Manage Fixed Asset Investments For The Long Term

Manage Fixed Asset Investments for the Long Term

Background

Fixed, or capital, assets are tangible assets that are intended for
long-term use or possession, are relatively permanent in nature, and are
not intended for resale in the normal course of operations but may be
sold at the end of the asset's usefulness to the organization [Endnote
1]. Fixed assets enable, and often expand, the capacity of an
organization to perform its mission and improve the effectiveness and
quality of the services performed.

The federal government purchases and uses a tremendous volume of fixed
assets. The government's investment in such fixed assets as buildings,
vehicles, airplanes, computer systems, and other equipment amounts to
hundreds of billions of dollars, making the acquisition and management
of fixed assets an important financial management issue. Although the
federal government may be the world's largest investor in fixed assets,
it has no overall investment policy or strategy for fixed asset
management. Therefore, agency decisions and actions regarding the
various aspects of fixed asset management-- prioritization of projects,
selecting alternatives, funding sources, repairs and maintenance, and
disposal policies--are not guided by any overall federal goals and are
not subjected to a governmentwide analysis. Furthermore, the government
lacks asset management planning tools (such as capital budgeting); and
evaluation and measurement tools (such as payback concepts, return on
investment standards and measurements, asset turnover, depreciation
concepts, and residual value assessments).

For purposes of this paper, fixed assets are here defined as those
common commercial-type products used to support the delivery of federal
services. These products include office buildings, hospitals,
laboratories, automobiles, and computers. Excluded from this definition
are military weapons systems, public infrastructure projects, and
research projects.

Fixed assets are acquired for use by either purchase or lease; leases
are either operating or capital. Operating leases tend to be for shorter
periods of time. Capital leases can resemble purchases in that they may
have a bargain purchase option at the end of the lease, or they may
extend over a majority of the useful life of the asset. A lease-purchase
is a type of capital lease, containing an agreement to buy the asset at
the end of the lease [Endnote 2].

Federal fixed asset acquisitions are affected by the budget process.
The Budget Enforcement Act (BEA) of 1990 constrained spending by setting
limits on discretionary spending and by requiring that new mandatory
spending be paid for through tax increases or reductions in other
mandatory spending [Endnote 3]. Compliance with BEA constraints is
measured by a set of rules that describe how items will be "scored" for
budget purposes [Endnote 4]. These rules were supplemented by a set of
scoring rules outlined in the conference report on the BEA. Scoring
rules are intended to portray the full costs of a proposed activity
consistently and accurately for informed decisionmaking on allocating
resources. Scoring also is intended to ensure that the government
provides budget authority for all contractual obligations.

One of the major changes in the 1990 BEA was the scoring of capital
leases (including lease-purchases). Previously, the costs of capital
leases were recorded over time as cash payments were made. Under the
BEA, budget authority equal to the discounted present value of the
capital lease payments must be scored in the first year of the capital
lease. The intent of this change was to ensure consistency with the
scoring of purchases and allow decisionmakers to compare the costs of
these two alternatives on a more equivalent basis. In contrast,
operating leases are scored over time as rental payments are made.

Need for Change 

The demands on the federal budget are great, but the resources are
extremely limited in comparison to those demands. Careful planning is
needed to ensure that the government is in the best possible position to
meet the needs of its citizens. Plans must be made for both short- term
and long-term aspects of governing. Investments in fixed assets clearly
fall under the category of long-term planning. Changes are needed in
five areas to improve the management of the federal government's fixed
assets: fixed asset acquisition analysis, long- term planning, fixed
asset funding mechanisms, fixed asset budgeting, and budget scoring.

Fixed Asset Acquisition Analysis:  Long-term planning for fixed assets
requires information on the long-term strategy of an organization, its
mission, and its goals. Fixed asset acquisitions require decisions based
upon analysis of alternative methods of achieving the long-term goals of
the organization. Fixed asset acquisition analysis for the federal
government can be divided into three basic parts.

--Analysis of needs. The needs analysis should include asset type, time
period needed, consequences of unmet need, ranking of need in relation
to the organization's other fixed asset needs, cost effectiveness of
this asset in meeting the agency's mission, and ranking of this need
into a cross-cutting analysis comparing needs of other agencies.

--Analysis of asset characteristics. The analysis of characteristics
should include location or acquisition site of asset, required special
features, optional features desired, availability of the asset,
specialized nature, disposability of the asset, and alternative
configurations of acquisition that could be developed for improved
efficiency or cost savings.

--Analysis of acquisition alternatives. For each acquisition
alternative, the agency should perform a cost-benefit analysis of the
full life-cycle cost, an analysis of risk, and other appropriate
analysis such as recognition of offsetting revenue streams from the
services of the asset and a quantification of the value of owning versus
leasing the asset. Finally, the best acquisition alternative should be
determined from among those being considered.

Currently, those three analytic aspects are not applied consistently by
asset type, by agency, or across agencies. Several Office of Management
and Budget (OMB) circulars require long-term planning; however, the
circulars are specific to particular types of fixed asset
investments[Endnote 5]. The three aspects of fixed asset acquisition
analysis are not consistently performed within agencies and are not
currently compared across agencies for the purposes of national
priority-setting of planning. If such cross-cutting analyses were
consistently performed, it would facilitate long-term planning for fixed
assets on a governmentwide basis and would help ensure that the most
economical acquisition alternatives are selected.

Long-term Planning:  Formalized long-term planning processes would serve
to reduce the inherent short-term focus on high-level policymakers whose
tenures are brief by the nature of their office.  It would also help to
counter the short-term focus of the annual budget process and the
effects of the two-year terms of Congress. A long-term fixed asset
investment plan that informed Congress of the needs and priorities of
the government could be even more effective if it were incorporated into
the budget process. For example, if the plans were presented to Congress
as part of the President's budget request to cover a five-year period,
the acquisitions requested could be detailed for each of the five years.
Each year, the executive branch could produce a five-year plan on a
rolling basis.

Fixed Asset Funding Mechanisms:  Market conditions sometimes give rise
to opportunities to purchase fixed assets--e.g., a foreclosed office
building for sale by the Resolution Trust Corporation. Exploiting such
opportunities could, for example, save millions of dollars in rent.
Agencies should have funds and funding mechanisms available to take
advantage of these unique opportunities to buy fixed assets.

Several funding alternatives could provide the flexibility needed to
better accommodate the complex and time-consuming nature of fixed asset
acquisitions:

--Multi-year appropriations. Most money appropriated by Congress is
designated for one specific year, and must be returned to the Treasury
if it is unused. Multi-year appropriations would allow the funds to be
available for a longer, though specified, period of time that matches
the time period needed to acquire the asset.

--Revolving funds. A revolving fund uses the proceeds of the sales of
the fund's goods or services to finance the purchase of more goods and
services [Endnote 6]. For instance, General Services Administration's
(GSA) leased vehicle program collects fees that may be retained by the
GSA for use at a later time. Also, GSA collects rent payments that go
toward building a reserve for building maintenance.

In small agencies or programs, fixed asset acquisition may be large
relative to a more or less even stream of operating expenditures and as
a result may currently be discriminated against under incremental
budgeting or budgeting by formula. Using revolving funds to buy fixed
assets and rent them to small agencies or programs might reduce the
problem of such "lumpiness."

Although revolving funds may be a useful mechanism in certain cases,
they do have their weaknesses. An organization with a captive market
could "allocate" its cost to another in the form of a "price" that the
agency charged cannot control.

--Sinking and reserve funds. The concept of sinking and reserve funds
originated in the private sector, where they are used to set aside funds
for a specific future use, such as repair or replacement of fixed
assets. This concept could be adapted in the federal government to
provide a mechanism for funding fixed asset investments, repairs, and
maintenance. Funding could be obtained from appropriations, fees, and
any other manner deemed appropriate.

--Opportunity funds. Agencies could be allowed to set aside funds to
take advantage of special opportunities to purchase fixed assets at
prices that could not have been expected when the budget was formulated.

Fixed Asset Budgeting:  The government should ensure that there is no
budget bias against long-term investments. The budget should recognize
the special nature and long-term benefits of investments in fixed assets
through a separate capital budget, operating budget, and cash budget.
The separate capital budget will explicitly show expenditures on fixed
assets, and will help to steer our scarce resources toward the most
economical means of acquisition of the most needed assets. Capital
budgeting is a concept commonly used in the private sector; it is also
used by a majority of the states [Endnote 7]. Poor choices of capital
investments and the acquisition methods are currently costing the
taxpayer millions of dollars each year. Another major benefit of a move
toward capital budgeting would be the very clear distinction between
capital budget proposals and operating expenses. This change would also
budget for fixed assets more consistently with regard to the way they
are treated financially, facilitating the integration of budget and
financial information.

An appropriate, conservative definition of capital would allow for only
tangible fixed assets owned or leased by the federal government to be
capitalized (excluding military weapon systems, public infrastructure
projects, and research projects). There could be a tendency to stretch
the definition of "capital" expenditures to include inappropriate items.
The definition of capital should not be able to be manipulated to
provide a relative advantage for some forms of assets versus others, nor
should it be broadened to encompass assets that do not yield genuine
returns over periods of more than one year. The definition will always
be controversial and subjective, and the design of a capital budget must
take this into account.

Another part of the budgeting process is the recognition of the actual
cash received and expended by the federal government-- information that
is not provided by either the operating or the capital budget. This type
of information is provided by cash flow budgets. The cash budget most
closely measures the effect of the government's operations on the
economy, reflecting the effect of both the capital budget and the
operating budget. Therefore, the discipline of the cash outlay caps in
the Budget Enforcement Act must be maintained. A capital budget is not a
license to borrow to purchase fixed assets.

Budget Scoring:  The changes made to budget scoring by the 1990 BEA were
designed to prevent hiding the cost of large fixed asset contractual
obligations by the federal government. The intent was correct; however,
the prescriptive rules have had unintended effects that have led to poor
economic decisions. Instead of forcing the full aspect of a large
capital expenditure to be allocated to the current year appropriation,
alternative acquisition methods were used, in some instances, that
lowered the initial impact on those appropriations, but have had higher
long-term costs.

The full cost of a fixed asset acquisition is scored up front in cases
of purchases and capital leases. However, front-end scoring is not
required of the sum of the operating lease expenses that will likely
exist over the term a fixed asset is needed. This is particularly
evident in real estate transactions where some more expensive annual
leases were executed versus less costly lease- purchases or "best-buy"
outright purchase alternatives. Examples are also found in the
information technology area. Before BEA, capital leases were the
standard business practice; after BEA, agencies were sometimes tempted
by annual budget constraints to use more expensive operating leases. The
practical effect of "scoring" has sometimes led to the wrong economic
decisions.

Estimated full life-cycle costs of various acquisition alternatives for
fixed assets need to be compared so managers can make informed
decisions. The alternative selected should be chosen based upon its
economic merits, rather than its scoring merits. Budget processes could
be adjusted to allow managers to make good economic decisions to buy or
lease. Those changes could include procedures to allow for "spikes" in
agency spending whenever fixed asset acquisitions have been justified
and purchase is the most economical method. These procedures could
include the creation of a special fund to which such purchases could be
charged and "rented" to the agency.

In the long term, shifting to a capital budget (as described above),
would serve to highlight these large capital investments and obligations
and facilitate more informed decisions about capital investments.
Capital projects will be surfaced--justified on their own merits--with
full financial impact clearly visible. This shift will be complex and
will take considerable time to implement. In the interim, budget scoring
rules should be reevaluated as described above, to avoid hindering
management from making good economic decisions.

In summary, the federal government should move to a comprehensive,
long-term, economically sound approach toward managing fixed assets.
This approach should include the following.

--Agencies should develop and justify their acquisition requirements.

--As asset managers, agencies should analyze the economic and market
alternatives for each requirement through budget formulation,
appropriation, and a long-range planning process.

--Agencies should propose the method of asset acquisition that
represents the lowest long-term cost to the taxpayer and satisfies
requirements.

--Agencies should continually review their current owned and leased
portfolio to determine if previous decisions are in the best interest of
the taxpayer in light of current market conditions.

--Based on this review, agencies should propose the optimal acquisition
strategy to OMB as a budget request. The optimal acquisition strategy
may result in higher short-run appropriations to purchase, rather than
lease, capital assets.

--Budget decisions should reflect sound management to ensure no bias
against long-term investment of fixed assets. Additionally, the best
decision among available acquisition alternatives should be available
within budget resources.

Endnotes 

1. Adapted from testimony of Paul L. Posner, Director of Budget Issues
for the General Accounting Office, before the Subcommittee on Economic
Development, Committee on Public Works and Transportation, House of
Representatives, May 26, 1993.

2. Capital leases under private sector generally accepted accounting
principles are "capitalized" on an entity's balance sheet to recognize
what is effectively an ownership of an asset. In other words, the value
of the asset is recorded as an asset and is depreciated over the life of
the asset. Similarly, the contractual debt associated with the asset is
recorded as a liability, with both a current (due within 1 year) and a
long-term portion. The concept of operating and capital leases has been
very beneficial in recognizing "substance over form" in certain
financial transactions for presentation in balance sheets and income
statements.

3. Budget Enforcement Act of 1990, P.L. 101-508.

4. See OMB Circular A-11,"Preparation and Submission of Budget
Estimates," on budget scoring.

5. See, e.g., OMB Circulars A-130, "Management of Federal Information
Resources," and A-94, "Guidelines and Discount Rates for Benefit-Cost
Analysis of Federal Programs."

6. Meyer, Annette E., Evolution of United States Budgeting: Changing
Fiscal and Financial Concepts (New York: Greenwood Press, 1989), p.
116.

7. See National Association of State Budget Officers, "Capital Budgeting
in the States:  Paths to Success," February 1992. The majority of the
states have adopted a form of capital budgeting, which differentiates
spending that benefits current years versus future years. The portion of
the budget dedicated to future years' benefits is financed over time,
but the portion dedicated to current years' expenses is usually required
to be balanced. This report lists good practices in state capital
budgeting, almost all of which could be applied in capital planning by
the federal government:

--Establish a clear definition of expenditures within the capital
budget.

--Define maintenance expenditures and provide for adequate funding of
maintenance in statute.

--Include specific operating costs for each capital project.

--Ensure that effective legislative involvement occurs throughout the
capital budgeting process.

--Strengthen the review of the years beyond the budget year in long-
range capital plans.

--Identify criteria used in selecting capital projects.

--Define all program outcomes for capital investments.

--Evaluate cost estimating methods to measure their validity.

--Establish a tracking system to keep projects on schedule and within
budget.

--Define the factors to consider in decisions to own or lease.

--Develop a clear debt policy.

--Review cost-benefit comparisons for private sector participation in
capital projects.

--Maintain an updated inventory system of capital assets.