““DEPRECIATION OFDEPRECIATION OFINFRASTRUCTURE ASSETSINFRASTRUCTURE ASSETS””

& Resource Allocation Decision& Resource Allocation DecisionMakingMaking

Dr John Sing

Director – Corporate Services

Noosa Council

OBJECTIVESOBJECTIVES�� General:General:�� To determine the purpose of accounting forTo determine the purpose of accounting for

the depreciation ofthe depreciation of IAIA’’ss

OBJECTIVES ContOBJECTIVES Cont

�� Specific:Specific:�� 1) Review fin. accounting requirements1) Review fin. accounting requirements�� 2) Consider the need to depreciate2) Consider the need to depreciate�� 3) Develop a framework for IA depreciation3) Develop a framework for IA depreciation�� 4) Examine the4) Examine the ‘‘conflict/problemconflict/problem’’ faced byfaced by

accountants, engineers & asset managersaccountants, engineers & asset managers�� 5) Offer a solution to the conflict/problem5) Offer a solution to the conflict/problem

IA AccountingInformation

Resource providersRecipients of G&SO’sight/review gpsManagement

IA AccountingPol. & Proc.

Internal requirements

External requirements

1) FIN. ACCOUNTING REQUIREMENTS

2) DEPRECIATION2) DEPRECIATIONREQUIREMENT(S)REQUIREMENT(S)

�� MandatoryMandatory�� Aust Accounting standardsAust Accounting standards�� Prescribe traditional methodsPrescribe traditional methods

–– Systematic allocation of cost conceptSystematic allocation of cost concept–– Relies on:Relies on:

»» estimating useful life & residualestimating useful life & residualvalue of the IAvalue of the IA

�� PrescribePrescribe ‘‘backward looking focusbackward looking focus’’

MANDATORY REQUIREMENTSMANDATORY REQUIREMENTS

Issue Financial Accounting

Requirement AAS4

Method S/L, R/B, U/U, S/D

Concept “Allocation of Cost”

IAIA’’S DEFINEDS DEFINED

�� According to supply & demandAccording to supply & demandcharacteristicscharacteristics ieie::–– a)a) ‘‘composite assetcomposite asset’’ where life extended bywhere life extended by

replacement of components and;replacement of components and;–– b) demand for the service makes it desirableb) demand for the service makes it desirable

�� ImpliesImplies ‘‘maintenancemaintenance’’ of infrastructure toof infrastructure toensure service provisionensure service provision

ALTERNATIVE PURPOSE(S) FORALTERNATIVE PURPOSE(S) FORCHARGING DEPRECIATIONCHARGING DEPRECIATION

�� Asset managementAsset management�� Full cost pricing & recoveryFull cost pricing & recovery�� Therefore essential to determine:Therefore essential to determine:

–– The funding required to supportThe funding required to supportrenewal/reinstatement of any loss in servicerenewal/reinstatement of any loss in servicepotential?potential?

MANAGEMENT REQUIREMENTSMANAGEMENT REQUIREMENTS

�� Adopting a method that:Adopting a method that:�� Tracks more closely the pattern ofTracks more closely the pattern of

consumptionconsumption�� Views depreciation as aViews depreciation as a ‘‘measure ofmeasure of

consumptionconsumption’’�� Is arguably more relevant and reliable forIs arguably more relevant and reliable for

‘‘allocation decisionsallocation decisions’’�� IsIs ‘‘forward lookingforward looking’’

Estimated Renewals Expenditure

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Ren.ExpAnnu

$000’s

ALTERNATIVE APPROACH

� Function of advanced asset management program� Based on life-cycle cost analysis� Not just a ‘wish list’ for maintenance� ie Produce an optimised list of renewal activities� Subject to ‘engineering’ audit

3) IA DEPRECIATION3) IA DEPRECIATIONFRAMEWORKFRAMEWORK

PURPOSE CONCEPT

Requirement ObjectiveConsumption

or loss inservice pot.

Allocation ofcost

InternalFull Cost Pricing

Asset Man.

Cell 1

#

Cell 2

External AAS4

Cell 3 Cell 4

#

4) CONFLICT/PROBLEM

�� Fin. Accounting requires accounting forFin. Accounting requires accounting forwhat has happened in the pastwhat has happened in the past

�� Man. Accounting requires forecasting whatMan. Accounting requires forecasting whatis to happen in the futureis to happen in the future

�� Therefore:Therefore:�� Determining 2Determining 2 ‘‘depreciationdepreciation’’ measures onmeasures on

the one IAthe one IA

5) WHAT WE NEED5) WHAT WE NEED

�� AA ‘‘tooltool’’ that enables the 2 measures to bethat enables the 2 measures to bedetermined (easily)determined (easily)

�� Use this tool as the basis for comparingUse this tool as the basis for comparingbackward measure with forward measurebackward measure with forward measure((ieie. S/L V Renewals annuity). S/L V Renewals annuity)

�� The ability to objectively determine theThe ability to objectively determine theamount ofamount of ‘‘depreciationdepreciation’’ to beto befunded/unfunded.funded/unfunded.

NSC ExampleNSC Example

�� ““AIM 21AIM 21”” is a microsoft based applicationis a microsoft based applicationthat provides Noosa Council with a uniquethat provides Noosa Council with a uniquesolution for dealing with this conflict.solution for dealing with this conflict.

OverviewOverview

�� ““AIM 21AIM 21”” solution:solution:�� Based on asset class and catchment basisBased on asset class and catchment basis�� DrawsDraws ‘‘engineeringengineering’’ andand ‘‘accountingaccounting’’

information togetherinformation together�� Produces a comparison of book deprn. withProduces a comparison of book deprn. with

renewal annuity based conceptrenewal annuity based concept�� Enables level of funding/unfunding of depn.Enables level of funding/unfunding of depn.

to be objectively determinedto be objectively determined

AssetAsset EnquiryEnquiry –– GraphicalGraphical

ConclusionConclusion�� Given that:Given that:

–– depndepn. means different things to different. means different things to different ‘‘economiceconomicdecision makersdecision makers’’

�� As accountants we need to be mindful of theseAs accountants we need to be mindful of thesedifferencesdifferences

�� Expected to produce relevant and reliableExpected to produce relevant and reliableinformationinformation

�� Ultimate aim is to ensureUltimate aim is to ensure IAIA’’ss are appropriately:are appropriately:--–– Managed in an operational sense and;Managed in an operational sense and;–– Monitored in a financial sense.Monitored in a financial sense.

Questions and further discussionQuestions and further discussion

Na viga tion Pane l

Case Be ing Mode lled

Population Growth Medium 2 High = 1; Medium = 2; Low =3

Consumption Growth Rate Medium 2 High = 1; Medium = 2; Low =3

Globa l Inputs W ater Demand Inputs

CPI (Indexation) CPI 2% Current Equivalent Population (EP) - Townsville T OW NSPOP 90,413Starting Year for Analysis YEAR 2000/01 Current Equivalent Population (EP) - Townsville 2000-05 2005-10 2010-15

Weighted Average Cost of Capital WACC 9.0% T _LOW POP 1-4 0% 0% 0%

Forecast Debt/Equity Ratio DERAT IO 100% T _MEDPOP 1-4 1.5% 1.5% 1.5%

Dividend Payout Ratio (Years 5 onward) DPR 65% T _HIGHPOP 1-4 3% 3% 3%

Current Loan Balance LOANBAL 8,782,284$Interest on Current Loans LOANINT 6.40% Current Equivalent Population (EP) - Townsville T hPOP 50,000Current Loan Term (Years) T ERM 11 Current Equivalent Population (EP) - Townsville 2000-05 2005-10 2010-15

Interest on NEW Loans NEWINT EREST 8.00% T h_LOWPOP 1-4 1% 1% 1%

Loan Term (New Loans) NEW T ERM 20 T h_MEDPOP 1-4 2.5% 2.5% 2.5%

Subsidy on New Works (DAM) SUBSIDY 1 50% T h_HIGHPOP 1-4 3% 3% 3%

Subsidy on New Works (OTHER) SUBSIDY 40%Subsidy on Replacement Works SUBSIDYOLD 0%Interest on Cash and Investmants (Revenue) INT EREST REV 3% Assumed Consumptionm (L/EP/day) - Townsville 2000-05 2005-10 2010-15

% Depreciation Funded DEPRECIAT ION 100% LOWGRO1-4 600 600 600

Total Length of Mains (km) MAINS - MEDGRO 1-4 912 870 870

Interest on surplus cash SURPLUS 3% HIGHGRO 1-4 1000 1000 1000

Effective Tax Rate (1999-2000) T AX1 36%Effective Tax Rate (2000-01) T AX2 34% Assumed Consumptionm (L/EP/day) - Thuringowa 2000-05 2005-10 2010-15

Effective Tax Rate (2001- ) T AX3 30% T hLOWGRO1-4 500 500 500

T hMEDGRO 1-4 588 625 625

T hHIGHGRO 1-4 750 750 750

Variable Inputs 0 0 1Year Yr 2000 2001-05 2005-10

ResultsForecast Growth in Charges NA 5.0% 0.0%

Internal rate of return (20 years) 12.7%Growth in Other Revenue (rentals etc) 0.0% 0.0% 2.0%

Growth in Community Service Obligations NA 2.0% 2.0%

10.39392 Growth in Expenses 5.6% 3.0% 3.0%

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