Budget Bulletin: Accounting Policy Changes

Introduction

Over the past two years, the government of Nova Scotia has been working to bring its accounting policies into compliance with generally accepted accounting principles. The accounting change implemented in budget 2000-01 is how the province reports the cost of tangible capital assets (TCA).

Past Practice The government of Nova Scotia has traditionally used a cash flow approach (expenditure basis) when recording the cost of capital assets. This means all tangible capital purchases, such as vehicles or buildings, were shown as an expenditure in the year they occurred. This method matches the cost of the capital purchase with the cash actually spent in a particular period.

For instance, the capital cost of a building or a highway was charged to expenditures each year based on the amount of work completed that year. Reporting in this fashion ignores the fact that the building or highway still has a significant remaining value and will continue to be used for many years.

New Policy Implemented In June 1997, generally accepted accounting principles were developed for governments to report on tangible capital assets. The province of Nova Scotia adopted a policy effective April 1, 1999, which is implemented for the 2000-01 Estimates. The impact of the policy is that rather than having the cash cost of the capital purchase recorded the year it was made (expenditure basis), the government will record the dollar value that has been used up that year (expense basis).

By following a simple matching process, a portion of the capital cost (amortization) is charged to each year of the useful life. Since a new asset usually provides better benefit, (i.e., less maintenance costs), than an older one, more amortization is recorded in the early years than in the later years. This is called the declining balance method, which is an accepted method under generally accepted accounting principles and is one of the most widely used methods in accounting.

Generally accepted accounting principles requires that a change in accounting policy be implemented retroactively. The new policy requires that government identify the original cost of all eligible tangible capital asset purchases and calculate the amortization charges to date, as if the policy had been followed in prior years, and the net residual book value of the assets. Impact of Tangible Capital Assets on 2000-01 Estimates It is important to understand that in the 2000-01 Estimates "Net Program Expenditures" means all capital purchases in the year they were purchased. In contrast, "Net Program Expenses" removes the cash cost of the capital purchase and replaces it with the related amortization expense for assets purchased in the current and prior years.

Here is an example of how the new policy shows an expense on a tangible capital purchase:

Assume a department planned to purchase a new vehicle with a cost of $25,000.

Previously: The $25,000 capital expenditure was part of their budget and an expenditure in that year.

New Policy: The vehicle will be set up as a tangible capital asset and charged to expenses at a rate of 30 per cent per year on the declining balance basis.

Impact: In 2000-01, $7,500 ($25,000 x 30 per cent) will be charged to their budget as a result of the purchase; $5,250 will be charged in 2001-02 [($25,000 7500) x 30 per cent] and so on.

Comparisons between what has happened in previous years and what is happening in the current year have become more complicated. However, it is possible to recalculate the accounts so that they are on the same basis. Below is an example of what has happened to the budget for the Department of Education ($ thousands):

1999-2000 1999-2000 2000-01
Estimate Actual Estimate Net Program Expenses 858,832
Less Amortization (16,472)

Net Current 849,645 844,145 842,360
Program Spending Capital Purchases 24,101 33,543 31,801

Total Education 873,746 877,688 874,161

Assistance to 197,232 197,232 201,232 Universities

Total Education 1,070,978 1,074,920 1,075,393 Cash Envelope

Benefits of TCA One benefit of this new policy is that year-to-year comparisons will not be distorted by significant capital purchases. For instance, in 1999 many departments and agencies had significant Y2K capital purchases that have not been repeated. However, as the new policy shows the amortized cost, the impact of a one-time bump in expenditure is lessened and the expense numbers are more easily compared.

The former method of reporting also did not provide meaningful information about the government's ability to provide future services. This new accounting policy will help measure the rate at which such long-lived assets are being used up. It will be possible to see whether the province is running down capital assets or whether we are replacing them as they wear out. This system should lead to better economic decision making and a proper respect for long-term decision making.

An example of where accounting policy can influence good decision making is with respect to building renovations. Government owns and operates many buildings, some of them in need of major improvements and renovations. Under the old system, when money is tight these much-needed renovation projects are often deferred because the full cost of the renovation has to be included in the capital budget for the year the project is completed. This approach could well lead to even more significant problems in the years ahead. Under TCA, however, the cost of the renovation will be charged over a number of years, making it more feasible to undertake what would otherwise be a significant one-time capital expenditure.

NOTE: For other 2000-01 budget information, visit the Department of Finance website at www.gov.ns.ca/finance .