Basic Considerations

Residual Value. Residual value is an estimate of the proceeds expected to be received from either selling the asset or scrap value or its fair value if traded in. The estimate can be based on prior experience or publicly available information but in many cases can be difficult to ascertain and hence many contractors simply assume a zero value.

Service Life. Physical life provides the upper bound for service life of the assets. Physical life can vary according to the purpose for which it is acquired e.g. heavy use versus light use can vary the physical life. The service life is usually less than the physical life where, for example, technological change can make the asset obsolete, assets purchased for one contract may be useful only until the end of that contract or its follow-on or management policy may limit use to a three year period after which newer models are purchased. Since service life cannot be known with precision, depreciation is charged over the estimated service life.

Depreciation costs. CAS 409 permits contractors to account for its assets either on an individual basis or by combining two or more assets as a single accounting unit. The depreciable cost of the asset (or group of assets) is the capitalized cost less the estimated residual value. The standard provides that the residual value need not be deducted from the capitalized cost if it does not exceed 10 percent of the capitalized costs or the contract uses either the declining balance (the asset is never fully depreciated so the remaining values is considered the implicit residual value) or the classic life asset range system. We occasionally receive questions on how to treat the investment tax credit the IRS sometimes provides the public. The issue is not addressed in the FAR and though contractors commonly ignore the effect of the credit with little resistance from auditors, a Comptroller General Opinion stated that failure to reduce the value of the asset by the credit “is not favored.”

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