CurrentCost Asset Valuation: Methodology

ReportNo WSAA 39

February 1992

ExecutiveSummary

1.             This research project, sponsored by the Urban Water ResearchAssociation of Australia and Melbourne Water (MW) reviews current costmethodology as it applies to water industry assets.

2.             Current cost methodologies are used by water authorities acrossAustralia and it is believed that the issues identified in this report willassist water authorities in the understanding of current cost accounting andits practical application to water industry assets.

3.             We strongly believe that Australian water authorities need to adopt oneuniform methodology and recommend such a methodology below. Uniform guidance onthe application of the methodology is also required.

Areas of Weakness in Water IndustryMethodologies

4.             Areas of weakness in published 1989/90 methodologies were noted asfollows:

·       Reproduction costwas not considered in a number of cases

·       Indexation ofhistorical costs was used without confirmation by expert valuation

·       Inconsistentaccounting treatments were employed in the recognition of current cost amounts

·       It was sometimeslost sight of that it is the asset held which needs to be valued and not itsintended replacement

·       Current costfigures were sometimes subject to audit qualifications

A number of these weaknesses were addressed by water authorities in1990/91.

5.             Areas of weakness were identified in MW’s methodology, and itsapplication, as follows:

Therewas lack of disaggregation of assets making reliable determination of currentcosts and useful lives difficult to achieve

·       Reproductioncosts, being the costs of replicating the existing assets were not confirmed byexpert valuation

·       Incorrectdeterminations were made of reproduction costs for certain assets making theamounts determined unreliable

·       The accuracy ofindex numbers used in the reproduction and replacement cost calculations wasnot confirmed by expert valuation

·       There wereinconsistencies in the application of methodology

·       There weredifficulties in reconciling the physical assets in existence and the accountingassets

·       Weaknesses wereobserved in the accounting systems for production of current cost information.

Water Industry Recommendations

6.             We recommend that a uniform current cost methodology be adopted byAustralian water authorities. A recommended methodology is shown on page 4.

7.             The adoption of a uniform methodology for the industry will ensure:

·       Comparability ofinformation between authorities

·       Consistency inthe production of information on water industry assets

·       More reliableassessment of the performance of water authorities

·       Betterinformation for pricing and decision-making

·       Improvedinformation on infrastructure assets

·       Bettercommunication between professionals within the industry.

8.             We recommend that:

·       For reproductionand replacement cost determination purposes, assets be clearly identified intocomponents which:

-              Enable clear physical identification of components; for example, damwall, lengths of pipe/sewer in similar soil conditions and topography, sewagetreatment lagoons of similar capacity

-              Enable indexes for components to be determined for changes in componentcosts

-              Enable engineering valuations to be determined for each component

-              Have useful lives which can be determined by engineering estimation andreassessed on a periodic basis

·       Reproduction costfigures be confirmed on a component basis by engineering estimation

·       Where indexnumbers are used for the purpose of replacement and reproduction costrestatements their accuracy be checked by engineering estimation of thereplacement/reproduction cost of the assets

·       Current costfixed asset recording systems be established to ensure that:

-              Physical fixed assets components are identified in the financialrecords

-              Additions to and retirements of fixed assets are identified in thefinancial records

-              Controls for each fixed asset or group of fixed assets are maintained

·      To enhance theapplication of current cost methodology a detailed methodology be madeavailable to engineers in the industry

·      It be clearlyspelt out in this methodology that:

-              Reproduction and replacement cost calculations are performed forexisting assets and are determined by engineering estimation every five years

-              Relevant index numbers are used to restate assets in the interveningperiods

·       Illustrations ofthe application of this methodology included in Appendix 1 be circulated withinthe industry.

Future Directions

9.             Areas of action to implement our recommendations have been identifiedas follows:

·       Circulation ofrecommended current cost methodology to accounting and engineering staff

·       Liaison betweenaccounting and engineering staff for reproduction and replacement costdeterminations

·       Confirmation ofreplacement and reproduction cost determinations by engineers

·       Identification ofdiscrete assets together with an assessment of their useful lives

·       The undertakingof projects to develop an automated Rate of Return Reporting system

·       Determination ofcurrent costs on a sample basis.

Recommended Statement ofCurrent Cost Methodology

10.         The following recommended statement sets out a uniform methodologywhich should be adopted by all Australian water authorities:

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