Valuers and Asset Management Email: [email protected] Depreciation Why it’s time to think a little differently SA LGFMG Conference March 2009 David Edgerton

Valuers and Asset Management

Email: [email protected]

Depreciation Why it’s time to think a little

differently

SA LGFMG ConferenceMarch 2009

David Edgerton FCPA



Outline

• Background• Prescribed Requirements• Comparison of Methods• Condition Assessment?• Material Misstatement?• Implications



Background• 2005 Inquiry into Financial Sustainability had

concerns with Depreciation• Three papers commission June 2008– Costing of Assets (Feb 2009) – Depreciation (Feb 2009)

• Object to provide a Technical Resource• Consistent with NAMS AIFMGs



Prescribed Requirements6 "Depreciation“ is the systematic allocation of the depreciable amount of an asset over its

useful life. 6 "Depreciable amount“ is the cost of an asset, or other amount substituted for cost, less its

residual value.43 Each part .... shall be depreciated separately.50 Allocated on a systematic basis over its useful life.51 The residual value and the useful life of an asset shall be reviewed at least at the end of each

annual reporting period60 The depreciation method used shall reflect the pattern in which the asset's future economic

benefits are expected to be consumed by the entity.61 The depreciation method applied to an asset shall be reviewed at least at the end of each

annual reporting period and...... the method shall be changed to reflect the changed pattern.



Key Issues• High Level– Relationship with future funding requirements– Allowable Methods (AASB 116 & UIG 1030)

• Specific Level– The Pattern of Consumption– Useful Life– Residual Value– Depreciable Amount



Allowable Methods• Must comply with all aspects of AASB 116 and UIG 1030• UIG Interpretation 1030 -

– Depreciation is calculated by reference to the “depreciable amount”– Appropriate consideration is given to technical and commercial

obsolescence– Maintenance and Capital expenditure are separably identified and

accounted for in accordance with AASB 116.– The “renewals annuity” method is not used – Depreciation is calculated separately for each component.



Pattern of Consumption



Useful Life• Be Careful with formulas !– Useful Life = Age + RUL (Remaining Useful Life)

Year

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

Age 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80

Method A Method B Method C

20,000

15,000

10,000

5,000

-

25,000

50,000

45,000

40,000

35,000

30,000

WDV

Method A Method B Method C WDV $25,000 36,667 40,000 %Error (37.5%) (8.3%) - Depreciation $625 $333 $1,000 %Error (37.5%) (66.7%) -



Residual Value



Depreciable Amount



Putting it all Together



Comparison of MethodsStraight-Line Condition Based

Depreciation Consumption Based Depreciation

Factors Used: Age only Typically uses Actual Age plus RUL to calculate a Total Useful Life. WDV is then determined by RUL/Total Life – Residual. If applied correctly this method is good for assets with a short and predictable Useful Life. However, in practice it is often incorrectly applied resulting in material misstatement. Care needs to be taken to ensure the critical assumptions reflect the asset lifecycle.

Factors Used: Physical Condition Typically a degradation profile is created based on a model that correlates the physical condition to an estimated total life cycle. Most commonly used with road pavements.

Factors Used: Holistic and Component Specific Factors Considers factors such as functionality, capacity, utilization, obsolescence, etc at the whole of asset level. Then takes into account the physical condition and repair and maintenance history of the asset to determine the level of remaining service potential. A Matrix is created to link the level of service to the valuation and depreciation.



Straight-Line v Advanced SLAM (Consumption Based Depreciation)

1

3

4

5

60

2

100

Cost to renew back to 100 = 60Therefore Residual = 40

Unacceptable LoSMUST be Closed

Very HighHigh

Adequate

Adequate ?

Barely Adequate



Condition Assessment?

• Must relate to factors that drive the consumption or

• Indicate the level of remaining service potential

• Don’t Assume !



Example: Be CarefulStraight-Line

1 100.00%1.5 87.50%

2 75.00%2.5 62.50%

3 50.00%3.5 37.50%

4 25.00%4.5 12.50%

5 0.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

1 1.5 2 2.5 3 3.5 4 4.5 5

Straight-Line

Straight-Line



Material Misstatement?

• Depreciation as % of Total Expenses• What if calculation > 10% ?• Depreciation is – allocation of the Depreciable Amount as an expense– over the useful life

• Sustainability Assessments?



Single Asset Comparison

• Do you “expense” too much depreciation via the Statement of Financial Performance?

• Is this a “true and fair view”?



Portfolio Comparison• SL v Advanced SLAM (Consumption Based Depreciation)

• Not just a timing difference



Summary of Prescribed Requirements6 "Depreciation“ is the systematic allocation of the depreciable amount of an asset over its

useful life. 6 "Depreciable amount“ is the cost of an asset, or other amount substituted for cost, less its

residual value.43 Each part .... shall be depreciated separately.50 Allocated on a systematic basis over its useful life.51 The residual value and the useful life of an asset shall be reviewed at least at the end of each

annual reporting period60 The depreciation method used shall reflect the pattern in which the asset's future economic

benefits are expected to be consumed by the entity.61 The depreciation method applied to an asset shall be reviewed at least at the end of each

annual reporting period and...... the method shall be changed to reflect the changed pattern.



Implications

• Compliance with AASB 116• Audit Evidence• Asset Management Planning• Material Misstatement• Corporate Governance• Public Accountability

Documents

Valuers and Asset Management Email: [email protected] Depreciation Why it’s time to think a little differently SA LGFMG Conference March 2009 David Edgerton