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 2

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 3

4. SA Local Government 2006 Infrastructure Asset Stock Storm water Drainage - ($1.5B) 15% CWMS (STEDS) - ($0.2B) 2% Gravel Roads - ($1.0B) 10% Other - ($0.1B) 1% Bdgs-($1.6B) 16% Parks - ($0.1.B) 1% Footpaths/Bikeways - ($0.6B) 6% Bridges - ($0.2B) 2% Sealed Roads - ($4.7B) 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 5

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) 6

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 7

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 8

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) 9

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 10

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 11

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) 12

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 13

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 14

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 15

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 16

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 17

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) 18

19. Thank You 19