Current Cost Asset Valuation: Methodology

This report was produced for the Urban Water Research Association of Australia, a now discontinued research program.

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Report No UWRAA 39

February 1992

SYNOPSIS

This research project, sponsored by the Urban Water Research Association of Australia and Melbourne Water (MW) reviews current cost methodology as it applies to water industry assets.
Current cost methodologies are used by water authorities across Australia and it is believed that the issues identified in this report will assist water authorities in the understanding of current cost accounting and its practical application to water industry assets.
We strongly believe that Australian water authorities need to adopt one uniform methodology and recommend such a methodology below. Uniform guidance on the application of the methodology is also required.

Areas of Weakness in Water Industry Methodologies

Areas of weakness in published 1989/90 methodologies were noted as follows:

Reproduction cost was not considered in a number of cases
Indexation of historical costs was used without confirmation by expert valuation
Inconsistent accounting treatments were employed in the recognition of current cost amounts
It was sometimes lost sight of that it is the asset held which needs to be valued and not its intended replacement
Current cost figures were sometimes subject to audit qualifications

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

Areas of weakness were identified in MW’s methodology, and its application, as follows:

There was lack of disaggregation of assets making reliable determination of current costs and useful lives difficult to achieve
Reproduction costs, being the costs of replicating the existing assets were not confirmed by expert valuation
Incorrect determinations were made of reproduction costs for certain assets making the amounts determined unreliable
The accuracy of index numbers used in the reproduction and replacement cost calculations was not confirmed by expert valuation
There were inconsistencies in the application of methodology
There were difficulties in reconciling the physical assets in existence and the accounting assets
Weaknesses were observed in the accounting systems for production of current cost information.

Water Industry Recommendations

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

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

Comparability of information between authorities
Consistency in the production of information on water industry assets
More reliable assessment of the performance of water authorities
Better information for pricing and decision-making
Improved information on infrastructure assets
Better communication between professionals within the industry.

We recommend that:

For reproduction and replacement cost determination purposes, assets be clearly identified into components which:
- Enable clear physical identification of components; for example, dam wall, lengths of pipe/sewer in similar soil conditions and topography, sewage treatment lagoons of similar capacity
- Enable indexes for components to be determined for changes in component costs
- Enable engineering valuations to be determined for each component
- Have useful lives which can be determined by engineering estimation and reassessed on a periodic basis
Reproduction cost figures be confirmed on a component basis by engineering estimation
Where index numbers are used for the purpose of replacement and reproduction cost restatements their accuracy be checked by engineering estimation of the replacement/reproduction cost of the assets
Current cost fixed asset recording systems be established to ensure that:
- Physical fixed assets components are identified in the financial records
- Additions to and retirements of fixed assets are identified in the financial records
- Controls for each fixed asset or group of fixed assets are maintained
To enhance the application of current cost methodology a detailed methodology be made available to engineers in the industry
It be clearly spelt out in this methodology that:
- Reproduction and replacement cost calculations are performed for existing assets and are determined by engineering estimation every five years
- Relevant index numbers are used to restate assets in the intervening periods
Illustrations of the application of this methodology included in Appendix 1 be circulated within the industry.

Future Directions

Areas of action to implement our recommendations have been identified as follows:

Circulation of recommended current cost methodology to accounting and engineering staff
Liaison between accounting and engineering staff for reproduction and replacement cost determinations
Confirmation of replacement and reproduction cost determinations by engineers
Identification of discrete assets together with an assessment of their useful lives
The undertaking of projects to develop an automated Rate of Return Reporting system
Determination of current costs on a sample basis.

Recommended Statement of Current Cost Methodology

The following recommended statement sets out a uniform methodology which should be adopted by all Australian water authorities:

Water industry assets comprising water supply, sewerage and drainage are stated at current cost.
The current cost of an asset is the lowest cost at which the gross service potential of that asset could currently be obtained in the normal course of business and is determined as the lower of reproduction cost or replacement cost of the existing asset.
Reproduction cost is determined by calculating the current cost of constructing or acquiring a copy of the existing asset.
Replacement cost is determined by calculating the current cost of the service potential of the existing asset by reference to the cost per unit of service potential of the most appropriate modern equivalent asset. Unit costs of constructing a reference asset are applied to the physical quantities of the existing asset.
For assetsconstructed within the last five years, historical costs are restated by theuse of specific indexes.
For assets constructed before this period reproduction cost and replacement cost amounts are determined by engineering estimations.

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