From Confusing to Cringe-Worthy: Errors Made in Calculating Net Investment in Capital Assets.

• Author: Levine, Michele Mark
• Position: ACCOUNTING

GFOA's Certificate of Achievement for Excellence in Financial Reporting Award Program (COA) will begin requiring all applicants to submit the calculation of the net investment in capital assets they report for governmental activities and business-type activities, as applicable, on their government-wide statements of net position. The requirement will be effective for all COA applications submitted on or after March 1, 2022.

If you have not regularly followed the technical accounting and financial reporting topics discussed in GFR, GFOA's annual GAAP Update, and other GFOA updates, you may not be aware of the relative frequency with which the calculation of net investment in capital assets--a classification of net position reported in the financial statements of U.S. state and local governments--has been the focus of articles such as this. If, on the other hand, you have been checking this space regularly, you might be forgiven for having rolled your eyes and considered skipping this article, once you saw the title.

But please do read on! A surprisingly large number of the annual comprehensive financial reports (ACFRs) submitted to GFOA's Certificate of Achievement for Excellence in Financial Reporting Award ("Certificate" or "COA") program report an incorrect net investment in capital assets. So, if your first thought on the topic was "not again" then you are in good company: GFOA's professional staff in the Technical Services Center who review ACFRs experience a similar sinking feeling while looking at reported net investment in capital assets amounts that seem to be, to use technical terminology, out-of-whack.

Some governments disclose the calculation of net investment in capital assets in their notes, but this is not required by generally accepted accounting principles (GAAP), and not all the information necessary to make--or check--the calculation is normally contained in an ACFR. Often some detective work and inquiries of preparers are needed to verify the calculation and to understand what, if any, errors were made. Because of the frequency of questions and errors, and the difficulty of that detective work, GFOA is making a small but significant change in our COA requirements. Beginning March 1,2022, COA applications must be accompanied by the calculations of net investment in capital assets reported on government-wide statements of net position for both governmental and business-type activities, as applicable. This article will review the principles of the calculation and highlight a few of the more commonly made mistakes.

Net position

As many readers know well, the residual amount reported in government-wide and proprietary fund financial statements, somewhat akin to "equity" in private-sector reporting, is called net position. Net position is the amount arrived at by deducting the sum of liabilities and deferred inflows of resources from the sum of assets and deferred outflows of resources. Net position is reported in one or more of the following classifications, as appropriate:

1. Net investment in capital assets (or investment in capital assets),

2. Restricted net position, and

3. Unrestricted net position.

These classifications are based on the degree to which there are constraints on the purposes for which amounts can be spent. Obviously, it's difficult to "spend" (rather than use) capital assets for any purpose, which puts them at the very top tier of constraint. (1) Regardless of the source and financing of capital assets, or their tangible or intangible nature, none of them is spendable, so whenever a government reports capital assets, it should also report a capital-asset classification of net position. (2) Capital assets are the core of net investment in capital assets, and all other amounts used in the calculation are included because they are directly related to the included capital assets. It's helpful to keep in mind that net investment in capital assets is simply the portion of net position related to the reported capital assets and those liabilities and deferred resource flows resulting from their acquisition. Said differently, net investment in capital assets is derived using the same formula as total net position, but applied only to capital assets and the liabilities and deferred resource flows that arose from the construction, acquisition or improvement of those capital assets.

In fact, the amounts of each classification of net position could be arrived at separately, starting each calculation with its respective asset values (capital assets, restricted noncapital assets, unrestricted noncapital assets) and then adjusting each by its respective portion of liabilities and deferred resource flows. In theory, all three are calculated in this manner, but in practice it is easier to make the calculations only for net investment in capital assets and restricted net position, and to report the remaining portion as unrestricted net position. (See Exhibit 1.)

Capital assets

Net position must be calculated for several reporting units in basic financial statements, as well as for many reporting units in individual fund and combining financial statements that are included in an ACFR. Reporting units generally correspond to columns in most financial statements. (See Exhibit 2.) The calculation of net investment in capital assets begins with the capital assets of the reporting unit for which net investment in capital assets is being calculated, as of the reporting date.

Everything else in the calculation is included solely because of its relationship to those specific capital assets. Because governmental funds (1) don't include capital assets, as they are reported using a current financial resources measurement focus (MF) and a modified accrual basis of accounting (BA), and (2) report fund balance rather than fund net position, governmental funds and aggregations of governmental funds do not report a net investment in capital assets. Capital assets, however, are included in governmental activities reported in the government-wide statement of net position, and so governmental activities will report net investment (or investment) in capital assets, unless there are no general governmental capital assets at all.

Starting with the capital assets of our reporting unit, the next step is to deduct, or "net out," all accumulated depreciation related to those assets, giving us what is generally referred to as their book value. (3) Depreciation needs to be netted out in the calculation of net investment in capital assets because it is both: 1) netted out of total net position, and so logically must be netted out of a component of net position; and 2) related to reported capital assets.

EXHIBIT 2 | REPORTING UNIT A reporting unit may be: * A general or special purpose government (a single legal entity). * A part of a government, such as --Governmental activities --Business-type activities --An individual fund or segment (as in a major governmental or enterprise fund) --An aggregation or consolidation of individual funds (such as total...