Mr. Marc Simon
Technical Manager, Accounting standards
File 4210.CC
American Institute of Certified Public Accountants
1211 Avenue of the Americas
New York, New York 10036-8775

Re: Proposed Statement of Position: Accounting for Certain Costs and Activities Related to Property, Plant and Equipment

Dear Mr. Simon:

The Association for Financial Professionals (AFP) welcomes the opportunity to comment on the exposure draft of the proposed statement of position Accounting for Certain Costs and Activities Related to Property, Plant and Equipment.

The membership of our Association currently includes approximately 14,000 financial executives employed by over 5,000 corporations and other organizations.  Our members represent a broad spectrum of financial disciplines and their organizations are drawn generally from the Fortune 1000 and middle-market companies in a wide variety of industries, including manufacturing, retail, energy, financial services, and technology.  AFP supports members throughout their careers with research, continuing education, career development, professional certifications, publications, representation to key legislators and regulators, and the development of industry standards.

AFP does not support the proposed statement of position (SOP).   We strongly believe the proposed SOP runs counter to Congressional stimulus initiatives and will hurt industries that are most in need of support; i.e., manufacturing, hospitality, airlines, and retailing.  The detailed component accounting requirements and the inability to capitalize certain costs will increase the initial cost of making capital investments and can be a deterrent to capital investment during a precarious period in the American economy.  In addition, certain practices are not within the Financial Accounting Standards Board's (FASB) conceptual framework of accounting.  Also, the two adoption options will result in divergent accounting, which will confuse investors and would be counter to a goal of the Securities and Exchange Commission of making financial statements easier for investors to interpret.  Finally, the effective date of January 1, 2003 for calendar year companies is aggressive and unrealistic.  In summary, we believe that that the costs of implementing the proposed SOP would exceed the incremental benefits to financial reporting.  Accordingly, we strongly urge the AICPA to reconsider and withdraw the proposed SOP.

The responses to questions asked in Areas Requiring Particular Attention By Respondents provide more discussion of why AFP does not support the draft SOP.  The Accounting Standards Executive Committee (AcSEC) of the AICPA has specifically requested comments on the following 19 issues.

Scope

1.  Are there significant practice issues or concerns related to accounting for contractually recoverable expenditures (in lease accounting) that should be addressed in the proposed SOP?  Do you believe that there are other areas addressed in the proposed SOP that, with respect to their application to lessors and lessees of PP&E, could create conflicts with existing lease accounting standards?

AFP Response.  AFP agrees with AcSEC's decision to exclude accounting for contractually recoverable expenditures from the SOP in order to not conflict with existing lease accounting guidance.  We believe however that the Project Stage Framework could result in divergent accounting of improvements to real estate.  One example of this would be how a  lessor would expense the cost of improvements because, from the lessor's viewpoint, the costs were incurred in the in-service stage.  A lessee on the other hand would capitalize the cost because, from the lessee's viewpoints, the costs are direct costs incurred in the acquisition-or-construction stage.

Project Stage Framework

2.  The guidance in this proposed SOP is presented in terms of a project stage or time line framework and on the basis of the kinds of activities performed during the stages defined in the proposed SOP rather than on whether an expenditure fits into certain classification categories such as ordinary repairs and maintenance, "extraordinary" repairs and maintenance, replacements, betterments, additions, redevelopments, renovations, rehabilitions, retrofits, rearrangements, refurbishments, and reinstallations.  Do you agree with that approach?  If not, what alternative would you propose and why?

AFP Response. We agree conceptually with the Project Stage Framework, however, as discussed below, we do not agree with SOP's accounting for the costs within the project stages.  As discussed above, it also could lead to divergent accounting for real estate improvements.

Issues three, four, five and six are closely related; therefore, we will address them collectively below.

3.  Paragraph 16 of the proposed SOP states that the preliminary stage ends and preacquisition stage begins when the acquisition of specific property, plant, and equipment (PP&E) is considered probable.  Paragraph 22 of the proposed SOP states that, other than the costs of options to acquire PP&E, all costs incurred during the preliminary stage should be charged to expense as incurred.  Do you agree with that conclusion?  If not, how would you propose to modify the guidance and why?

Accounting for Costs Incurred

4.  The proposed SOP states that PP&E-related costs incurred during the preacquisition, acquisition-or-construction, and in-service stages should be charged to expense unless the costs are directly identifiable with the specific PP&E.  Directly identifiable costs include only (a) incremental direct costs incurred with independent third parties for the specific PP&E, (b) employee payroll and payroll benefit-related costs related to time spent on specified activities performed by the entity during those stages, (c) depreciation of machinery and equipment used directly in the construction or installation of PP&E and incremental costs directly associated with the utilization of that machinery and equipment during the acquisition-or-construction stage, and (d) inventory used directly in the construction or installation of PP&E.  All general and administrative and overhead costs incurred, including all costs of support functions, should be charged to expense.  Do you agree with these conclusions?  If not, what alternatives would you propose and why?

5.  Paragraph 32 of the proposed SOP states that for real estate that is not being used in operations, costs of property taxes, insurance, and ground rentals should be capitalized, to the extent of the portion of the property that is under development, during the time that activities that are necessary to get the asset ready for its intended use are in progress.  Do you agree with that conclusion?  If not, what alternatives would you propose and why?

6.  Paragraph 37 of the proposed SOP states that the costs of normal, recurring, or periodic repairs and maintenance activities should be charged to expense as incurred.  It also states that all other costs related to PP&E that are incurred during the in-service stage should be charged to expense as incurred unless the costs are incurred for (a) the acquisition of additional PP&E or components or (b) the replacement of existing PP&E or components.  Do you agree with these conclusions?  If not, what alternatives would you propose and why?

AFP Response. We do not agree with the issue three conclusion that companies should expense all costs incurred during the preliminary stage, other than the costs of options to acquire PP&E.  We also do not agree with the issue four conclusion that companies should expense PP&E-related costs incurred during the pre-acquisition, acquisition-or-construction, and in-service stages unless the costs are directly identifiable with the specific PP&E.  Regarding the in-service stage, we do not agree with the issue six conclusion that companies should expense all costs other than costs that are incurred for (a) acquisition of additional PP&E or components or (b) replacement of existing PP&E or components.

AFP believes  the proposed SOP  is contrary to the fundamental definition of an asset in Financial Accounting Standards Board (FASB) Concepts Statement No. 6 Elements of Financial Statements.  It also is inconsistent with the matching of costs and related probable future revenue in Concepts Statement No. 6 and full costing concepts established in the following FASB Statements of Financial Accounting Standards (SFAS):

• SFAS 19 Financial Accounting and Reporting by Oil and Gas Producing Companies
• SFAS 34 Capitalization of Interest Costs
• SFAS 67 Accounting for Costs and Rental Operations of Real Estate Projects

Paragraph 25 of Concepts Statement No. 6 defines assets as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events."  Paragraph 248 addresses deferred costs of assets and states that in applying the definition of an asset, the question to be answered is whether economic benefits of the costs were "used up at the time the costs were incurred or shortly thereafter or future economic benefit remains at the time the definition is applied."  Paragraph 145 addresses matching of revenues and expenses through accrual accounting.  According to the paragraph, "accrual accounting uses accrual, deferral, and allocation procedures whose goal is to relate revenues, expenses, gains, and losses to periods to reflect an entity's performance during a period instead of merely listing its cash receipts and outlays.  Thus, recognition of revenues, expenses, gains, and losses and the related increments or decrements in assets and liabilities—including matching of costs and revenues, allocation, and amortization—is the essence of using accrual accounting to measure the performance of entities."

SFAS 19, SFAS 34, and SFAS 67 address the concept of full cost accounting and should be analogized to all PP&E.  SFAS 19 states that all costs incurred in acquiring, exploring, and developing properties within a large area are capitalized when incurred and amortized as mineral reserves are produced.  SFAS 34 establishes standards of financial accounting for capitalizing interest cost as a part of the cost of acquiring certain assets. Clearly the impact of including on the income statement within current interest expense, the cost of financing a capital project that will not generate revenue until future periods, is not just a disincentive to investment in PP&E, it grossly distorts the operating income for the reporting entity during the pre and post investment periods.  SFAS 67 provides that indirect project costs that relate to multiple projects are capitalized and allocated to the projects.  Such costs are capitalized because they meet the definition of an asset; i.e., they provide a probable future benefit. 

The proposed SOP's requirements to generally expense as incurred all costs except costs directly identifiable with specific PP&E are inconsistent with Concept Statement No. 6 and SFAS 19, SFAS 34, and SFAS 67.  The proposed SOP does not consider that other direct costs, certain indirect costs, and certain general and administrative  would provide probable future benefits and therefore should be capitalized and amortized over future periods.

The requirements could also open another method for companies to manage earnings using the proposed SOP for PP&E.  Costs that meet the definition of an asset would presumably increase the value of PP&E above the net book value.  Under the proposed SOP, companies would expense such costs as incurred.  A company that needed additional revenue to meet an earnings target could then sell the item and recognize a gain on sale.

Regarding issue five, we agree with AcSEC's conclusion that companies should capitalize the costs of property taxes, insurance, and ground rentals for real estate that is not in use but that is under development.

AFP believes that the requirement to generally expense all costs except those directly identifiable with specific PP&E will meet AcSEC's goal of converging the accounting practices.  However, this convergence is somewhat arbitrary, represents the lowest common denominator, and is not consistent with established accounting standards.  We recommend that AcSEC not include the requirement in the final SOP and instead require companies to assess costs related to PP&E to determine if they meet the definition of an asset.

7.  Paragraph 39 states that the costs of removal, except for certain limited situation demolition costs, should be charged to expense as incurred.  Do you agree with that conclusion?  If not, what alternative would you propose and why?

AFP Response.  We question whether contractors would break out removal and installation costs and suggest that the draft SOP not make the distinction.

Issues eight and nine are similar; therefore, we will address them below.

8.  Paragraph 44 states that the total costs incurred for planned major maintenance activities does not represent a separate PP&E asset or component.  It states that certain of those costs should be capitalized if they represent acquisitions or replacements and that all other costs should be charged to expense as incurred.  Paragraph 45 prohibits alternative accounting treatments including (a) accrual of a liability for the estimated costs of a planned major maintenance activity prior to their being incurred and (b) the deferral and amortization the entire cost of the activity.  Do you agree with those conclusions?  If not, what alternatives would you propose and why?

9.  Paragraph 45 further prohibits, as an alternative accounting treatment, the "built-in overhaul" method for costs incurred for planned major maintenance activities.  In lieu of the built-in overhaul method, AcSEC concluded that better cost allocation would result from the use of component accounting and limiting the major maintenance activities that would be capitalizable to costs that represent replacements of components of PP&E.  Should the costs of restoring PP&E's service potential, in addition to the cost of replacements that would be capitalizable under this proposed SOP, be eligible for capitalization?  Do you believe that prohibiting the built-in overhaul method is appropriate, or should it be allowed as an alternative method?  If you believe that the built-in overhaul method should continue to be allowed, what industries or entities should be allowed to use it, and why?

AFP Response. We do not agree with issue eight and believe that companies should determine whether costs meet the definition of an asset and if so, capitalize or defer the costs and amortize over the periods of benefit.  We do not support the built-in-overhaul method of accounting for these costs, as described in issue nine.  These costs should be capitalized or deferred as incurred and amortized over an appropriate period, if they meet the definition of an asset.  See our discussion of issues three, four, five and six.

Inventory Use in Production of Internal-Use PP&E

AFP Response.  We believe that the guidance is appropriate and entities should not be required to redetermine the carrying amounts of PP&E.  AcSEC should not provide additional guidance on what constitutes a pattern of changing intended use because it would be difficult for AcSEC to consider all the possible facts and circumstances.

PP&E-Type Assets Produced for Sale or Operating Lease

11.  The proposed SOP requires an entity to accumulate costs differently for similar assets depending on whether the asset is sold outright or leased out under a sales-type lease (in either case, inventory cost accumulation rules would apply) or leased to a lessee under an operating lease (in which case, cost accumulation provisions of the proposed SOP would apply).  Do you agree with that conclusion and, if so, do you believe the proposed SOP should provide additional guidance on such cost accumulation?  Or would it be preferable for a single cost accumulation model to apply during the production process and that there should be a presumption that the assets should be accounted for all as inventory or all as PP&E.  If so, which presumption should be applied and why?

AFP Response.  We agree with the conclusion that there should be a single cost accumulation model to apply during the production process.  AcSEC should consider using the cost accumulation model for real estate property developed for sale as the single cost accumulation model.  This model can be found in SFAS 67 Accounting for Costs and Rental Operations of Real Estate Projects.

Issues 12, 13, and 14 are related; therefore, we will address them collectively below.

Component Accounting

12.  Paragraphs 49 through 56 of the proposed SOP discuss component accounting and state that if a component has an expected useful life that differs from the expected useful life of the PP&E asset to which it relates, the component should be accounted for separately and depreciated or amortized over its separate expected useful life.  Do you agree with this approach to accounting for PP&E?  If not, what alternative would you propose and why?

13.  Paragraphs 38 and 51 of the proposed SOP state that when existing PP&E is replaced or otherwise removed from service and the replacement is capitalized, the net book value of the replaced PP&E should be charged to depreciation expense in the period of replacement.  Do you agree with this approach?  If not, what alternative would you propose and why?

14.  The proposed SOP requires the use of component accounting to depreciate identified components over their expected useful lives.  As noted in paragraph A48, entities have developed and utilized various conventions to depreciate assets, including group depreciation or use of composite lives.  Those conventions are acceptable only if they result in approximately the same gross PP&E, depreciation expense, accumulated depreciation, and gains or losses on disposals of PP&E as the component accounting method required by this proposed SOP.  Do you agree with this approach.  If not, what alternative would you propose and why?

We also do not believe that the component accounting requirement will achieve convergent accounting, a purpose of the draft SOP.  Companies will have considerable latitude to define components.  They also can estimate remaining book value of components, which provides an opportunity for earnings management when replacing components, the subject of issue 13.

For issue 13, as noted above, a company's estimate of component cost will determine the effect of the replacement in the financial statements.  We do not see any benefit to charging the value of replaced PP&E to depreciation expense in the period of replacement.  We believe that such losses would be more transparent under current GAAP, which treats them as gains or losses on the disposition of fixed assets.

We do not agree with the approach to depreciation conventions described in issue 14.  That approach would require companies to compute depreciation expense twice in order to demonstrate that alternate conventions result in the same approximate gross PP&E, depreciation expense, accumulated depreciation, and gains or losses on disposal.  Alternate conventions such as group and composite depreciation are currently acceptable methods used in many industries that are supported by industry specific accounting literature.  Such conventions sufficiently reflect economic reality and therefore should not be prohibited.

Amendments to Other Guidance

15.  Paragraphs 61 and 63 of the draft SOP list amendments to SOP 85-3 Accounting By Agricultural Producers and Agricultural Cooperatives and the AICPA Audit and Accounting Guide Audits of Agricultural Producers and Agricultural Cooperatives, respectively.  Do you believe that there are unique aspects of agricultural accounting, such as accounting for the breeding and producing of animals and plants and vines, that should not be amended by the SOP, and why?

AFP Response.  We have no basis for comment on this issue.

Transition

16.  Paragraph 71 of the proposed SOP states that the prescribed component accounting should be initially adopted for existing PP&E using one of two alternatives, the election and disclosure of which should be made when the SOP is adopted.  Do you agree with this approach and, if so, do you agree with choice of the two alternatives from which the election is to be made?  If you do not agree with that approach for existing PP&E, what approach would you propose and why?

AFP Response.  We do not agree with providing two adoption options for existing PP&E.  This will result in divergent accounting and a lack of comparability and serve to confuse investors.  We do not support component accounting; however, retroactive application is preferable from a consistency standpoint.  This option will result in the separate accounting of all PP&E and components, instead of only PP&E and components acquired after adoption.  Prospective application is preferable from accuracy and ease of application standpoints because historical cost records would be available.

17.  Under paragraph 71 (a) if the proposed SOP, allocation of existing net book value to components at transition should be based on (1) allocation of original accounting records, if available, (2) relative fair values of components at transition, if original accounting records are not available, or (3) another reasonable method, if relative fair value is not practicable.  Do you agree that the ordering of methods is appropriate?  If you believe that a different order would be appropriate, what order would you propose and why?  Should the SOP provide additional examples to illustrate what constitutes "another reasonable method"?

AFP Response.  We agree that the ordering of methods is appropriate.  It is not necessary for the SOP to provide additional examples to illustrate what constitutes "another reasonable method."

18.  Paragraph 72 of the proposed SOP states that the SOP should be applied prospectively for all costs incurred after the adoption of the SOP.  It also states that costs incurred prior to the adoption of the proposed SOP should not be re-characterized (as capital or expense items) to conform to the guidance in the SOP, with the exception of certain costs of planned major maintenance activities.  Do you agree with the approach?  If you do not agree with that approach, what approach would you propose, and why?

AFP Response.  We agree with the approach.

19.  Under paragraph 71 (a) of the proposed SOP, and as illustrated in Example 3 in appendix C, an entity applying component accounting retroactively at adoption may calculate a difference between the pre-adoption balance of accumulated depreciation and the balance recalculated based on the estimated useful lives of components that previously were not accounted for as separate components.  Under that paragraph, the difference is allocated back to accumulated depreciation of each component based on the net book values of the components.  Two alternatives considered were recording the difference at adoption as a cumulative effect type adjustment and recording the difference as additional depreciation expense at adoption.  Do you agree with either of the alternatives?

AFP Response.  We agree with the first alternative, recording the difference as a cumulative effect type adjustment.  Under the allocation approach of the proposed SOP, as illustrated in Example 3, the incorrect amount of accumulated depreciation and net book value remains in the financial statements and distorts the value of the firm.  If, after a detailed cost segregation study, a company believes that accumulated depreciation should be $647,200 instead of $475,000, then the difference of $122,200 should be recorded in the financial statements.  This difference should be recorded as the cumulative effect of a change in accounting principle, in accordance with Accounting Principles Board Opinion 20 Accounting Changes.

Sincerely,

Alvin C. Rodack, CCM
Associate Treasurer
The Ohio State University
Chairman
Government Relations Committee

James R. Haddad, CCM
Vice President Corporate Finance
Cadence Design Systems, Inc.
Chairman, AFP Financial Reporting
AFP Accounting and Investor Relations (FAIR) Task Force