Annuities

Renewals accounting best reflects the true costs of operating long-lived infrastructure. It allows authorities to model future impacts of a large amount of ageing infrastructure.

100 year straight annuities reflect the total life cycle of most assets, cover inter-generational equity issues and better represents the abatement factors (reductions) that are likely to occur as more accurate information becomes available. It also reflects the real orders of cost to maintain the system's integrity, over an entire life cycle of all assets.

For organizations that are struggling to meet break even cash flow, it is essential that the next 20 year rolling figures be considered in 5 year blocks to try to identify the negative cash flow periods that may occur, particularly for organization units where assets are at a later stage of life.

Typical renewals programs will include large annual variations. The annual variations can be evened out by using an annual (average) annuity. The organization can then act as its own treasury. The "treasury pool" concept is intended to balance out the typical lumpiness of a renewal program over the long term, however they will not balance in the short term annuities in most cases.

Run down assets really represent a backlog of works, or the consumption of assets by past consumers, and this is reflected in the modeling of the replacement programs. Whether or not some contribution could be made by the government or other users to overcome these "backlog works" is an issue which should be addressed.

Renewals accounting should be based on:

The Forward Renewal Program Expressed as an Average Annual Annuity

The question is "what term of annuity"? It should be suited to the financial situation in which the organization finds itself at present eg., Viable, Marginal or Negative.

If the organization is trying to correct a poor financial position, then a long-term view may need to be taken. It is most likely that a short-term annuity (20 years) will derive a much higher figure than the longer term (50 or 100 years), especially with long-lived, high value passive assets such as dams that will only require nominal rehabilitation costs in the future.

However, for any viable organization it is considered that a period of 20 years is the longest in which tangible planning and costing can be done. It sufficiently focuses the organization on the critical issues for its future viability within the planning period, beyond which the figures will bear little relevance because of need, risk and technology changes.

The minimum or bottom line figure can be effectively reduced by possible future abatement impacts, e.g.:

• Increased maintenance, or better allocated maintenance, that defers the timing of the replacement, rehabilitation
• Rehabilitation, not replacement, as more cost effective techniques become available
• New technology and techniques that may reduce the capital cost
• Asset rationalization (disposal or transfer to private ownership).

With computerized databases it is easy to check longer-term annuities to ensure that there are no major "brick walls" just around the corner.

Annual Level of Maintenance Expenditure

Renewal accounting is intended to reflect "Life Cycle Costing" i.e. maintenance levels plus true depreciation (Average Replacement Annuity). But what level of maintenance should be used?

The current condition of long lived passive assets such as irrigation systems, sewers, drains, etc. is dependent on the maintenance that has been carried out during their life, or at least for the last 20 to 30 years. A more realistic maintenance figure is the previous 10 year average of maintenance expenditure expressed in current cost terms.

Other Future Abatement Allowances (Ultimate)

Future allowances need to be made for:

• Changes in staff productivity as a result of Total Quality Management (TQM) and other programs
• Changes in maintenance levels to suit the ageing asset profile
• Abatement of replacement or rehabilitation estimates due to future technology and productivity gains
• The adoption of renewal/rehabilitation costs rather than replacement costs where this is a cost effective option.
• The ability to change the renewal profile by:
  • More effective maintenance
  • Changes in operating regimes.
• Studies and research needs to be undertaken in the areas of:
  • Optimal construction techniques (to reduce replacement costs)
  • Specialist construction plant development (to reduce replacement costs).