Renewals Accounting

Renewals accounting is an extension of current cost accrual accounting methods. It provides a more realistic view of asset life cycle costing, looking to the future rather than just assessing assets on a replacement cost basis.

This method involves the addition of the current annual maintenance expenditures to the average estimated annual renewal, planned replacement or rehabilitation capital works programs, to yield a form of life cycle costing.

Because of the long-lived nature of passive assets, the projected (future) annual replacement/renewal of those assets will reflect to some degree the maintenance undertaken on those assets. That is, if an authority has been doing inadequate maintenance, then this will be reflected in the replacement or rehabilitation programs that will be required for the assets. Alternatively, if an authority has been doing excessive maintenance, then the longer life will result in a lower replacement or rehabilitation value, but may result in a higher renewal accounting sum because of the over expenditure on maintenance.

The other major benefit of this approach is that it better reflects the issue of "Inter generational equity" i.e. "We paid the original capital cost - why should we also pay for the replacement when another generation will benefit from the service it gives".

Renewals accounting helps to distribute the burden over all generations; however, that someone has to pay for the provision of infrastructure assets is inescapable.

One of the major benefits of this form of accounting is that it obviously reflects the impact of maintenance on the renewals program, and could be readily understood by most elected members or customers of large service authorities. This provides a degree of validity that is essential for good customer relations between users and the service authorities.

Of course, replacement programs will not result in nice, orderly annual expenditures - lumps and bumps will occur due to the types of assets that are reaching the end of their lives and the amounts required to renew them. It is common practice for these lumps and bumps to be smoothed out by the use of some annual or average annuity that reflects a time period sufficiently long enough to take into account the true life cycle costs of the assets (true depreciation).

The program needs to be analyzed closely to ensure that there are adequate returns to accommodate the higher cash flow that may be required over shorter annuity periods that occurs with older assets where past provisions have been inadequate. The short-term annuity cash flow will exceed the longer-term figure.

With contemporary financial management practice, it is not necessary to keep depreciation funds or trust accounts. What is needed is an indication of the real cost of our assets and the rate at which we are consuming them. From this we can derive the future needs for capital (replacement/ rehabilitation) and then derive sufficient income to meet this program. The organization will then become self sufficient.