Life of asset. The depreciation expense of an asset should be based on the estimated useful life of an asset. Though the government has traditionally preferred the use of physical lives of assets for computing depreciation, American Electronics Labortories (ASBCA No. 9879) established that economic life of assets is acceptable. The physical life, economic life and technical life have all been held to be acceptable for measuring the service life of an asset. The FAR has established that useful lives should be assigned as provided in the IRS’s asset depreciation range (ADR) guidelines. Even though the IRS has switched to the Accelerated Cost Recovery System (ACRS), which are usually shorter periods, ADR is preferred for government cost and pricing. ACRS is acceptable for contract costing purposes if it is also used for non-government work in the same cost center and is used for both financial accounting and income tax purposes. If ACRS is not used for both financial accounting and tax purposes it can be used for contract costing if (1) the ACRS recovery period is the same as the useful life and (2) ACRS is used for non-government work. In any case, allowable depreciation cannot exceed amounts used for financial accounting. It should also be recognized that it is not uncommon to have a contract that limits depreciation to, for example, common practices established in a particular industry.

Acceptable depreciation methods. With the general proviso that "inequities" can still occur, DCAA considers both asset lives and methods of depreciation that are consistent with the ADR system to be compatible with FAR 31.205-11(d). If ADR is not followed, only the straight line, declining balance or the sum-of-the-years digits methods are considered reasonable within certain limitations (e.g. only the straight-line method can be used if the depreciation period is less than three years, IRS guidelines for using the 200 percent declining balance must be followed, etc.).

Residual values. In computing depreciable assets, government auditors follow IRS guidelines in allowing the residual value of an asset to be ignored if it is less than 10 percent of the original amount capitalized (this provision has been accepted as part of the CAS and there is currently an outstanding proposal to amend the FAR to be consistent with CAS).

Government provided assets. No depreciation, rental or use charge is allowed on property obtained from the government at no cost to the contractor or obtained at no cost from an organization under common control.

Depreciation at other than cost. Depreciation based on the price paid for assets acquired from an organization under common control is permitted if the practice is consistently applied and if the price is based on established prices or adequate price competition. This does not apply if the price paid exceeds the price the seller would have charged its most favored customer or if the contracting officer determines the price is unreasonable.

Fully depreciated assets. Use charges for fully depreciated assets are allowable provided the charges are negotiated and documented in an advance agreement. In computing a reasonable use charge consideration should be given to: (1) the replacement cost and estimated useful life at the time of negotiation (2) the effect of increased maintenance costs and decreased efficiency because of the age of the asset and (3) the amount of previous depreciation charges made to the government contracts and subcontracts. In practice, established commercial practices of setting charge out rates are commonly accepted. Board decisions have established that use charges need not be recorded in the contractor’s books and records to be allowable on government contracts.

Asset valuations. As a result of a merger or acquisition contractors may be required to value their assets at fair market value in accordance with Accounting Principles Board Option No. 16, "Business Combinations." However, the new and usually higher valuations may not create depreciation charges greater than what would have been incurred had no merger or acquisition taken place. In 1996, CAS 404 was revised to preclude any write-up or write-down of assets based on a business combination. This created a conflict between the FAR and CAS because the FAR required a write-down of assets where the CAS did not permit such a write-down. The conflict was resolved in 1998 when the FAR was revised to match the CAS. DCAA, however, has taken the position that if an asset write-down occurs allowable depreciation is based on the written-down value of the acquired asset.

Sale leasebacks and related party transactions. Depreciation under sale-leaseback arrangements is limited to constructive ownership costs meaning allowable costs are limited to what would have been incurred had the asset been purchased. Similarly, the costs of leases between related parties are also limited to the constructive costs of the assets unless leasing of similar assets to non-related parties is part of their business.

Foreign exchange rates. Depreciation costs initially recorded in a foreign currency will be required to be converted to US dollars if the contract is payable in US dollars. The question of what is the appropriate currency exchange rates was addressed in General Electric Company (ASBCA 44646) where the Board denied use of the historical exchange rate and required use of the current rate. This decision was reversed by a higher court that ruled depreciation charges had to be based on average historic exchange rates. The Court stated both the FAR and CAS were silent on the matter but that Financial Accounting Standard 52 required use of the historic exchange rates.

Investment tax credits. As a matter of policy, the Department of Defense does not deduct the amount of any investment tax credit from the depreciable value of assets or require that such credits be used to offset contract costs.

{TAG_FORM_TITLE}