An important focus of private schools is the property and equipment which the school uses on a daily basis to educate students and provide extra-curricular activities. Capital projects occur frequently at schools, and the accounting treatment for these capital projects often presents unique challenges.
The first accounting challenge arises before the project is even undertaken. Prior to starting the construction or demolition phases of a capital project, the school needs to determine the project’s financing and funding cash inflows. A feasibility study is often completed to assess the needs of the school, the viewpoints of the school’s constituents, and potential capital campaign amounts to be raised. The costs of such study should be expensed.
Once the school decides on the capital project’s overall improvements and additions, costs incurred for architectural drawings are capitalized.
Interest costs incurred on amounts borrowed to fund the capital project should also be capitalized up to the time when the project is placed in service.
Construction costs for the capital project are capitalized, and depreciation begins when the assets are placed in service. The estimated useful lives of the assets are determined and used to depreciate the assets. The assignment of estimated useful lives to not-for-profit organizations’ assets can vary greatly, from assigning one useful life to one entire project to assigning different useful lives to the various components of the project such as flooring, HVAC, electrical, plumbing, roof, etc.
Before placing a capital project in service, the school should analyze its project and the costs to determine the most appropriate useful lives based on the knowledge available at the time. In anticipation of future replacement and repair needs, the separation of the project into more asset groupings with shorter estimated useful lives can lead to more meaningful capital assets, net of related accumulated depreciation, being reported in the financial statements.
For example, when a roof is replaced, the old roof should be written off. If a shorter estimated useful life was assigned to the roof portion of the initial building project, the roof might possibly be already fully depreciated so no loss would need to be recognized; however, if the roof was being depreciated using the same life as the underlying building, a significant loss might need to be recognized. It also facilitates the removal of the assets from the accounting records should a disposition, replacement or involuntary conversion occur with respect to a specific asset. This is an important, necessary step any time a repair and/or replacement occurs to ensure fixed assets are not inflated.
Other areas involved in a capital project that might pose an accounting challenge include land improvements. Although the costs of land are not depreciated because land does not wear out, become obsolete, or get used up, certain costs for land improvements such as paving, sewers, fences, and landscaping should be capitalized and amortized over their estimated useful lives.
Demolition costs are sometimes necessary before a capital project can begin. Such costs are analyzed based on the property which is being demolished. If a piece of property is purchased which includes a building, and if at the time of the purchase, the school intends to use the property only after the building is demolished, then the costs of demolishing the building should be capitalized with the cost of the land. This is deemed to be the cost paid for the land to put it in a condition which the purchaser can use. However, if a building is on property already owned by the school, the costs of such demolition should be expensed in the year in which the demolition occurs. The remaining book value of the demolished building should be written off when the demolition occurs.
When it is determined that a building will be demolished (such as for a planned capital expansion), this is considered to be an indicator of impairment such that the carrying value of the asset might not be recoverable. If the asset’s estimated future undiscounted cash flows are less than its carrying value, an impairment loss should be recorded in the period when the indicator of impairment occurred.
If you have questions about accounting for capital projects, please contact RubinBrown’s Not-For-Profit Services Group.
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