Testimony: Mr. Ives began by recounting the financial crisis New York City endured in the mid-1970s. By attaching "periods of probable usefulness" to activities that should not have been considered capital expenditures, the City of New York was able to use debt financing to fund annual costs of high school vocational education, garbage transport, and administrative costs that could remotely be linked to debt.

In State and local governments capital assets (fixed assets) are long-lived tangible assets, including buildings, equipment, improvements other than buildings, and land. Capital resources associated with business-type activities are generally capitalized on acquisition and depreciated over their estimated useful lives. Capital acquisitions for general government activities are accounted for as expenditures and are not capitalized and depreciated.

Mr. Ives explained that FASAB governs Federal capital asset accounting and has developed financial accounting and reporting standards for property, plant, and equipment (PP&E), and "stewardship investment." Some categories of PP&E are depreciated and others are not. Costs associated with stewardship investment, which includes non-federal physical property, human capital, and research and development, are expensed when incurred, rather than capitalized.

Mr. Ives concluded his presentation with four main points. First, like the Federal budget, State and local budgets are generally balanced on a cash basis. As such, introducing an accrual based concept such as depreciation into the Federal process can be problematic. Second, capital should be limited to physical capital investments. Third, Mr. Ives noted that there are some good arguments for introducing depreciation into the Federal budget process, but the method by which it is introduced is of the utmost importance. Finally, capital outlays for non federally-owned capital assets - those purchased by States and localities through Federal grants - should be treated the same as federally-owned capital with regard to capitalization and depreciation.

Questions from the Commissioners:

Q.    When FASAB decided to account for Federal tangible assets with depreciation, was there concern that this would cause a bias against non-depreciated activities such as research and development?

A.    This was an issue, however, there were strong arguments, which I have mentioned, to depreciate Federal tangible assets. It is important to remember that the great bulk of Federal capital assets, such as defense weapons systems, are not depreciated.