Condition Based Infrastructure Asset Valuation Implementation Framework-Part II

ACCOUNTING FOR INFRASTRUCTURE ASSETS IN THE PUBLIC SECTOR

By Silbert Barrett, BAA

Affiliated Member of the American Society of Civil Engineers (ASCE)

Public Sector Accounting Board (PSAB) Exposure Draft 3150 (s.43)http://brittenwoods.com/index.html 

Section 43 of the then PSAB exposure draft would have allowed for the reporting of asset condition while maintaining the fundamental premise of GAAP accounting principles; whereby historical cost is the basis of financial statement presentation. In my judgment, the inclusion of section 43 was a compromise similar to the modified approach that was adopted by the Government Accounting Standards Board (GASB) Statement 34, in the United States. However, section 43 of the original PSAB exposure draft 3150 was greatly misunderstood. The opposition had characterized it as current cost asset accounting to replace historical cost or imposing upon municipal governments the financial liability for their infrastructure deficits and so it was subsequently taken out of the exposure draft. 

The guidance for implementing capital asset accounting in Canada should have been drawn from the International Financial Reporting Standard (IFRS s.16) rules as adopted by Australia (s.116) and other governments around the world. It introduces the concept of depreciated replacement cost instead of discounted replacement cost as an estimate of historical cost in instances where historical cost for an asset was not available. Depreciated replacement cost or value in use is far more an accurate measure of asset valuation and consumption over time than discounted replacement cost, since it relies on the condition state of the asset as oppose to the average inflation rate over time to arrive at the opening balance or value in use.  

According to the original exposure draft, “Nothing precludes management form using estimated replacement costs for the purposes of rate setting and future revenue requirements for asset replacement planning”. With the introduction of Bill 175, the Provincial government at the time recognized the importance of depreciated replacement cost as a measure for setting service levels and cost recovery.

Section 43 stated that “Governments are encouraged to measure and disclosed the extent to which maintenance has been deferred on their material and complex network assets, such as highways. Government may want to consider providing this information in the financial statements because it can add to the picture given of the financial condition of a government. Deferred maintenance information, like information on contractual obligation and contingencies, is useful for understanding and assessing future revenue requirements and could be presented as supplementary information”.

In light of these challenges, PSAB had conducted a study to assess the implication of asset condition measures or standards for reporting capital asset and to provide guidance for disclosure about this type of reporting, although the draft had already stated that the disclosure could be presented as supplementary information in the form of management decision analysis.

It was hoped that PASB Exposure Draft 3150 would have been amended to allow municipalities to record and report on the state of infrastructure assets as supplementary financial information in the form of a Management Decision Analysis (MDA) to their annual financial reports. This policy option was vigorously advocated as having distinctive advantages for older municipalities such as the City of Hamilton with significant infrastructure deficits. This would have allowed for a better alignment of development charges and other cost recovery measures to the actual cost of infrastructure maintenance and development.

The premise of the original PSAB exposure draft 3150, was not to fundamentally change GAAP as it relates to capital asset accounting but rather to allow improve financial management of major infrastructure assets in terms of rate setting for cost recovery and long-term financial planning; an integrated approach to asset accounting from an economic and financial sustainability perspective.  

Ontario Municipal Benchmarking Initiatives (OMBI) Municipal Guide to Accounting for Capital Assets (excerpts):

The OMBI accounting guide is intended to apply the principles outlined in PASB 3150 in a practical setting as it relates to the implementation of capital assets accounting at the municipal level.

“This guide aims to give municipal financial officials and operational manager’s practical information and tools to set up and operate a capital asset accounting system. This guide does not, however, replace the need for the planning and discussions that will be required between a municipality’s professional finance staff and its operational management in implementing such a system”.

The OMBI guide requires the valuation of capital asset using the historical cost, however, in the absence of historical cost, estimated historical (discounted replacement and or depreciated replacement) cost is considered a reasonable alternative. Depreciated replacement cost would more accurately reflect asset condition and value in use pursuant to the International Financial Reporting Standards (IFRS) rules.

Government Accounting Standards Board ( GASB) Statement 34

The valuation of infrastructure assets has been the focus of municipal financial officers and engineers in the U.S. since GASB 34 was issued in 1999. It recommends two valuation methods; depreciation method and the modified approach. “GASBS 34 allows respondents to either depreciate the value of their infrastructure assets as they age or leave the value recorded in the balance sheet unchanged if they can demonstrate that the assets are being effectively preserved”.

The depreciation method estimates the value of capital assets using indexation to historical or replacements cost and then amortized it over the estimated useful life of the asset using the straight-line approach. How capital assets are amortized and depreciated appears to be the point of departure between accounting and engineering and have resulted in the adoption of the modified approach. The key to meeting GASB 34 requirements using the Modified Approach is having an Asset Management System with the following characteristics:

• an up-to-date inventory of assets;
• ability to perform condition assessments of assets and summarize these assessments using a measurement scale; and
• annual estimates of the amount needed to maintain and preserve the assets at the level established by the jurisdiction.

Australia Accounting Standards Board (AASB-116 Accounting for Property, Plant & Equipment)

The Australian Accounting Standards Board (AASB 116) has gone further than both the Canadian (PASB 3150) and the U.S. (GASB 34) in recognizing the role of infrastructure asset accounting as an integrated approach for effective asset management and financial reporting.

Unlike GASB 34 and PSAB 3150, straight-line depreciation is not mandated under AASB 116 capital assets accounting guidelines. Instead, it suggested that “the depreciation basis must reflect the pattern of consumption of economic benefits embodied in the asset (that is, what is actually happening to the asset as a result of the way that it is actually being managed)”. Not all assets lose their service potential in a uniform (straight-line) way. Many assets degrade or decay on a curve as shown below.

Pavement Life Cycle 

Source: Timely Preventive Maintenance for Municipal Roads — A Primer

            Issue No 1.1, A Best Practice By The National Guide To Sustainable Municipal Infrastructure   April 2003

This implies that the useful life of the assets must be assessed annually to determine the level of depreciation and make the necessary changes or adjustments to depreciation charges. Invariably, the useful life of the asset should be managed so as to ensure that the expected pattern of consumption of the economic benefits is consistent with the asset’s lifecycle. Asset management is, therefore, managing the useful life of the infrastructure assets based on condition and age to optimize the value of the asset over its life cycle in monetary terms rather than engineering terms. 

The importance of this analysis is to conduct infrastructure asset valuation based on life cycle costing to determine "value for money" and to demonstrate how opportunities for cost savings increase or decrease depending on changes in the condition state of the asset over time. The greater the risk of asset failure or impairment, the lower the opportunity for cost savings. Timely capital improvements will extend the life of the asset and will result in greater "value for money" or return on investments. Asset management based accounting, therefore, allows for meaningful management decision analysis and reporting.

—Silbert Barrett
These are the author’s personal opinions and do not reflect those of his employer. Nor is the author making inferences about how infrastructure assets are managed. The author bases his opinions on his involvement in the pilot implementation of capital asset accounting as a project manager for the City of Vancouver, City of Hamilton and the Ontario Benchmarking Initiatives (OMBI). Research Analyst II (Operational Planning), City of Toronto Transportation Services Division.