capital asset planning and property accounting kent allen northrop grumman
TRANSCRIPT
Capital Asset Planning and Property Accounting
Kent AllenNorthrop Grumman
Key Subjects
• Reasons for Capital Investment• Key Elements of Capital Investment• The Capital Planning Process• Predicting and Measuring Investment
Effectiveness• Capitalization Issues• Depreciation and Other Accounting Principles
Main Financial Components
CAPITAL ASSET PLANNING
PROPERTY ACCOUNTING&
Highly Interrelated
PROPERTY MANAGEMENT
Planning & Analysis
BudgetingImplementationOversight &Reporting
Capitalization, Control & Utilization
Disposition
The Three Critical Phases for Traditional Property Management
Capital Asset Life Cycle
1960
(80 Bytes) (16 GB)
ONE KNIFE
200,000,000 CARDS
I TOOK THINK-A-TRON APART…--- IT WAS JUST A SIMPLE CARD READER – NOT A REAL COMPUTER, AFTER ALL…
PROGRESS CHANGE
The Ongoing Cycle of Asset Management
PropertyManagement
Dynamics of Capital Investment
• Technological Advances
• Changing Markets or Service Populations
• Process Changes
• Legal and Regulatory Changes
• Aging of Existing Assets
Capital Planning - Points to Consider
• Not limited to Private Sector businesses.• Seeks to maximize the efficient use of
financial resources.
• Major impact on profitability and
effectiveness.
Related Funding Categories
• Capital Budget• Funding associated directly with the asset’s
intrinsic value.
• Associated Burden• Funding for other costs not directly related
to the asset’s value.
Key Characteristics of Burden• Items Below Cost and Longevity Thresholds• Administrative Expenses• Support of Requirements Not Adding to Asset Value.
• Examples:• Demolition Costs• Architect and Accounting Fees• Insurance Premiums • Closing Costs• Damage Payments
Capital Project Features
• Capital Project is defined chiefly by two characteristics:• Larger Cash Requirements (Greater than
a Defined Cost Threshold).• Longer Asset Life as Compared to
Burden (Expense) Items.• These are precisely defined in the
Disclosure Statement .
Capital Project Thresholds
0
2
4
6
8
10
12
- 2 4 6 8 10 12
CAPITAL
EXPENSE
VA
LUE
ASSET LIFE
>
>
Other Resource Requirements
• Budget for Unanticipated Costs
• Overruns of Total Project Cost
• Both Capital and Burden budgets are affected.
• Inadequate EAC cost estimates cause shortfalls.
• Scope Creep
• Over time, many projects tend to expand in terms
of purpose, application and cost.
Other Resource Requirements• Time
• Realistic Schedules
• All projects require adequate time to complete.
• Cash Cost and Availability• Expenditure patterns must be accurately
forecast.
• Unanticipated cash requirements cost money.• Business practices may include reliance on
short-term credit for funding of day-to-day cash needs.
• Unexpected demand drives the cost of money.
Reducing Resource Requirements• Alternative Funding – Contract-Direct vs.
Capital• Wherever possible, seek to obtain items as
direct-charge contract assets• “One Purpose” items with no use other than
contract support.• Must have customer approval.• Results in better financial results.
• Fewer assets to track and account for.• Improved returns on assets employed.
P u b l i c l y T r a d e d C o r p o r a t i o n s
Sarbanes OxleyP u b l i c l y T r a d e d C o r p o r a t i o n s
GASB 34S t a t e & L o c a l G o v t . ’ s
OMB A-87L o c a l G o v e r n m e n t s
CFO Act
Legal Environment
Capital Projects - Broad Categories:
• Strategic Needs • Anticipated Markets or Service
Challenges (Capacity)• Use and Development of Emerging
Technologies
Capital Projects - Broad Categories:
• Operational Needs
• Safety, Legal and Environmental
• Productivity Improvement
• Maintenance, Repair or
Replacement of Aging Assets
Uses of Capital Funding• Provide equipment to support current contracts.
• Maintain existing technology levels.
• Establish strategic capabilities.
• Meet all regulatory obligations.
• Maintain, modernize, and expand infrastructure.
• Buildings
• Grounds
• Support Systems.
Strategic Perspective
• Investments in land, equipment, buildings and other assets for future economic gain are part of an organization’s strategic direction which must be periodically revisited.
• Business investment decisions cannot be made lightly, because a significant commitment of funds is made over the long term.
Strategic Perspective
• Limited resources require that various alternatives must be narrowed down.
• The process of identifying, analyzing and selecting capital investment opportunities is known as capital budgeting.
• The capital budget is comprised of those projects selected to provide economic returns that meet the goals
set by management.
Key Aspects of Capital Budgeting • Timing:
• Define an effective time interval for budgeting.
• Standard Process:• Establish consistent and effective practices for gathering and processing capital requests.• Apply process across the board for all requesters.
• Categorization• Employ well defined categories based on type of need.
Key Aspects, continued• Prioritization:
• Have well-defined methods for ranking competing requests by criticality.
• Allocation of Funding:• Establish clear affordability levels and distribute funding proportionately.
Key Aspects, continued• Budget Review:
• Develop a hierarchy for coordinating requests.
• Preliminary Budget Approval by Top Management• General Presentation of Preliminary Budget.• Coordination of Resultant Changes
• Prioritization• Timing• Inclusion vs. Exclusion
Review of Capital Requests• Consistency with Strategic Plan• Elimination of Duplication• Technical Effectiveness• Correct Asset Category
• Legal and Regulatory • Maintenance and Sustainment• Technology Development• Process Improvement
Selecting the Best Capital Project
• Given the cash frequency of need and the spectrum of investment categories, a system must be established for distributing cash most effectively by:
• Determining total affordability limit• Aligning competing projects with operational and strategic
objectives • Ranking projects within each investment category.
Legal / Regulatory
Operational Needs
Strategic Initiatives
Productivity Improvement
Other
• The type of investment largely determines its eventual selection for the budget proposal.
Legal / Regulatory
Operational Needs
Strategic Initiatives
Productivity Improvement
Other
INVESTMENT TYPE PRIORITY TIER PORTION SELECTED
ALL
MOST
SOME
DISCRETIONARY
Selecting the Best Capital ProjectAFFORDABILITY
Property Accounting Responsibilities
• Services Provided:– Asset Capitalization – Asset Transfers – Asset Retirements – Depreciation – PP&E Reporting
Property Accounting Responsibilities
• Assets Under Construction (AUC) • Capital Project Types :
• Capital Fabrication• Straight Buy
• Capitalization• Closure of Capital Projects• Initiation of Depreciation
Definitions of Depreciation
• Physical Depreciation - Decline in the economic potential of assets originating from normal wear and tear, environmental exposure, and technical obsolescence. (Asset deterioration).
• Financial Depreciation - Spreading of original cost over the estimated life of an asset. Different methods are employed based on a given asset’s typical patterns of use and its ability to maintain a stable value over time.
CASHCAPITALASSETS
CAPITALASSETS
DEP.EXPENSE
DEP.EXPENSE
CAPITALASSETS
CAPITALASSETS
DEP.EXPENSE
PROCUREMENT &CAPITALIZATION
ASSET USEFUL LIFE(DEPRECIATION PERIOD)
YEAR 0 YEAR 1 YEAR 2 YEAR 3
AUC (CASH TIED UP WITH NO BENEFIT)
DEPRECIATION CURVE
CAPITALIZATIONPROCUREMENT
Financial Depreciation Process
0 1 2 3 4 5 6 7 8 90
1
2
3
4
5
6
STRAIGHT LINE
DECLINING BALANCE
RESIDUAL VALUE
ACQUISITION VALUE
CO
ST
YEAR
Basic Depreciation MethodsStraight-Line vs. Declining Balance
• To ensure consistent accounting methods, asset classes are assigned to different types of assets, based on the asset’s estimated useful life and the general pattern of physical depreciation.
Asset Class Description Depreciation MethodLand No depreciationBuildings 39 Year Straight LineBuildings - Temporary/Portable 15 Year Straight LineOffice Machines 10 Year Variable Declining BalanceFactory Machinery & Equipment 18 Year Straight LineHeavy Trucks 10 Year Double Declining BalanceAutos 5 Year Double Declining BalanceFurniture & Fixtures 12 Year Straight LineElectronics Equipment 4 Year Declining BalanceAircraft & Aircraft Equipment 6 Year Variable Declining BalanceComputer Equipment 3 Year Double Declining BalanceLeasehold Improvements Straight Line spread over remaining term of the leaseAssets Under Construction No depreciation
Depreciation Based on Asset Class
Investment Analysis
• A wide choice of capital investments are typically available: Some examples:
– Invest in new facilities for expansion (new volume)
– Upgrade outmoded facilities (improve cost effectiveness, cost savings)
– New equipment for potential new opportunities
• Various alternatives/choices must be narrowed down (limited resources)
Capital projects can be assessed by their Return on Investment (ROI), generally achieved through one or both of the following processes:
• Cost Reduction
• Better Use of Limited Resources (Limiting or Reducing
Cash Outflows).
• Does not include cost avoidance.
• Cash Generation
• Realizing Greater Cash Inflows due to Increased Markets
and/or Service Populations.
Measures of Capital Investment Effectiveness
Cash Inflows Should Exceed OutflowsMUST
• Two basic measures of projected investment value:– Return on Investment (ROI)
• Best applied on an individual project basis, typically before investment.
– Return on Net Assets (RONA)• Usually a measure of many combined projects.• Typically measured on the basis of all-up fixed asset
values.• May be a forecasting tool, but generally used as an
ongoing metric following project implementation.
Investment Analysis, Continued:
Application of Simple Payback Method4-Year Cost Recovery Scenario
Year 0 Year 1 Year 2 Year 3 Year 4
$25K
($75K)
$25K
($50K)
$25K
($25K)
$25K
($100K)
PAYBACKOUT
IN
BALANCE OF COST OUTSTANDING
Discounted Payback Method5-Year Cost Recovery Scenario
Year 0 Year 1 Year 2 Year 3 Year 4
($75K)
$25K
($53K)
$22K
($33K)
$20K
($100K)
PAYBACKOUT
IN
BALANCE OF COST OUTSTANDING
Year 5
$15K
($15K)
$18K
-100
-80
-60
-40
-20
0
20
40
60
80
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Cash Generation
Time Value of Money
CapExCompletion &
Asset Capitalization
“Simple”Cost
Recovery Point
Cash Flow
Capital Investment
Cash GenerationCash Return
on Investment
Cash UseDiscounted
Cost Recovery Point
Positive ROI
Cumulative Cash Flow and ROI
Comparative Return-On-Investment:
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1 2 3 4 5 6 7 8 9 10 11 12
Project A
Project B
Project C
CUMULATIVE CASH FLOW
1st
2nd
3rd
$M
Year
156% (9% IRR)
($K) ACASH OUT 500CASH IN 1800
B200
1000
C500950
IN/OUT 360%ROI 265%
500%390%
190%156%
IN/OUT 360%ROI 265%
390% (48% IRR)
265% (29% IRR)
DISCOUNTED ROI
Asset Turns(Asset Utilization)
RONA Return on Sales (Profitability)
=X
NOPAT=
Net Assets
(Net Operating Margin less tax rate)
Net Income=
Net Assets
Sales
NOPAT* Sales
Net Assets= X
* NOPAT = Net Operating Profit After Taxes
RONA Formula
Net Income
Net Assets
Capital Planning Effect on RONA
Net Income
Net Assets
Good Poor
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
1 2 3 4 5 6 7 8
Capital Project Value
AUC COST
NETBOOK VALUE
VA
LUE
TIME
RESIDUAL VALUE
NEGATIVE INVESTMENT
IMPACT
INVESTMENT EFFECTIVENESSUTILITY
VALUATION=
DISPOSITION POINT
REDEPLOYSELLDONATEABANDONSCRAP
(TOTAL BENEFIT FROM USE OF ASSET)
CA
PIT
AL
IZA
TIO
N
POSITIVE INVESTMENT
IMPACT
UTILITY
Investment Effectiveness Over Time
• Accumulated Cash Expenditures Against Projects Not Yet Completed/Received and Therefore Not Yet Capitalized
• Drains Assets (Cash) • Generates No Benefits or Depreciation
• Increased Revenue• Cost Savings• Improved Profit Margin
Assets Under Construction (AUC)
• Accelerate Procurement and Construction Processes
• Ensure that Capitalization Process is Efficient:• Speed• Accuracy
• Where Possible, Apply Progressive/Partial Capitalization
Most Common Approaches:
Limiting AUC Cost
• Ensure capital investments align with strategic objectives.– Better use of assets to generate revenue and expand
business base.
• Minimize capital commitments and expenditures.– Challenge requests for capital funding.– Conduct project analysis (ROI, etc.) to objectively assess
projects’ potential profitability/positive cash balance.
Improving Investment Effectiveness
Improving Investment Effectiveness
• Identify objectives and monitor efforts to eliminate aging and obsolete assets.
• Encourage redeployment of surplus assets where possible to reduce the quantity and cost of new commitments for similar assets.
Property Management’s Central Role
Questions
JIC
New CapEx CurrentDepreciation
CurrentDepreciation
CAPITALIZED
Prior-Period CapEx
CAPITALIZED
Current CapEx
Reinvestment Rate vs. Shareholder Value
Balanced Ratio
Asset Turns(Asset Utilization)
RONA
Return on Sales (Profitability)
=X
NOPAT=
Net Assets
(Net Operating Margin less tax rate)
Net Income=
Net Assets
CurrentDepreciation
Current CapEx
R a t i o > 1 . 0 R a t i o < 1 . 0
Current CapEx
CurrentDepreciation
Reinvestment Rate vs. Shareholder Value