A Brief Explanation of Capital Spending

Restrictions on spending City sales tax revenue changed retroactive to January 1st as a result of the recent special election. A total of 54.3% now must be spent on capital items.

Sales tax is the primary source of revenue for government services, such as fire and police protection, streets and parks maintenance, recreation and administrative activities. Some costs are capital and others are operating expenditures. There does not appear to be a common understanding about spending for capital items versus operations. This column provides information we hope will help our community understand these terms.

Government Accounting Standards state, “the term capital assets includes land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period…”

Streets are examples of infrastructure assets, and project that improves the street and/or extends its useful life is capital spending (eg. a re-building or applying a slurry seal to a street). Costs to fill potholes, paint crosswalks, crackseal, and remove snow are a few examples of operating expenditures.

Best practices of the Government Finance Officers Association states, “When outlays for capital-type items are, in fact, reported on the statement of position, they are said to be capitalized. The monetary criterion used to determine whether a given capital asset should be reported on the balance sheet is known as the capitalization threshold.” And, “in no case should a government establish a capitalization threshold of less than $5,000 for any individual item.”

The City council adopted a policy in 2004 when government accounting standards began requiring the capitalization of assets. The minimum cost for items to be capitalized and depreciated was set at $5,000, and items capitalized and depreciated have an estimated useful life longer than three years.

However, City ordinances restricting the use of sales tax have specific definitions of capital that create differences between the audited financial statements and the budget.

Of the two-percent sales tax, 35% is used to provide streets and other capital improvements or to pay debt service on bonds or other obligations of the City issued to provide for such capital improvements, and 9% is used for the purchase of machinery and equipment that is greater than $500 with a useful life in excess of one year. The new ordinance now requires at least 75% of the one-percent sales tax (“2A funds”) be used solely for capital expenditures that, for simplicity in this article, will be called “streets.”

The portion of revenue not restricted for capital is available for operations. Sales tax that is restricted for capital cannot be spent for operations. That includes restricted revenue not spent in one year held in a restricted reserve account. In other words, cutting a one-time capital project from the budget cannot fix the deficit that has been created in the City’s ongoing operating budget. These restrictions are set by ordinance and can only be changed by new ordinances.

Personnel costs, outside professional services, supplies, utilities, repairs and maintenance, equipment rental and property insurance are some examples of operating expenses.

Some businesses capitalize costs of employees who develop or construct capital assets. A policy for capitalizing salaries could be adopted by the city council. This is not recommended by staff for several reasons. Previously, a portion of the 2A funds were used for salaries of public works employees who repair and maintain streets and other infrastructure. Since this was a point of contention in the election, a policy to capitalize salaries could be viewed as an end run around the new restrictions. Remember that the voters defeated the ballot question that would have relaxed the other capital restrictions and commit at least $1 million annually to capital improvements of the streets. The time involved with more detailed time tracking and calculations of capital costs for various projects would detract from employees’ productive time. Finally, this practice is not normally followed by small governments and would obfuscate comparability to other municipalities.

We encourage citizens to participate in the May 18 work session (6pm at council chambers) when council will continue to discuss re-balancing the operating budget. This subject was previously discussed during budget work sessions on September 30, October 20, November 17, December 1, January 5 and May 5. Information from all meetings is available in the document library. The proposed 2015 budget presentation also provides good background information and a slide about contingency planning.