments) represent major modifications of an existing asset such as major renovations to an existing building or overhaul to equipment that will significantly increase its efficiency, its useful life, or the quality of the asset. Demolition costs resulting from the improvements of internal structures such as walls or flooring are also considered part of the improvement.

Improvements made to buildings or equipment that meet one or more of the criteria described above should be recorded separately in the appropriate subsidiary account. The depreciation rate for the improved asset should be recalculated based on the new useful life, net book value, and salvage value of the improved asset. If the improvement is made to a building and is considered to have an independent useful life, depreciation is recognized over the service life of the improvement. The revised depreciation charges should begin in the first month following final payment or when the asset is placed in service, whichever occurs first.

Specialized improvements are separately identifiable building improvements or renovations that usually have a distinct useful life and may not meet the improvement criteria above, but are significant changes to the original asset.⁴ For specialized improvements, any remaining costs of the original improved or replaced asset cannot be separately identified from the cost of the original building asset; therefore, it cannot be written-off or the useful life cannot be accelerated. Any loss associated with the impairment of a specialized improvement is charged to expense.

When conducting floor renovations, Reserve Banks should look to their historical renovation trends to determine if the renovation should be capitalized and given a distinct useful life. For example, if the Reserve Bank has a history of renovating floors every ten years, a useful life of ten years would most likely be assigned to a current renovation. However, if floor renovations are rare, or no particular trend emerges in the frequency of the renovation, a Reserve Bank may consider assigning the remaining useful life of the building as the useful life of its current renovation. Improvements that replace assets with a separately distinguishable book value should be treated as a replacement (see replacement requirements below). See paragraphs 30.85-30.87 for the appropriate treatment of leasehold and tenant improvements.

The accounting for costs associated with improvements made to computer equipment should be capitalized if the improvement meets the $5,000 capitalization threshold of individual assets and the improvements are tangible. To illustrate, assume that a two-year old computer is initially purchased for $l,000,000 and the expected useful life is set at six years. At the end of four years, an improvement is made for $300,000 which is considered tangible and is expected to extend the useful life two years beyond the original useful life period (four years from the time of the improvement) and increase the salvage value $30,000. Initially, the computer was being depreciated at $150,000 per year to a salvage value of $100,000. After the improvement, it would be depreciated at $142,500 per year to a salvage value of $130,000. An equipment improvement that can function independent of the underlying asset (for example, a storage array added to a server that can be moved to another server if needed) should be capitalized as a separate asset with a unique useful life. If the improvement cannot function independent of the underlying asset, the costs associated with the improvement should be depreciated over the remaining useful life of the original underlying asset.

Replacements:

A replacement is a substitution of an existing asset by a new asset. Replacements should be capitalized if they meet one of the criteria discussed above. Replacements should be accounted for under the substitution approach which requires removing the cost of the existing asset and its accumulated depreciation from the books and charging current expense for the difference. The new asset should be depreciated over its own useful life.

30.71 Capitalization Thresholds

For an outlay to be capitalized, it should be material in value. For purposes of recognizing long-term physical assets, materiality is defined as equal to or greater than established capitalization thresholds.Table 30.72 provides the capitalization thresholds for the types of assets described in this chapter. The thresholds stated in the table represent the lower limit above which these transactions must be capitalized. A Reserve Bank has the option to implement more stringent (lower) thresholds if it deems such a policy preferable. If a more stringent threshold is used, the Reserve Bank must consistently apply the threshold throughout the District (i.e., the head office and Branches must all use the same capitalization thresholds for all asset classes.) Such policy must be documented and provided as information to the RBOPS Accounting Policy and Operations Section.

30.72 Capitalization Thresholds Table

30.75 Depreciation

Depreciation is defined as the accounting process of allocating the cost of tangible assets to current expense in a systematic and rational manner in those periods expected to benefit from the use of the asset. Depreciation is an occupancy or usage cost and therefore, should begin the month following the date equipment is placed into production. When constructing a building, if it is occupied prior to closing the Construction account, depreciation should be estimated as closely as possible and applied to current expense effective in the month following when at least 50 percent of the Reserve Bank's staff is operating from the new quarters. Any adjustments for over or under estimates of depreciation, as may be determined when the Construction account is closed and final figures for Building and Building Machinery and Equipment are capitalized, should be adjusted to current expense in the current month.

For all fixed assets (except software) reported on the balance sheet, depreciation starts the month following the fixed asset is placed into service. Depreciation is recorded by debiting current expense and crediting the related allowance for depreciation on the balance sheet. Thus, the amount of accumulated depreciation reported on the balance sheet represents the sum of the individual depreciation charges for each asset that have been recorded in the subsidiary accounts of the Bank.

Assets are depreciated on a straight-line basis. The depreciable basis of an asset is its acquisition cost less its estimated salvage value. The formula for calculating the straight-line method of depreciation is as follows:

Cost less Salvage Value/Estimated Useful Life (in months) = Monthly Depreciation Charge

Depreciation should continue until the asset is fully depreciated or disposed. At the end of an asset's estimated useful life, the asset's net book value should equal its salvage value and depreciation should be discontinued. Depreciation on impaired assets should continue until the Reserve Bank ceases the operations for which the asset is used. Assets that are held for sale are reclassified to other real estate and depreciation ceases. The asset and related allowance for depreciation should not be removed from the balance sheet until the asset is retired or disposed, even if the net book value of the asset is zero. (See paragraph 30.95.)

Appropriate subsidiary records, reflecting the original acquisition cost, the cost of any improvements, and allowance for depreciation balance should be maintained in all cases. Land, artwork, and assets held for sale or future use are not depreciated.

30.76 Depreciation Rate and Salvage Value

Table 30.78 provides information for establishing useful lives and salvage values for the types of assets described within this chapter. Similar assets, within an asset category, that have the same useful lives may be grouped for depreciation purposes, as long as memorandum records are maintained detailing the original charges to the account by piece of equipment. It should be noted that Table 30.78 provides parameters within which the Reserve Bank may determine the appropriate depreciation schedule for assets. It should not be viewed as an indication of rates that are automatically to be assigned to new or used equipment. If a Reserve Bank has a special case where the documented useful life or salvage value of an asset exceeds the guidelines set forth, a request, with substantiating documentation, should be sent to the Manager of the RBOPS Accounting Policy and Operations Section for review and approval. A Reserve Bank may utilize a lesser useful life or salvage value than the guidelines listed without Board notification with the exception of the bank building (excluding improvements).

The depreciation rate should be based on the expected unique useful life to the Reserve Bank, taking into account such factors as probable technological obsolescence and projected capacity limitations consistent with the Bank's long-range procurement plans, industry information, and improvements. The salvage value assigned to an asset should reflect the Reserve Bank's expected recovery upon sale or trade-in of the asset. Assessments of the useful life and salvage value of all assets, excluding building but including Building Improvements, and Building Machinery and Equipment should be reviewed annually, at a minimum. Should the Reserve Bank note a change in the expected remaining useful life or salvage value of the asset, the depreciation rate should be adjusted prospectively such that the remaining net book value is depreciated to the estimated salvage value over the expected remaining useful life of the asset.

30.78 Maximum Useful Lives and Salvage Values Table

30.80 Operating and Capitalized Leases

Operating leases: An operating lease is defined as a lease contract that allows the use of an asset, without conveying rights of ownership, such as tenant leases and equipment. Consistent with the requirements of FASB ASC Topic 840-20; formerly SFAS No. 13, the monthly income or expense recognized should be derived by dividing the minimum rent to be received or paid (including any rent escalations) equally over the non-cancelable lease term. Minimum rental payments include those called for by the lease agreements, such as broker commissions, tenant improvements, incentive payments, rent escalations and CPI adjustments, and exclude executory costs (insurance, maintenance, and taxes) and contingent payments. The non-cancelable lease term should include all free rental periods granted. Improvements should be capitalized and amortized as discussed in paragraphs 30.85, 30.86, and 30.87. For example, if a Reserve Bank enters into a lease agreement with a rent escalation clause, the Reserve Bank's monthly rental expense (or income) will be equal to the total rent that will be paid over the minimum non-cancelable lease term divided by the number of months in the minimum non-cancellable lease term. The difference between the rental expense (or income) and the actual rent payment will be recognized as a liability in the Sundry Items Payable (SIP) account (or an asset in the deferred charges account) and as an offset to the liability (or asset) as the payments escalate. For example, assume a Reserve Bank enters into a three-year lease for $100 per month for the first two years and $115 per month for the third year. The total rental payments over the 36-month life of the lease would be $3,780 ($1,200, $1,200, and $1,380). The monthly expense would be $105 per month for all 36 months ($3,780/36 months). Each month, for the first 24 months the $5 difference between the expense recognized and the rent paid would be credited to the SIP account. Beginning with the first payment of the third year the $10 difference between the rent paid and the expense recognized ($115 - $105) would be debited to the SIP account.

Terminating or restructuring operating leases (equipment or facility) related to restructuring events: Lease termination costs should be accrued when a lease contract is terminated. Termination of the contract is determined by the contract provisions (i.e. notifying the lessor of intent to terminate in accordance with contract provisions), or by subsequent negotiation with the counterparty.

If a lease is being restructured, a liability for costs that will continue to be incurred under the lease contract without economic benefit to the Bank shall be recognized when the Bank ceases using the asset (cease-use date).⁵ This liability should be measured at its fair value on the cease-use date. In general, this liability should be the present value of remaining lease payments after the cease-use date reduced by estimated sublease rentals that could be reasonably obtained for the asset, even if the Bank does not intend to enter into a sublease. If the value of the sublease rentals exceeds the lease costs, no liability (or asset) is recognized. Due to the complexity of this accrual, Reserve Banks should contact RBOPS Accounting Policy and Operations Section for guidance.

Capital leases: A lease that is entered into that transfers substantially all the benefits and risks of ownership of property to the Reserve Bank is a capital lease and should be accounted for as the acquisition of an asset and the incurrence of an obligation.

The FASB ASC Topic 840-10; formerly SFAS No. 13 establishes that leases which meet any one of the following four criteria at the inception of the lease should be classified as a capital lease:

1. The lease transfers ownership of the property to the lessee by the end of the lease term.
2. The lease contains a bargain purchase option. This is a provision that allows the lessee to purchase the leased property for a price sufficiently lower than the expected fair value of the property and the exercise of which appears reasonably assured.
3. The lease term is equal to 75 percent or more of the estimated economic life of the leased property. The estimated economic life is the estimated remaining period during which the property is expected to be economically usable for the purpose for which it was intended at the inception of the lease. This criterion should not be used if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property.
4. The present value of lease payments equals or exceeds 90 percent of the excess of fair value of the leased property over any related investment tax credit retained by the lessor. This criterion should not be used if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property.

To justify the additional time and expense of capitalizing a lease, the materiality test to apply is that the leased asset value equals or exceeds $100,000 (see paragraph 30.01 for guidance in determining the asset unit for capitalization). If the lease has been determined to meet any one of the four criteria above and has passed the materiality test, the transaction should be treated as the acquisition of a capital asset. If the lease meets either criterion 1 or 2 listed above, the asset should be depreciated as any similar capital asset would be, otherwise, the asset should be depreciated over the lease term. The amount capitalized should be equal to the lesser of the current fair market value of the asset or the present value of the lease payments and the payment called for by the bargain purchase option (if any). The present value of the lease payments should be calculated using the current Treasury borrowing rate for a term comparable to the lease term unless the interest rate implicit in the lease, as computed by the lessor, is both readily determinable and less than the current Treasury borrowing rate. At the time of capitalization, a liability in the Sundry Items Payable account (see paragraph 11.70) should be recorded for the capitalized value of the lease. Additionally, a portion of each lease payment should be treated as interest expense at the time each payment is made such that a constant periodic rate of interest is in effect over the life of the lease. The interest rate used should be the same as that used in determining the present value of the lease payments.

In order to maintain proper accountability for capitalized leases, separate subsidiary accounts under the appropriate asset and liability categories should be established. Potential capital leases with lease payments over the lease term in excess of $500,000 along with the proposed accounting treatment should be sent to the RBOPS Accounting Policy and Operations Section for review.

For the purposes of this paragraph, the lease term is defined as the fixed non-cancelable term of the lease. The lease term should include any periods covered by bargain renewal options but should not include standard renewal periods. The lease term should also include the entire period up to the time a bargain purchase option becomes exercisable. See paragraph 30.86 for an example of how to determine the lease term or "known life of the lease."

30.81 Lease Incentives

When the Bank is the lessee, the Bank should record incentive payments, including tenant allowances, received from a lessor in a liability account, and recognize the payments received ratably over the lease term as a reduction of rental expense. The Bank should recognize costs (such as moving expenses) as incurred without regard to the terms of the lease and the lease incentive. When the Bank is the lessor, the Bank should record incentive payments, including tenant allowances, granted to the lessee in a deferred charge account and recognized it ratably over the lease term as a reduction of rental income.

30.85 Leasehold Improvements

Major expenditures made in connection with the renovation or alteration of a space rented for Bank use should be capitalized in Deferred Charges (see paragraph 4.20). A leasehold improvement must be capitalized if the cost is $25,000 or more. The cost of minor repairs and maintenance involved in the upkeep of leased quarters should be charged to current expense. The term "renovations and alterations" as used here is intended to include the construction of any new building for Bank use on leased property where the title to the building passes to the owner of the land either upon completion of construction or termination of the lease agreement.

30.86 Amortization of Leasehold Improvements

Leasehold improvements should be amortized to current expense as rent over the shorter of the non-cancelable lease term or the unique useful life of the asset. For purpose of this amortization, the non-cancelable lease term of a lease is that period of time during which the Bank agrees to rent the property including periods covered by bargain renewal options but not including standard renewal periods. The bargain renewal option should be sufficiently below fair rental value such that renewal is reasonably assured. For example, if a Bank enters into an agreement to lease property for 5 years with a bargain renewal period after 2 years, the known life would be 7 years and the cost of the improvements would be amortized over a maximum of 7 years. If, however, the 5 year rental period was followed up by a standard (rather than bargain) renewal period of 2 years, the known life and period of amortization would be a maximum of 5 years.

30.87 Tenant Improvements

Significant expenditures associated with tenant improvements that are unique to the needs of the lessee should be accumulated in a subsidiary construction account until completion of the project. The expenditures should then be capitalized in one or more subsidiary accounts under the appropriate Bank premises asset. A tenant improvement must be capitalized if the cost is $25,000 or more. The amount charged to Bank premises as tenant improvements should be amortized to current expense as depreciation over the shorter of the non-cancelable lease term or the unique useful life of the asset. In the event that a tenant leaves before the expiration of the lease, any remaining unamortized amount should be charged to current expense as a loss on disposal of fixed assets.

30.90 Disposals and Trade-ins

When disposing of assets (either voluntarily or involuntarily) the gross asset value and the related accumulated depreciation should be deducted from the appropriate asset account and from the allowance for depreciation account. Any difference between the net book value (gross asset value less accumulated depreciation) and the proceeds from a sale should be debited or credited to current expense. When an asset is traded in, if the net book value exceeds the trade-in allowance, that difference should be debited to current expense (i.e., the amount capitalized when an asset is traded in for a new asset should equal the cash outlay for the new asset plus the lesser of (1) the net book value of the asset traded-in, or (2) the allowance provided for the trade in). In the event equipment is sold by one Reserve Bank to another, any net difference between book value and selling price should be recorded as an increase or decrease to current expense on the books of the selling office. Any transfer of assets between offices of the same District should be made at book value. The receiving office should record the asset on a cost basis equal to the net book value.

30.95 Asset Impairment

At the time an asset is judged to be materially and permanently impaired (whether partial or total), a loss should be recognized in accordance with FASB ASC Topic 360-10; formerly SFAS No. 144. As a general rule, the loss associated with the impairment of land, building (in-service date ending 1995), and building machinery and equipment (BM&E), should be charged to Profit & Loss. The loss associated with impairments of land improvements, building improvements (in-service date beginning 1996), and furniture and equipment should be charged to Current Expense.⁶ The offset should be recognized by reducing the book value of the asset through a credit to the asset account if the asset is held for use. The reduction in book value for impaired assets held for disposal should be credited to an asset valuation account. The valuation account may be adjusted for subsequent revisions in estimates of fair value less costs to sell, provided that the carrying amount of the asset does not exceed its original carrying value (prior to any impairment recognition). Regardless of the outcome of the impairment analysis, the useful life and salvage value of the asset should be evaluated and adjusted in accordance with FAM 30.75 and 30.76.

All write-downs of impaired assets must be approved by the RBOPS Accounting Policy and Operations Section. Information such as the description of the asset, whether the asset will be written down or written-off, the reason for the impairment, and the proposed entries to account for the asset impairment should be provided along with the request for approval. The fair value of assets considered for impairment should be determined in accordance with FASB ASC Topic 820-10; formerly SFAS No. 157, Fair Value Measurements.⁷ A fair value measurement assumes that an asset is exchanged in an orderly transaction between market participants, and assumes the highest and best use of the asset. In determining the amount of an impairment, the fair value is not to be reduced for transaction costs such as incremental direct costs to sell the asset.

Asset Grouping

For purposes of evaluating and recognizing impairment losses, assets should be grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets.⁸ For example, a check only facility to be closed would group all of its equipment into one group. Other likely groupings include: buildings including general improvements, land, specialized improvements (those related to a unique function), and leasehold improvements.⁹ In the case of assets (groups) that do not have cash flows that are identifiable as largely independent of the other assets of the Bank, such as head office buildings, those assets should be grouped with all the assets of the Bank.

Is this asset (group) available for sale?

If an asset is held for sale, then it is recorded at its fair value less selling costs and not depreciated (even if it is held and used). There are six conditions that must be met in order to classify an asset as held for sale.

1. Management commits to a plan to sell the asset (group).
2. The asset (group) is available for immediate sale in its current condition.
3. An active program to find a buyer has been initiated.
4. The sale is expected to be completed within one year.
5. The asking price is reasonable in relation to fair value.
6. Actions taken indicate that it is unlikely that the plan to sell will be withdrawn or significantly changed.

Evaluating for Impairments

Whenever major events or changes in operating circumstances indicate that the carrying amount of an asset may not be recoverable, perform an evaluation of the recorded carrying value of the associated asset to determine if a write-down due to impairment is needed.¹⁰ The following tests should be applied when such events or changes in circumstances occur or on an annual basis in the absence of such events or changes to determine if asset impairment is appropriate:

• A significant decrease in the fair value of an asset held for disposal.¹¹
• A significant change in the extent or manner in which an asset is used or a significant physical change in an asset.
• A significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator.
• An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset where these costs are not anticipated to be recoverable in the future.
• A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an asset used for the purpose of producing revenue.
• A current expectation that it is "more likely than not" that the asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

Does the carrying value (book value) exceed the amount that can be recovered (undiscounted net cash flows)?

This step is focused on whether the current value is recoverable not whether it is impaired. It is possible, for example, that an asset could have a carrying value well in excess of current market prices that still produces enough cash flows to cover its costs. Loss impairments are not recognized in these cases. The undiscounted cash flows include the cash flows throughout the life of the asset (group) including disposal. If, for example, the useful life of the asset is shorter because of changes in the extent of how it will be used, the cash flows should be measured over the shorter life. In the absence of a better source for cash flow information, Reserve Banks should consider the current depreciation costs as a proxy for undiscounted cash flows on assets that will continue to be used at "pre-impairment" production levels.¹² If the assets will be used in a reduced capacity, a reasonable pro-ration of the current depreciation should be made. In order to balance the costs associated with estimating and evaluating an impairment loss with the benefits, impairments should only be pursued if the carrying value exceeds recovery amount by the following thresholds.¹³ For those assets that are grouped, the thresholds apply to the group. These measurements, and those in the remaining steps, should be made as of the date the impairment was probable and estimable.

• Land: $500,000
• Buildings: Larger of $500,000 or $50,000 x the remaining useful life of the building
• Specialized Improvements: $100,000
• Equipment: $50,000
• Software: $50,000

Asset Fair Value and Impairment Loss Based on the Difference between Carrying Value and Fair Value

The fair value of the asset (group) is the amount at which the asset could be bought or sold in a current arms-length transaction. The ideal method for determining fair value is to use the price for the asset if it is traded in an active market. The next best method is to base fair value on the prices for similar assets (appraisal). The remaining method is to use the discounted present value of the expected cash flows for the asset. In general, assumptions and techniques used to determine fair value should be the same that marketplace participants would use if the information is available without undue cost and effort. Otherwise, the Reserve Bank should use its own assumptions. In general, absent reasonable appraisals of market, the undiscounted amount calculated in step three will be used for those assets that will be disposed of within five years. If applied to an asset that will be held for longer than five years such as a building, use the applicable Treasury rate for a security of that duration as of the impairment date. The impairment loss should be recorded as an adjustment to the asset account (proportionately to assets in a group) and a charge to the same account that would have been charged if the asset was sold.

Fair Value

After adjusting the carrying value for an impairment loss, consider adjusting the remaining useful life and salvage value assumptions from the impairment date. Once the adjustment is recorded, subsequent restoration is not permitted. Depreciation should be based on the adjusted values at the impairment date.

Other Costs Associated with Exit Activities

All other exit costs, such as relocating employees and equipment, and costs associated with closing facilities should be recognized in the period the goods or services are received (see FAM 11.56).

30.96 Sale or Transfer of Assets to Another Office

If an asset will be transferred to another office in same District, the depreciation continues and the cost to relocate and reinstall the equipment is charged to expense.¹⁴

If an asset will be sold to another Reserve Bank, the deprecation will cease when production ceases and the sale should be recorded at book-value (no gain or loss).¹⁵ The receiving Reserve Bank should record the asset at the transferring Reserve Bank's book-value, capitalize the installation and transportation costs and begin depreciation when the equipment is placed into production and continue over the asset's remaining useful life.

30.97 Other Real Estate

This account should be debited upon acquisition of real estate to be held for future Bank use or when Bank property is classified as held for sale. All costs associated with the purchase of real estate should be capitalized. Generally, buildings carried in this account should not be depreciated. When the site is approved for construction, Other real estate should be transferred to the appropriate Bank premises accounts (in most cases, Land).

In some cases, other real estate will include buildings with tenants. Income and expenses involved in operating buildings purchased after 1976 should be functioned through current expenses. If the real estate contains a building that will eventually be razed, depreciation should be discontinued upon acquisition.

The carrying amount of other real estate that is held for sale should not exceed its fair value. The carrying value of other real estate held for sale should be evaluated by the end of the calendar year, at a minimum, to determine if adjustments are necessary (see 30.95). This does not necessarily require an annual formal appraisal; however, valuation methodologies should be consistent.

31.00 Real Estate Reporting Requirements

Paragraph 60.40 provides instructions for the preparation and submission of required accounting reports FR 612 and FR 892.

References

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