Distinguishing between Current and
Capital Expenditure
Introduction
This part of the guidelines draws up rules for determining whether expenditure associated with capital assets is of a capital or current nature. Fundamentally, the underlying principle for distinguishing between capital and current expenditure is to ensure that the classification reflects the economic and financial reality of the transaction. Nonetheless, National Treasury asserts that well-defined classification rules are necessary to ensure consistent classification across time and across various government departments.
It is necessary to formulate rules that are sufficiently specific to enable uniform implementation. This is the only way to ensure that expenditure items are classified in a consistent manner across all South African government units. To achieve this, it is necessary to introduce cut-offs or estimates, even though they do contain an arbitrary element. This approach is fully in line with accepted accounting practice as well as standard procedures in IMF manuals.1
National Treasury acknowledges that the objective of each relevant expenditure item should be the determining factor for distinguishing current from capital expenditure. However, it also believes that it is impossible for those responsible for classification of detailed expenditure items to assess in a consistent way the objective of each item and, based on this assessment, determine whether it is current or capital expenditure.
National Treasury takes the view that minimising the risk of misclassification arising from individual judgement leads to improved consistency and quality of data. This would also improve knowledge of the content of statistical series, enabling analysts to make better use of data. It is in this spirit that National Treasury proposes a set of rules, which should be used by practitioners when determining whether a certain expenditure item is of current or capital nature.
The rules, set out below, are in line with the financial reporting requirements in the Asset Management Guide (AMG), based on International Public Sector Accounting Standards (IPSAS). They also conform with the economic reporting needs as spelled out in Government Finance Statistics 2001 (GFS’01), and are harmonised with the System of National Accounts, 1993 (SNA’93).
In a situation where it is clear that applying these rules will result in incorrect classification that distorts the reality of the transaction, a motivation for the preferred treatment should be submitted to the relevant Treasury for consideration and approval.
The decision tree inserted below gives practical form to these rules. The decision tree aims to provide an easy-to-use practical guide for practitioners when deciding if a transaction should be classified as either current or capital.
Stand-alone items versus projects
Two main types of expenditure are identified:1
It is accepted financial accounting practice to make estimates based on knowledge and experience. Also, in macroeconomic accounting cut-offs are often used. For example, fundamentally, an acquisition of equity in a non-resident company is considered direct investment if the equity holder has a controlling stake in the company and portfolio investment if he/she does not. In practice, in Balance of Payments Manual (1995) by the IMF it is recommended that the acquisition of a 10 per cent stake or more of total equity be classified direct investment and the acquisition of a stake smaller than 10 per cent, portfolio investment. Naturally, the 10 per cent cut-off point is somewhat arbitrary but has been introduced to facilitate and streamline classification.
• Expenditure on stand-alone items • Expenditure on projects.
Thus, practitioners need to first determine whether a particular expenditure item should be classified as stand-alone or part of a project.
Expenditure on stand-alone items occurs when the government buys individual goods or services from outside units, provided that these purchases are not part of a project. For example, the government buying computers and vehicles, not part of a project, constitutes expenditure on stand-alone items. The government paying an institution to train government employees is another example of expenditure on a stand-alone item.
A project is a collection of tasks to achieve a certain goal, for example the construction of a new road. Normally, projects are related to a capital asset, for example building a new road, extending a building or repairing a car. Projects related to capital assets are carried out in one of three forms:
• Construction of new assets;
• Improvement/extension/rehabilitation/enhancement of existing assets; and • Repair/maintenance of existing assets.
Expenditure associated with construction of new assets and improvement/extension/rehabilitation/enhancement to existing assets is capital expenditure and will be added to the carrying value of the relevant asset. Expenditure associated with repair/maintenance of existing assets is current expenditure. These terms, “improvement”, “repair”, etc. are discussed below.
It deserves notice that not all projects are related to a capital asset. Such projects come in two forms: • Projects costing less than R5,000;
• Projects that are not related to capital assets, for example, a project to develop the new chart of accounts.
Both government units and outside contractors, for example builders, can be involved in the production of projects. Stand-alone items, on the other hand, are always made by outside producers.
Classifying expenditure on stand-alone items
This section presents a set of rules for delineating current from capital expenditure on stand-alone goods and services. The discussion is about purchases of products as stand-alone items only, and not products that form part of a project. Examples of purchases of stand-alone products are stationery, computers, furniture, vehicles, consultant services and taxi services to be used in the normal work of the department. This must be distinguished from a project to construct, improve or repair a capital asset of the department.
1. Rules for distinguishing current from capital stand-alone items
Rule 1.1 Expense on stand-alone items whose value is less than R5,000 is current.
Stand-alone items costing less than R5,000 should be classified as current, irrespective of the nature of such items. Thus, purchases of stand-alone tools and equipment worth less than R5,000 should always be classified as current expense, even though such tools and equipment may very well be used continuously or repeatedly in production for more than a year.2
2
This rule may in some instances lead to anomalies. For example, the same item may be bought in one store for slightly more than R5,000 and in another store for slightly less than R5,000. If the nature of the good is such that it can be used repeatedly or continuously for production, it would then be classified as a capital good in the first instance and as a current in the second. This fact notwithstanding, strict adherence to the R5,000 rule is necessary.
When a number of the same good is purchased at the same time, it is the value of each individual item that matters. For example, if 51 hammers, each costing R100, are purchased in bulk, this expenditure is classified as current even though the total value of the purchase exceeds R5,000.
Rule 1.2: Expense on services as stand-alone items is current.
All expenditure on services as stand-alone items is classified as current expense, including expense on training, health and research. This is so even though these items may very well enhance future productive capacity and could therefore be regarded as investment in a broad sense. However, services are of a current nature, implying that expense on them is always current (unless they are capitalised within the context of a capital project).
Rule 1.3: Expense on weapons and their supporting systems used by the armed forces is classified as specialised military assets.
According to the GFS and SNA, weapons and their supporting systems3 used for military purposes are considered current goods. In public sector financial accounting, on the other hand, International Public Sector Accounting Standards (IPSAS) stipulates that arms and their supporting systems should be treated as non-current assets. To circumvent these conflicting recommendations, such items should just be called spending on specialised military assets. This will be reflected as part of property, plant and equipment in the financial statements of the Department of Defence, and as goods and services in the consolidated government account.
Infrastructure, vehicles, machinery and equipment purchased or used by a defence department are classified as capital assets in both accounting frameworks.
It is sometimes difficult to determine where to draw the line between the two kinds, weapons used for military purposes and other military expenditure. The SNA, Paragraph 10.67, stipulates that “if it is not feasible to separate expenditures on capital assets from expenditures on weapons and their support systems, all expenditures on equipment for the military have by default to be treated as intermediate consumption”. This implies that if it is not possible to separate weapons used for military purposes and other military expenditure, all spending on such equipment should be classified as military weapons and weapons systems.
It is important to note that weapons used for security or policing are considered capital assets and purchases of such assets classified as capital expenditure. This is because they can normally be used continuously or repeatedly for more than a year, and their use is constructive in that it serves to enhance security.
Rule 1.4: Expense on goods other than capital assets as stand-alone items is current.
There are no exceptions to this rule.
Rule1.5: Expenditure on land and sub-soil assets is capital expenditure.
There are no exceptions to this rule.
Rule 1.6: Expenditure on remaining stand-alone capital assets is capital expenditure, with the exception of expenditure on some components.
There are two types of stand-alone items:
Separate capital assets; that is assets that are sufficiently important to be considered separate
capital assets: For example, goods that are functional in their own right constitute separate capital
assets. Buildings , dams, vehicles, machinery, computers, dairy cows, fruit trees, vehicles, roads and bridges belong to this category. In addition, goods that the government can use to earn revenue are
3
Examples of weapons supporting systems are missile silos, warships, submarines, fighter aircraft, bombers and tanks whose sole function is to release weapons.
sufficiently important to be considered separate capital assets. For example, land, buildings, vehicles, machines and equipment such as earthmoving equipment and cranes can be used for rental to third parties, and are thus separate capital assets.
Goods that are sufficiently important to be considered separate capital assets are divided into two main categories: The first is very big assets, such as dams and buildings that can be broken down into a set of sub-assets. Examples of sub-assets are pumps and computer systems of a dam, and air-conditioning systems of a building. Each sub-asset is considered sufficiently important to be considered a separate capital asset. The second category is smaller assets that cannot be broken down into a set of sub-assets, for example aeroplanes and vehicles.
Components; that is goods that are not sufficiently important to be considered a separate
capital asset:4 By definition, a component does not constitute a separate asset. Components are parts
of a capital asset. These items will be replaced over the lifetime of the main asset and form a significant part of the main asset in terms of their importance to its main use and value.5 Examples of components are tyres, propellers, bulbs, and light tubes.
It is recognised that this distinction between “separate asset” and “component” may leave scope for uncertainty. To minimise uncertainty, a set of detailed instructions currently being compiled will complement the present document and include numerous examples of these asset categories.
The fact that big assets can be broken down into a sub-set of assets is important for distinguishing between current and capital spending. Pumps and gates could be seen as standing in the same relation to the dam as light bulbs to a lamp. Everybody agrees that the cost of replacing light bulbs is a current expense; and, based on the similarity of the relationship between pumps and gates to dams and light bulbs to lamps, currently, spending on gates and pumps could be classified as current. There is certain merit to this argument.
Similarly to pumps and gates, light bulbs can often be used continuously or repeatedly for more than a year. Their value is normally very small relative to the value of the lamp. Without the bulb the lamp is not functional, and neither is the dam without the pumps and gates. However, very big assets, such as dams, are seen as a set of assets; thus, pumps can be considered sufficiently important to be separate assets.
The rationale for considering very big assets, such as dams and buildings, as a set of assets rather than as a single asset is explained here. Purchases of certain equipment categories in hospitals and dams are enormous; for example air-conditioning systems and pumps are very expensive, perhaps much more expensive than police cars and ambulances. Similarly to police cars and ambulances, air-conditioning systems and pumps can be used repeatedly or continuously in production and the government may derive future service potential from these goods. Yet, nobody disputes that a car is functional in its own right, but many argue that the purchase of a pump worth several hundred thousand rand is a current expense, because it is part of the maintenance cost of a dam. However, in fact, both are important enough to be regarded as a separate capital asset.
It is also necessary to point out that frequency of replacement is not the main determining factor for the distinction between capital assets and components. Certain capital assets may need to be replaced at regular intervals, say, every two years or so, but may nevertheless be capital expenditure. Thus, an ambulance is a capital asset even though it might need to be replaced regularly and quite frequently due to, for example, poor quality of roads. This is in spite of the fact that even though each time a new ambulance is purchased it is expected that it must be replaced within a relatively short time.
Similarly, equipment in dams includes pumps and gates that sometimes must be replaced at fairly frequent and regular intervals, say every two or three years. However, the determining factor is not the
4
Obviously, this discussion pertains to goods costing at least R5,000, as goods costing less than R5,000 are always classified as current, see Rule 1.1.
5
It deserves notice that in terms of the AMG accounting framework (section 3.2.1.12 page 3-18) the classification of these items as secondary assets to be depreciated over a different useful life than that of the main asset is allowed, in keeping with the whole life cycle approach to asset management.
frequency of replacement but whether or not they are sufficiently important to be considered separate assets.
Rule 1.6.1: Expenditure on stand-alone goods that are sufficiently important to be considered separate capital assets is capital.
Purchases of such assets are always capital expenditure. No exception is made.
Rule 1.6.2: Expense on stand-alone components is current if the value of the component is less than a determined percentage cut-off (for example 15 per cent) of the value of the capital asset to which it is attached.
Such components are called current components.
Rule 1.6.3: Expenditure on stand-alone components is capital if the value of the component exceeds a determined percentage cut-off (for example 15 per cent) of the value of the capital asset to which it is attached.
Such components are called capital components.
Justification for rules pertaining to current/capital split for stand-alone items
Fundamentally, the objective of the purchase of a stand-alone item or its inherent nature ought to determine whether it should be classified as current or capital expenditure. However, this principle leaves too much scope for interpretation. This means that classification would not be consistent across the various departments and agencies that make up the South African government. This would make analysis of data difficult, as it would be difficult to determine the economic reality underlying the numbers. Therefore, National Treasury recommends that the above rules be applied to distinguish current from capital spending on stand-alone items.
The rules for components might warrant additional justification. Spending should be classified as capital if the new good enhances the value of the existing asset to which it is attached, either by contributing significantly to an increase in the life span, enhancement of productivity, expansion in capacity, increase in size or usability of the asset. Thus, for example, purchasing a new propeller and attaching it to an aeroplane is capital expenditure, provided that the attachment of the new propeller implies a significantly longer life span or enhanced capacity of the aeroplane compared to the situation before the new acquisition.
Similarly, if an old dam gate is replaced by a new gate that is of significantly better quality than the old gate and this results in enhanced capacity or improved running of the dam, the cost of the gate is classified as capital expenditure. This implies that the replacement of the propeller or the gate can be done at any time and is not determined by the condition of the asset – the aeroplane or the dam – to which it is attached.
Components are considered current if they serve to maintain the existing asset to which they are attached in good working order and this is carried out at certain regular intervals. Components are also current if they serve to restore the existing asset to which they are attached to its original value. Similarly, if the old propeller is replaced because it fell into disuse, but the new propeller is not enhancing the value of the aeroplane, the cost of the propeller is classified as current. The dam gate is treated according to the same principle.
There must be a correlation between the nature of the spending – current or capital – and the cost of the component relative to the existing asset to which it is attached. A propeller acquired to replace an old one but without enhancing the value of the aircraft must be cheaper than a propeller that increases the life span of the aircraft. Indeed, the more expensive the component relative to the existing asset, the higher the probability that the component really does enhance the value of the existing asset, and thus should be considered capital in nature.
National Treasury proposes that the somewhat arbitrary percentage cut-off rule be used to determine whether the component is current or capital, as an interim measure to facilitate classification. This rule is easily implemented and ensures consistency in classification across various government departments and agencies and across time. It also provides the analyst of the data with a dependable yardstick to evaluate the evolution in the trends of current and capital spending.
It should be noted that the 15 per cent cut-off proposed is illustrative at this point. A different cut-off percentage would have to be used for each different category of asset. These percentages will be discussed and agreed with departments bilaterally. A detailed list of cut-off percentages will be inserted into the guide as an appendix to the decision tree and will be communicated to departments in due course.
Classifying expenditure on projects
This section contains a set of rules for differentiating current from capital spending on projects.
2.1 Rules for differentiating current from capital projects
Rule 2.1.1: Inexpensive projects costing less than R5,000 are current.
All projects to acquire new assets and to repair, maintain, improve or rehabilitate existing assets costing less than R5,000 are current.
The calculation for the R5,000 rule should be based on the total expected value of the project. It is important not to base the valuation on expected cost to be incurred in the current year only. For example, at the end of an accounting year, the government may hire a consultant to do a feasibility study for a project to construct a new building. The estimated value of the whole project might be R1 million. However, for the first year a total cost incurred on the project might be R4,000 only, consisting of the fee to the consultant. It is then important not to use the R4,000 amount as the basis for classification, but rather the R1 million.
However, if the project is not carried out or if it is uncertain that the project will be carried out, all associated research and development costs should be categorised as current expense.
Rule 2.1.2: All projects that are not related to capital assets are current.
As mentioned in Introduction, certain projects are not related to capital assets. Examples of such projects are the development of a new chart of accounts and development of new standards for infrastructure spending. Because such projects are not related to a capital asset, the expenditure associated therewith is always current.
Rule 2.1.3: All projects to construct new capital assets are capital.
All projects to construct new capital assets, for example new buildings or roads, are capital projects except in the (very unlikely) case of the project costing less than R5,000. It deserves mention that a new extension to an existing road or a new wing to an existing building is considered a new asset. Regarding valuation, if the executing agency is a government unit, the total value of the cost of production6 directly associated with the construction constitutes the value of the capital expenditure. If the executing agency is not a government unit but an outside contractor/builder, the total value of the amount payable to that outsider contractor/builder is considered the capital expenditure.
6 “Cost of production” is discussed in more detail below.
Rule 2.1.4: Projects on existing assets are current if they cost less than a given percentage of the value of the existing asset or if the existing asset is a current component.
Projects on existing assets are capital if they cost at least a given percentage of the value of the existing asset, except if the existing asset is a current component.
There are no exceptions to this rule.
The value of the existing asset is defined as the replacement cost of the asset.
Regarding valuation, the same principles as in Rule 2.1.3 apply: if the executing agency is a government unit, the total value of the cost of production7 directly associated with the construction constitutes the value of the capital expenditure. If the executing agency is not a government unit but an outside contractor/builder, the total value of the amount payable to that outsider contractor/ builder is considered the capital expenditure.8
The percentage cut-offs suggested in this proposal will require much more work. The exact percentage values will presumably differ according to asset category. However, at the stage of formulating this proposal, the main point is not whether a specific percentage, say 15 per cent, is the most appropriate cut-off – it is the principle of distinguishing current from capital expenditure according to a certain, pre-determined percentage of cost that matters. The correct percentage cut-offs will be included as an appendix to the decision tree.
Justification for rules pertaining to current/capital split for projects
Fundamentally, the objective of each project should be the determining factor when deciding whether a given project should be classified as current or capital. However, this principle leaves too much scope for interpretation. This means that classification would not be consistent across the various departments and agencies that make up the South African government. This would make analysis of data difficult, as it would be difficult to determine the economic reality underlying the numbers available on current and capital spending on projects. National Treasury therefore suggests that the above rules be applied to distinguish current from capital spending on projects.
Capital projects
Additional justification of Rule 2.1.4 might be useful. Fundamentally, a capital project enhances the value of the existing asset, either by contributing significantly to an increase in its service life, boosting its productivity, expanding its capacity, increasing its size or changing its use. Furthermore, a capital project is not undertaken on a recurring basis to ensure that the asset remains in good working order, in which case it is classified as current. Instead, a capital project can be undertaken at any time even when the good in question is in good working order and not in need of repair.
Thus, for example, a project not carried out on a recurring basis, to renovate all lifts within a building so that they are brought up to a certain standard, is a capital project. Expenditure on a new road surface which is of better quality than the previous surface (for example replacing gravel with asphalt), is also capital expenditure. Similarly, opening up new land by clearing it from trees increases the value of the land and is therefore a capital project. Another example of a capital project is rehabilitation of an existing asset that has been very seriously neglected for a long time, because this will significantly enhance the value of this asset.
7 “Cost of production” is discussed in more detail below.
8 The amount paid to outside contractors may not necessarily coincide with the estimated value of the building, as recorded on the balance sheet at the end of the
period. This fact notwithstanding, the amount paid to outside contractors should be recorded as capital expenditure. The difference between the capital expenditure and the value of the asset should be recorded as holding gain/loss in a separate account so that the sum of the capital expenditure and the holding gain/loss equals the amount entered in the balance sheet.
Current projects
Current projects, on the other hand, are either in the form of repair, maintenance or minor works. Repair of existing assets implies that the asset is restored to its original condition. Repair work is not necessarily carried out at regular intervals. However, contrary to capital projects, repair work does not change the capital asset’s performance, capacity or expected service life.
Maintenance is defined as work carried out at a certain frequency to sustain usability of the asset or prevent breakdown. The precise frequency varies, mainly depending on the type of asset. For example, roads subject to torrential rains may require main tenance much more often than roads located in places where it rains less. Minor works to keep pace with changes in practice or use are also of a current nature.
A project to support all lifts within a building, carried out on a recurring basis to ensure that good working order prevails, is of a current nature. Similarly, a paint job, not being part of a capital project and expected to be repeated within a given time span, is current, because it merely results in restoration of the asset to its original value. Expense on road resurfacing, carried out at a certain frequency and not being part of a capital project, say, to build a new road, is also current. Maintaining land that has been cleared from trees in that condition is also a current project.
Determining factors for distinguishing between current and capital projects
It should be clear that the frequency of the project is not a determining factor for distinguishing current and capital projects. Repair work can be undertaken at any time, but, contrary to a capital project, the dictating factor for repair work is the condition of the asset. Maintenance work, on the other hand, is normally undertaken at a certain frequency, and this frequency varies depending on the type of asset and other conditions.
Thus, frequency is not the most important determining factor for distinguishing current from capital projects. Rather, it is the objective of the project that matters: Is undertaking the project dictated by the condition of the asset? And is the objective to upgrade, change, improve or change the nature of the relevant associated asset to increase its service life, enhance its productivity, expand its capacity, increase its size or change its use? In this case it is a capital project. However, if the project is dictated by the condition of the asset so that the objective is to restore the asset to its original value, shape or use, it is a current project.
There must be a correlation between the nature of the spending – current or capital – and the cost of the project relative to the existing asset. A project to support lifts to ensure good working order must be cheaper than a project to renovate all lifts within a building so that they are brought up to a certain standard. The more expensive the project is rela tive to the existing asset, the higher the probability that it really does enhance the value of the existing asset.
National Treasury proposes that a somewhat arbitrary percentage cut-off rule be used to determine whether the project is current or capital. This rule is easily implemented and will ensure consistency in classification across various government departments and agencies and across time. It will also provide the analyst of the data with a dependable yardstick to evaluate the evolution in the trends of current and capital spending.
2.2 Treatment of cost of production associated with capital projects undertaken by government units
Rule 2.2.1: Total cost of production of capital projects undertaken by government is capitalised.
Once a project has been identified as capital, the cost of production directly associated with this project should be capitalised, i.e. it should be treated as capital expenditure – the total value of all current expense is referred to as cost of production.
More specifically, cost of production is defined as:
• Goods and services; i.e. purchases of current goods9 and services to be used as input into the project;10
Plus
• Compensation of employees paid to employees directly involved in the project; Plus
• Estimated value for depreciation11.
Regarding depreciation, this item is not included in the value of the capitalised expenditure unless the government account is compiled on accrual basis. This is not yet the case in South Africa. However, once accrual accounting is implemented assets will be “depreciated”, marking the beginning of a scheduled shift towards accrual accounting. Until then, expenditure to be capitalised within the South African context, is the total value of expense on current goods and services used as input in the project plus compensation of employees for government staff directly involved in the project.
Purchases of current goods and services
This category includes all expenditure on current goods and services used as input in a capital project. It does not include expenditure on capital assets, as these are recorded separately.12
It is important to include all expenditure on current goods and services consumed in connection with the capital project even though they may not directly form part of the capital asset being constructed or rehabilitated. It is obvious that expenditure on bricks and cement in association with a capital project, for example, improvements to a building, must be capitalised, because they are current goods that become part of the building.
However, it is less obvious whether some other current cost should be included. For example, during the work to improve a building it might be necessary to erect a temporary fence around the building to prevent theft and misuse. The cost of erecting this fence should also be capitalised even though the fence will not form part of the permanent structure. The reason is threefold:
• If the building is rehabilitated at a later stage, it would be necessary once again to erect a temporary fence;
• Without the fence the construction work cannot proceed unhampered and, similarly to the cost of contracting the services of, say, an architect, it is therefore an integral part of the current cost associated with the capital project;
• If the work had been contracted to a building contractor, the latter would have used all current costs, including expenditure on erection of the fence, to determine the price to be charged to government.
This treatment also conforms with IPSAS 17, which states that the cost of a self-constructed asset is determined, using the same principles as for an acquired asset.
However, if it can be demonstrated that the fence constitutes an abnormal cost that would not have occurred if an outside contractor/builder had been responsible for the construction work, the value of
9For definition of a current good, the reader is referred to the Appendix, section A.3.1.
10 When accrual accounting is introduced this must be rephrased as use of goods and services in macroeconomic accounting. In financial accounting, this is
normally referred to as material and labour. Professional services used directly as input in the project are included here
11 In the GFS and SNA, the term depreciation is obsolete. It has been replaced by the term consumption of fixed capital.
12
For example, even though a cement mixer may very well be purchased for a particular project, the expenditure on the mixer should not be included in the capitalised value for that project. Strictly speaking, the loss of value of that mixer, referred to as depreciation, should contribute to the capitalised value of that project. However, as mentioned above, an estimate for depreciation is only made when accounts are compiled on accrual basis, and this is not yet the case in South Africa.
the fence should be excluded from the capitalised amount. Similarly, all other abnormal cost on wasted material and labour should be excluded from the same.
In addition, if the fence can be used at other building sites after dismantling, it is a capital asset (not current good) because it can be used continuously or repeatedly in production for more than one year and future benefits can thus be derived to the owner. In this case, the cost of the fence should not be capitalised to the project. In this sense, the fence is treated the same way as all other capital goods; for example, earth moving equipment or cement mixers.
No other costs incurred on goods and services than those directly associated with the construction or the new asset or improvement/extension/rehabilitation/enhancement of the existing asset should be capitalised. For example, if a capital project to construct a new hospital has been identified, it is only the current cost associated with the construction of the building that should be capitalised, not the cost of purchasing, say, future provisions and stores or equipment to be used by the hospital. Similarly, administration and other general overheads are not capitalised unless they can be directly attributed to the acquisition of the asset or bringing the asset to its working condition. Start-up and similar costs are treated in the same way; they do not form part of the cost of production of the capital asset unless they are necessary to bring the asset to its working condition.13
Compensation of employees
– The total value of compensation of employees paid to employees directly involved in the capital project should be capitalised.
It is important to note that it is only the remuneration of government employees that should be included under the item, compensation of employees. Payments to people who are not government employees constitute purchases of services. Examples of such people are architects, consultants, engineers and occasional workers, not on the government’s payroll. (It deserves mention that payments to such people should also be capitalised if the expense is directly associated with a capital project. This is so because these payments are then part of expense on services used as input in a capital project.)
Compensation of employees in administration is not capitalised unless the employees in question are directly and exclusively involved in the construction, improvement/extension/ rehabilitation/enhancement of the asset. This is fully in line with IPSAS standards.
In practice, workers spend part of their time on capital projects and part on current projects. Conceptually, it is only the part spent on capital projects that should be capitalised. Ideally, for each time period, the time spent on current versus capital projects should be determined for each worker and the share corresponding to the time spent on capital projects over total time applied to the compensation of employees for each employee and for each time period. However, this is not a practical proposition. Instead the following rule is proposed:
Rule 2.2.2: The total value of compensation of employees who effectively spend more than half of their time on capital projects should be capitalised. The compensation of employees of all
other employees sho uld not be capitalised. Employee time should be revised every year.14
Presently, information to execute this rule is available. When taking this decision time spent on the project must be compared on a monthly basis. In other words if the employee is remunerated on a monthly basis, and more than half of the employees time for a certain month is spent working on a
13
According to IPSAS, initial operating losses incurred prior to an asset achieving planned performance are recognised as an expense. According to GFS standards these costs are not capitalised.
14
Alternatively, if data recording systems permit, a share of each employee’s compensation of employees should be capitalised. If, for example, a certain employee spends 40 per cent of his/her time effectively working on capital projects, 40 per cent of his/her total remuneration, including social contributions, should be capitalised, not his/her whole remuneration.
It is not clear if current government data systems allow for this type of allocation between capitalised and non-capitalised compensation of employees. Also, it has not been verified whether it is possible to identify the value of compensation of employees separately for each individual capital project.
capital project, then the remuneration for the full month will be capitalised. Implementation of this rule will considerably enhance quality of data.