Depreciation ... is it of any relevance to an Asset Manager or just Accountant mumbo jumbo?

1. Depreciation... is it of any relevance to an Asset Manager or just Accountant mumbo jumbo? Presented by John Comrie 25 Aug 2011

2. ROLE OF ASSET MANAGER • identifying infrastructure related needs to meet prioritised and affordable community service levels • Involves planning for and optimised maintenance regime and asset renewal/replacement timing to minimise whole of life costs and achieve desired service standards

3. Depreciation • Simply involves assessing and recognising as an expense the rate of consumption of assets (rather than full cost at time of acquisition) • Assets are things that provide economic benefits over more than 1 year • Roads are assets • Local governments have lots of assets

4. SA Local Government 2006 Infrastructure Asset Stock Storm water Drainage - Gravel Roads - ($1.0B) Other- ($0.1B) ($1.5B) 10% 1% 15% Bridges - ($0.2B) CWMS (STEDS) - ($0.2B) 2% 2% Bdgs-($1.6B) 16% Footpaths/Bikeways - ($0.6B) 6% Parks - ($0.1.B) Sealed Roads - ($4.7B) 1% 47%

5. Depreciation • Calculating depreciation involves assessment of an asset’s; • Current replacement cost • Useful life • Current remaining useful life • Residual value @ end of useful life • Depreciation is approximately 25% of average council’s total operating costs

6. Depreciation • Amount, method and rate of depreciation is to a large extent irrelevant to asset manager • Asset management responsibility unchanged regardless of whether depreciation recognised or not • (up until mid-1990’s accounting requirements didn’t provide for recognition of depreciation of local government infrastructure)

7. Asset management needs money • Assets are long-lived. Expenditure needs associated with providing service from assets will vary between years • In order for funds to be provided when required for asset management need to base service levels on affordability

8. Service level affordability • cannot be determined by considering historic asset management outlays or projected available budget cashflow capacity or expected immediate needs for asset management

9. Service level affordability? • only simple, practical way of assessing is by looking at an under-lying trend accrual accounting projected operating result over at least a 5 year and preferably a 10 year period • Accrual accounting operating result is operating revenue less operating expenses (including depreciation)

10. Service level affordability? • If revenue generated to offset depreciation expense then will (all other things being equal) have sufficient cash to renew assets when required • Even though asset management cashflow needs will vary between years

11. Service level affordability? • If a council bases service levels and revenue generation on ‘cash costs’ then will struggle to accommodate increased maintenance and asset renewal as assets age

12. Service Level Affordability • Where unable to financially sustain current standards of service from assets and not practical to generate additional operating revenue then no choice but to; • plan to reduce the range and level of service from assets to achieve long-run service level affordability • Involves reviewing needs and priorities (eg establishing road hierarchy and varying service levels accordingly)

13. Resolving Asset Management Funding Gaps • Even if service levels are affordable long-term there may though be a cash flow gap in any year between revenue generated and outlay needs • If so then need to use existing financial assets/increase borrowings to accommodate asset management needs

14. I&AMP and LTFP • Long-term financial plan should be based on achieving financial sustainability and affordable service levels • Infrastructure and Asset Management Plan should be based on minimising whole of life asset costs and affordable service levels • Financial projections in both documents need to be consistent

15. Forecasting Renewal Needs • I&AMP renewal/replacement projections should be based on each asset’s economic life • Useful life for accounting purposes should be based on same (and reviewed annually) • Asset manager and CFO should work collaboratively to determine useful lives

16. Mumbo Jumbo? • Depreciation not of direct relevance to asset manager • But is vitally important to Council in determining revenue raising and service level decisions • Recognising and generating revenue to offset depreciation enables • Service levels to be sustainable • Equitable revenue raising over time • Helps ensure funds available when optimally required for asset management

17. Measuring depreciation • Is hard to reliably determine (replacement cost, rate of asset consumption, remaining useful life, residual value) all uncertain • Soundly based estimate is sufficient • Is much better than ignoring altogether which is what historically did

18. Improved Asset Management Performance • Various previous studies identified that SA councils were substantially under-funding asset management • Asset renewal outlays have increased from estimated $55m in 1998/99 to $275m in 2008/09 (ie by about 3.5 times after adjusting for inflation) • Has been achieved because councils have on average generated revenue to offset depreciation (Operating result improved from -17% to breakeven)

19. Thank You