situation when some capital
are reclassified, intentionally or unintentionally, as operating expenses
either on a temporary (annual) or permanent (multi-year) basis.
Causes of Spillover:
This spillover of expenditure
classification occurs as a result of one or more of the
following asset management styles and practices:
- Low-Capitalization Assets -
where the individual assets do not exceed a deemed capital
Historical practices of including some capital expenses into the annual
operating budget that simply get carried out each fiscal year.
- the implementation of a capital project into numerous
smaller projects that either drop
below the capital cost threshold each fiscal year and can be carried
out by in house staff. One example could be the painting of the fences
at a townhouse complex by the caretaker.
- Autonomous Maintenance
- The use of volunteer owners, committee and/or a site caretaker to
carry out certain projects,
which results in the avoidance of a capital expense that would
ordinarily have been incurred through the use of 3rd party contractors.
that results in relatively small expenses being automatically paid from
the operating budget.
- The inefficiencies and delays to hold a special general meeting
to approve a relatively small expense.
Contracts - Annual maintenance service contracts where the
automatically replaces certain assets. For example: the annual fire
inspection may include the immediate replacement of some faulty smoke
and heat detectors. The semi annual inspection of the emergency
generator may result in the contractor replacing the batteries as part
of the service program.
Assets Susceptible to Spillover:
following asset are prone to this form of spillover because each item
is low cost and they only have material value as a group:
- Battery packs in generators and fire
- Lamp ballasts
- Fire extinguishers, smoke detectors,
- Wood fence repairs and painting
of wood fences.
- Interior and exterior light fixtures
- Fitness equipment
- Plumbing fixtures (taps, sinks, toilets)
- Acoustic ceiling tiles
Examples of Spillover:
To help illustrate the concept, some case study
examples have been included:
- Painting for the wooden fences is
reflected in a reserve study
as a capital expense (capEx) but the work is done by the caretaker as
his/her activities and funded from the annual operating budget as an
operating expense (opEx).
reserve study includes an allowance for replacement of 33% of the smoke
alarms every 8 years (capEx) but the fire protection contractor
replaces 5% of
these devices as part of the annual alarm certification process (opEx).
Impact of Spillover
can result in a skewing of the cash flow statement of the funding
models in a reserve study (depreciation report) due to:
Analysis of Spillover:
classification can have a tremendous impact on the financial modeling.
If the local statutes require a long planning horizon, the accumulated
costs of the spillover can have statistical relevance.
the 100 assets in a typical reserve study, approximately 10% have
attributes or internal components that may be subject to spillover.
Alternative Solutions to Spillover:
There are four primary ways in which spillover can be addressed in a
reserve study (depreciation report):
Separation with Funding Separation.
All capital costs are removed from the operating budget. There is no
overlap whatsoever between capital and operating expense. This is the
Comingling and Funding Separation. The
capital costs are reported in the capital budget but will be paid, as
required, at certain fiscal cycles as an operating expense. The funding
model therefore includes a pure contribution to the reserve account
that does not
contemplate any capital in the operating budget.
Comingling and Funding Comingling.
costs are eliminated from the capital budget on the grounds that they
are being carried in the operating budget. Expenses are there
- Expense Separation and Funding
funding models reflects two funding sources annual reserve contribution
portion of the operating budget that has been set aside for capital
Fig. Examples of
some assets that may sometimes be subject to expense classification
"spillover" due to their materiality.