ADOPT GOOD BUSINESS PRACTICES
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.
Actions 1. Establish a long-term fixed asset planning and analysis process. (2)
OMB, in consultation with the Chief Financial Officers (CFO) Council, should establish a long-term planning and analysis process for fixed assets acquisitions, maintenance, and disposal by October 1994. OMB should review any related circulars to incorporate this governmentwide planning process and seek to minimize duplication of effort that might arise in establishing new procedures. This guidance should set dollar threshold levels below which less extensive analysis will be permitted. The planning process should establish goals and objectives and result in an overall investment policy or strategy for prioritizing federal investment in fixed assets.
2. Incorporate fixed asset long-term planning into the federal budget process. (2)
OMB should revise appropriate circulars to change the budget process to incorporate fixed asset long-term planning, including governmentwide analysis to ensure prioritization of fixed asset acquisitions and optimization of resources allocated to long-term investments. This should be completed by March 1994 and included in the fiscal year 1996 budget request. The revised process should call for a prominent display of a division of budget outlays between operating expenditures and long-term investments in fixed assets.
The definition of long-term investments should be limited to tangible, long-term assets that are owned by, or leased on a long- term basis to, the federal government.
3. Ensure that there is no budget bias against long-term investments. (2)
OMB, in consultation with the Congress and the CFO Council, should develop a plan for budgeting that recognizes the special nature and long-term benefits of investments in fixed assets through a separate capital budget, operating budget, and cash budget. The plan should be completed by June 1994. The discipline of the cash outlay caps in the Budget Enforcement Act must be maintained, capital budgeting should not be a license to borrow to purchase fixed assets, and capital should be defined narrowly as discussed in this paper.
4. Provide more flexible funding mechanisms for the acquisition of fixed assets. (2)
Agencies, working with OMB, should develop and present budget requests for fixed assets for the fiscal year 1995 budget using more flexible funding mechanisms. These mechanisms should include multi- year appropriations, revolving funds, sinking/reserve funds, and opportunity funds.
5. Consider revisions to budget scoring. (2)
The President's Management Council should lead a review of the impact of current budget scoring rules to make sure that they accomplish their goal of acquiring fixed assets at the lowest possible cost to the taxpayer. The review team should consult with the legislative as well as the executive branch. Results of the review, with any recommended legislative changes or changes to OMB guidance, should be recommended to OMB by November 1994.
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.
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