Overview
This topic covers:
Asset Accounting is a vital part of sound asset management.
It plays a role in:
- The creation of the asset, that is the original cost
- The cash flow throughout the life of the asset, that is the operations and maintenance costs
- The replacement or rehabilitation of the asset at the end of its effective life.
Asset Economics is used to continually determine the real cost of owning and operating assets, and in particular long term costs, future liabilities etc.
This allows the rate of return needed to continue to provide the level of service required by the users of the assets, and funding requirements to maintain the long-term viability of the infrastructure, to be determined throughout the life cycle of the assets as shown in the following diagram.
Modern infrastructure asset accounting needs to be able to determine the financial impacts relating to:
- Customer Service
- Wholesale
- Retail
- Determine the cause of the expenditure, eg:
- Equipment upgrade
- Vandalism
- Determine the activity involved, eg:
- Operation
- Maintenance
- Unplanned
- Planned
- Determine the assets involved.
In most organizations, fixed assets form a substantial proportion of the total asset base. It is therefore vital for an enterprise's financial well being that it manages those assets well. From a financial perspective this means:
- Having a clear capitalization policy
- Knowing the cost of each asset
- Providing adequately for depreciation
- Accounting properly for asset retirements and transfers
- Accounting properly for asset additions
- Differentiating appropriately between leased and owned assets
- Reconciling financial records with physical assets
- Reconciling the asset sub-ledger with the general ledger
- Revaluing assets as appropriate.
Clear policies must be in place providing guidance on:
- Thresholds below which expenditure will be charged against recurrent revenue
- What type of expenditure above these thresholds will be considered capital?
This will define clearly expenditure to be regarded as fixed assets, and subject to the checks and controls laid down for such assets.
The cost of an asset must be capable of being clearly established. As such it is essential that the boundaries of each asset be clearly identifiable. This may be simpler for a purchased asset than for a constructed asset.
Consideration must also be given to the collection of costs against such assets eg, car parks by area or number of spaces.
Adequate provision must be made for the depreciation of fixed assets. This requires the determination of:
- Appropriate service lives for the assets in question, and should consider technical and commercial issues in addition to usage
- Allowance for any residual value.
Adequate systems must be in place to account properly for additions, retirements and transfer of assets. These movements will incorporate:
- Outright purchase of an asset
- Piecemeal purchases
- Improvements to assets
- Construction of assets in-house
- Full disposals
- Partial disposals
- Transfers between organization units
- Transfers within individual organization units.
Asset accounting systems, work-in-progress systems and accounts payable, must provide the organization with the capability to collect all appropriate costs against individual assets.
In the event that the organization leases some assets rather than owning them, a distinction must be drawn between those, which are finance leases, and those, which are operating leases.
Finance leases will be treated in a manner consistent with owned assets. Operating leases are not regarded as fixed assets, although a sub-system may be desired to monitor these, should they be significant.
Those asset registers maintained by the organization must have sufficient detail to:
- Link the asset on the register directly to a physical asset on site
- Enable regular agreement between the register and the main financial records. Postings of movements of fixed assets within the assets register should ideally be posted by way of control total to the general ledger.
Similarly each physical asset should be capable of being linked directly to its entry on the asset register. This may be done through use of identity numbers, either attached directly to the asset or maintained on a suitable alternative medium.
For assets of significance to the organization, periodic revaluation should take place. The benefit of such action is two-fold:
- It clearly indicates the true underlying value of the assets
- It highlights the true cost of having to replace these assets.
Adoption of the above points should help considerably in the proper management of the organization's fixed assets by:
- Ensuring the records reflect physical reality
- Recognizing the true life-span of assets
- Identifying the likely cost of asset replacement and planning accordingly
- Allowing continuing assessments to be made of the appropriateness of the mix of assets held to meet the requirements of the organization
- Assisting in meeting regulatory requirements.
Advanced asset management requires three key elements, namely:
A demand stream - a clear knowledge of historic and predicted demands for the services delivered by our assets including the level of standard of that service.
The supply stream - which consists of a thorough knowledge of the capabilities of our assets to meet this service demand in the most optimal way using existing or new assets, owned or leased.
The asset cost stream - this stream indicates the actual cost of our service delivery both in present terms and with the capability of predicting future costs.
The key element to operating a commercial organization activity in making appropriate asset management decisions requires appropriate asset cost records.
Many organizations have difficulty in answering the two key questions related to cost records namely:
- What costs should be recorded?
- Against what level of asset?
Best practice in this area of asset management involves the following principles, namely:
Maintenance Costs
Maintenance costs should be recorded against the maintenance managed item (MMI) for which individual work orders are issued.
The level of MMI adopted by the organization should relate to the benefits that this data is capable of deriving for the organization.
The benefit derived is directly related to:
- The condition of the assets
- Its criticality to the organization
- The organization drivers or objectives of the organization.
Using these principles it is desirable for an organization to set a minimum level at which the maintenance managed item should exist in their asset hierarchy, however, it needs to be recognized that this level may warrant going to lower levels depending on the key factors listed above.
A best practice system should therefore allow an Asset Manager to take the MMI to a lower level for different assets thereby enabling the organization to collect the necessary data to justify some renewal decision organization case. Once this work has been completed it can then lift the level of data recording back to one related to the new condition and performance of these assets.
Operating Costs
Operating costs and depreciation are not generally required at the same level as the MMI and can be recorded at suitably higher levels using the integrated hierarchical asset register system.
An example of this can be seen in water supply pumping stations where the maintenance managed item will be related to components such as pumps (or in larger installations, parts of the pump), whereas the operating costs may only warrant being collected at either the facility level (for smaller pump stations) or at individual pump level for larger facilities, where a monitoring the power consumption and other operational inputs can be warranted through savings made from appropriate monitoring.
Life Cycle Costing
Too often in the past organizations have focused on the preliminary engineering costs and the costs of creation and acquisition.
For some short lived or dynamic assets, recurrent expenditures for the operations and maintenance of assets represent a significant proportion of the total life cycle costs of these assets. Also, for facilities that store contaminated material or dangerous wastes, the costs of cleaning up (disposal) at the end of the service life of these facilities are usually substantial.
Therefore, it is essential that any investment decision must be based on a proper appraisal of initial, current and future costs.
For asset management to be effective and proactive, the total life cycle costs must be identified, realistically aggregated, evaluated and used as an essential decision making tool for management.
These total life cycle costs include:
- Preliminary investigation and planning costs
- Design and construction costs/acquisition (creation)
- Operations and maintenance costs
- Rehabilitation and renewal costs
- Ultimate replacement costs
- Disposal costs
- Depreciation costs.
The life cycle costs of assets and their applications are shown below:
Different costs occur in each phase of an asset’s life. Depending on the level of service intended, it is possible to provide service at vastly different cost levels.
For some short lived or dynamic assets, recurrent expenditures for the operations and maintenance of assets represent a significant proportion of the total life cycle costs of these assets. Also, for facilities that store contaminated material or dangerous wastes, the costs of cleaning up (disposal) at the end of the service life of these facilities are usually substantial.
It is important to be able to attribute the costs to each phase in an asset’s life cycle so that the total life cycle costs can be established to enable better management decision-making.
The cost of infrastructure asset services is therefore quite complex; it is vital to understand not only the current costs but also the long term life cycle costs and the current position of the asset in its life cycle.
The key elements in asset costing include the following:
- Financial costs
- Asset depreciation
- Asset operations
- Asset maintenance
- Asset administration.
Capital investments occur at asset creation or acquisition and can continue throughout the life of the asset in the form of major repairs, rehabilitation or refurbishments/ augmentations and the blend of capital investment and maintenance activities will impact on the consumption of asset or the depreciation.
The true costs of providing infrastructure services depend on the standard or level of services required by the bulk of customers/users.
While a high standard of service is what every user expects, the full cost of providing that level of service must be made transparent so that a realistic level of service is set and ties into the expectations of customers or stakeholders. All service providers should strive to provide the required (finally agreed) level of service at the lowest appropriate costs as shown in the figure below:
Capital costs are those costs incurred during the planning, design, construction or acquisition phase of an asset and should generally include all advance expenditure on research, feasibility studies, program planning, land acquisition and improvement; building and site facilities; machinery and equipment; management services, quality control and commissioning; duties and taxes, consulting service fees, cost of raising funds (financial charges), and interest charges during the construction period.
Financial charges represent a real cost to an organization as they are incurred as a result of an asset’s acquisition or creation. This cost has to be included so that the true cost of owning the asset can be accounted for fully.
As capital costs constitute an up front cost to an organization in the acquisition of a new asset it is not uncommon for decisions to be made purely based on the capital costs. However one must not lose sight of the total life cycle costs of an asset, which also includes other costs such as the depreciation (consumption of the asset), operations and maintenance and the ultimate disposal of the asset.
The way an asset is acquired or created may have great impact on its future operations, maintenance or even disposal. For example, water service fittings of a particular material may perform below standard, resulting in excessive leakage and increased replacement/maintenance costs.
Because infrastructure assets have long lives it is most common that the loans or finance charges levied for their creation will have been repaid long before the asset has ceased to operate. To ensure the effective use of the assets it is essential to derive an appropriate return on the capital invested in the form of a capital use charge.
The application of a capital use charge in the cost of infrastructure ensures a more appropriate resource allocation techniques and the rationalization of excessive asset portfolios.
By using this “opportunity cost” of capital approach, some form of level playing fields can be achieved between privately and publicly funded infrastructures.
The key issue involves the choice of valuation upon which the capital charge should be based, either:
- Asset valuation, or
- Organization (economic) valuation.
In most infrastructure service organizations, the determination of economic value is directly tied to the rate approval process. If the asset is highly valued and an adequate return is allowed in the rate, then a higher income is generated.
This can be considered as a circular argument. What comes first: The economic value or the asset value and resulting rate?
This becomes even more difficult when some organizations have been privatized and a “market value” has been established. A key issue for regulators is, “Has this sum paid for the utility or for some other perceived potential benefit?”
If we accept that some form of asset value is more logical than an economic or market value, then the issue becomes what type of valuation:
- Replacement valuation
- Deprival (optimized) valuation.
By using the optimized or deprival evaluation method, the capital use charges are only levied against those assets that necessary to deliver the required levels of service to the existing customer base. In this way issues relating to excess capacity or ineffective or inappropriate infrastructure assets can be compensated for as apposed to normal modern engineering equivalent replacement type valuations.
It is considered that the most appropriate methodology for such a charge should involve the application of a weighted average cost of capital (WACC) commensurate with the risks involved in the investment being applied to the optimized depreciated value (ODRC) of the infrastructure assets.
Most organizations with large non-current assets including service utilities are currently using conventional depreciation methods in preparing annual financial statements. The situation arises because of its simplicity and taxation requirements.
However, it is important to make a distinction between infrastructure assets and other non-current assets such as office equipment in considering the depreciation issues.
Infrastructure assets by their characteristics are often renewed or rehabilitated throughout their life cycle to provide (in some cases) almost close to infinite lives in their service provision. This is different from other non-current assets such as pumps and motors which, although they can be refurbished to provide new lease of life in terms of service potential, are often depreciated to zero and/or often replaced in their entirety at some stage after their original effective lives have expired.
A depreciation method using the average annual annuity of the renewal cash flow (capital necessary to sustain service delivery) has been advocated for application to the infrastructure assets to provide more managerial information and a better measure of the consumption of these long-lived assets. This approach constitutes the most valid assessment of actual depreciation for mature asset portfolios.
The following figure shows an example of how a utility may assess the long-term implications of renewal (or asset consumption) and new growth/augmentation works, using the renewal annuity approach.