tangible capital assets beyond psab 3150

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Tangible Capital Assets Beyond PSAB

3150

Nancy Gomerich, BBA, CAwww.ngconsulting.ca

604-463-9845

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SESSION 2

Source: David Watt, Senior Asset Management SpecialistAssociated Engineering


3150

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Agenda – Session 2 Long-Term Capital Planning

Funding for Asset Replacement/Renewal – Lifecycle Funding Example: Calculating LG Infrastructure Deficit and related annual

funding targets (4 different models) Annual Funding Targets Presentation Model

Overall Conclusions

Policy Considerations

SORP-4

Q&A and General Discussion – Where do we go From Here?

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Lifecycle Funding – Funding RExample

Variables:Useful Life 50Useful Life Consumed 30Useful Life Remaining 20Historical Cost (beg. Yr 1)

Historical Cost 1,200,000Less Salvage Value 200,000Amortization Base 1,000,000

Cost Inflation 3.00%Investment/Interest Rate 5.00%Replacement Cost End UL (Yr 50) (1) 4,383,906

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All Options – Fund R over the remaining 20 years of useful life Option 1 and 2 - Ignores impacts of interest and inflation. Is a method to approximate needed R. Option 1 – Based on HC values. Option 2 – Based on current RC values. This option is offered as a simplified alternative to Option

3&4 as many LG will have this information as a result of the recent PS3150 work. Option 3 & 4 – Accounts for interest and cost inflation. Will provide a value for R that will produce

the required Reserve Balance. Annual/periodic adjustments to R would be required to account for differences in the actual interest and cost inflation rates.

Option 3 – Funds R using the Current Cost Model. Amount shown must be increased by the 5% cost inflation every year.

Option 4 – Funds R using the Proportion of Replacement Cost Model. Amount shown will remain at that amount for the remaining 20 year period.

Option 1 Option 2 Option 3 Option 4HC Model RC Model CC Model P RC Model

Infrastructure Deficit: 600,000 1,456,357 1,172,599 1,391,280

Annual CFE:Replacement Lifecycle (RL) 20,000 48,545 30,044 20,941Replacement Ketchup (RK) 30,000 72,867 73,449 111,640

50,000 121,412 103,493 132,581

Reserve Balance in Yr 50: 4,383,906 4,383,906 4,383,906 4,383,906Replacement Cost Yr 50: 1,653,298 4,014,604 4,383,906 4,383,906

Surplus/(Deficit): -2,730,608 -369,302 0 0


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

What is the Infrastructure Deficit?

FCM Infrastructure Deficit Components: The unfunded investments required to maintain and upgrade existing, municipally owned infrastructure assets

IS – Unfunded R at any point in time.

The funding needed over and above current and projected levels to bring existing facilities to a minimum acceptable level for operation over their service life, through maintenance, rehabilitation, repairs and replacement.

IS – Funding for specified Enhancements and/or Deferred Maintenance Works


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

Infrastructure Deficit* HC Model

Equals the Accumulated Amortization at end Year 30 1,000,000/50 x 30 = 600,000

RC Model Equals the Accumulated Replacement Cost Amortization at end

Year 30 RC in Year 30 = 1M inflated to end yr 30 at 3%/yr = $2,427,262 RC Accu. Amort. = 2,427,262/50yrs x 30 yrs = 1,456,357

* In this example, no amount of R has been funded (ie no related reserve balance exists). If there was you would deduct this balance from the above figures.


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

Infrastructure Deficit* CC (current cost) Model

Equals the amount of Cash that would be sitting in a Reserve Fund for the asset replacement if the LG had started funding R (as calculated under this model) at the end of year 1 to end of year 30, increasing the amount by the cost inflation each year

Proportion of RC Model Equals the amount of Cash that would be sitting in a Reserve

Fund for the asset replacement if the LG had started funding R (as calculated under this model) at the end of year 1 to end of year 30 (would be the same annual amount each year)


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

Annual CFE Calculation HC Model

RL = 1,000,000HC /50yrs = 20,000/yr RK = 600,000HC ID /30yrs = 30,000/yr

RC Model RL = RC in Year 30 (2,427,262) /50yrs = 48,545/yr RK = 1,456,357RC ID /20yrs = 72,867


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

Annual CFE Calculation - Current Cost Model

RL = 1st Year contribution required to raise the Replacement Cost Value at the end of the assets useful life IF started and continued funding from year 1 and increased contribution by cost inflation rate each year

RK = Incremental contribution (over RL) in year 31 required to raise the Replacement Cost Value at the end of the assets useful life IF started and continued funding from year 31 and increased contribution by cost inflation rate each year


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0

Annual CFE Calculation - Proportion of RC Model

RL = Annualized contribution required to raise the Replacement Cost Value at the end of the assets useful life IF started and continued funding from year 1

RK = Incremental annualized contribution (over RL) in year 31 required to raise the Replacement Cost Value at the end of the assets useful life from year 31


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50,000 121,412 103,493 132,581


Surplus/(Deficit): -2,730,608 -369,302 0 0


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Overall Summary

There is a lot of estimating going on…

The longer the life, the greater the estimation

The numbers are sensitive to changes in interest and cost inflation changes and in the relationship b/w these items, as well as potential changes to planned maintenance and asset use

The calculated Infrastructure Deficit and Target Annual CFE Target and related asset funding plan must be reviewed regularly and will be “fine-tuned” in the later part of an assets life


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Summary

HC Model

Is an estimate ONLY Funding HC amortization, IF you start in year one of an assets

life AND IF there is a sufficient positive spread b/w interest earnings and cost inflation will raise “close to” the needed RC value

If funding for R is not started until later in an assets life, or where there is not a sufficient positive spread b/w interest and cost inflation, funding HC, will not raise sufficient funds

The later is likely the situation for most LG and therefore funding HC amortization only will result in a significant shortfall in replacement cost funding needs


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Summary

RC Model

Is an estimate ONLY Will raise either too much or too little based in interest rate

and cost inflation changes and the time funding starts, but will come much closer to replacement needs than the HC Model

May be a good model to use to get a reasonable “ball park” figure for planning purposes, if have current RC values from PS3150 work


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Summary

CC Model and P RC Model Will raise the exact RC and can be adjusted each year based

on actual interest and cost inflation rates CC Model will be easier to implement as starts with a lower

required contribution and may be “fairer” as charges the current year with the current “market value” consumption cost (plus or minus impacts of actual interest and cost inflation rates)

Is the best choice, but requires a system to efficiently manage calculations and annual/periodic updates


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RC Model What about Short Cuts to estimate RC Amortization,

Accumulated Amortization and Useful life remaining?

This model will require a calculation of current RC, accumulated RC amortization, annual RC amortization and useful life remaining

A “high level” estimate could be estimated by: RC Acum. A.= Current RC x (HC Accumulated Amortization/HC Value) RC Useful Life Remaining = HC NBV/HC Annual Amortization RC Annual Amort. = RC NBV / RC Useful Life Remaining

As the older an asset is the lower its HC value and visa versa, this method may result in materially inaccurate RC estimates and is therefore, ONLY an option for internal finance department “initial guesstimates”

Lifecycle Funding – Funding RRC Model – Short cuts?

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RC Model Extreme Example of why Short-Cuts can be risky!!

Lifecycle Funding – Funding RRC Model – Short Cuts?

Dec/31/2008:In-

Service Year

(Jan/1)Useful

LifeUseful Life Remaining HC

HC Accum. Amort. HC NBV

HC Ann. Amort.

Asset 1 1950 80 21 64 47 17 0.80Asset 2 2007 80 78 1,000 25 975 12.50

1,064 72 992 13.30In-

Service Year

(Jan/1)Useful

LifeUseful Life Remaining RC

RC Accum. Amort. RC NBV

RC Ann. Amort.

W.A. Yrs to Replacement (by Unit/km)

Asset 1 1950 80 21 1,061 782 279 13.26 10.5Asset 2 2007 80 78 1,061 27 1,034 13.26 39

2,122 809 1,313 26.52 49.50Estimate RC Numbers using HC Information:

RC Accum. Amort. = 2,122 * (72/1,064)143.59

RC Annual Amort. = (1,313) / (992/13.30)26.53

Years to Replacement = (2,122-143.59)/26.5374.57

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TCA Historical Cost Annual Amortization - $H

TCA Replacement Cost Annual Amortization - $RL

100% TCA RC Annual Funding Target - $R

Existing Annual CFE Funding - $A(General Revenue for TCA replacement)

HC Amortization Funding Gap $(H-A)

RC Amortization Funding Gap $(RL-H)

Ketchup Funding Gap$RK =(R-RL)

R x Y% = Annual Funding Target for Replacement

Lifecycle Funding – Funding RPresentation Model – Annual Funding Target R

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Long Term Capital PlanningConclusions


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Step 1: Identify Your LG’s Situation

Existing TCA Replacement/Renewal Needs:

Calculate the HC or ideally the RC Infrastructure Deficit, or even just extrapolate from FCM 2007 Study

Identify extent of Deferred Maintenance that is resulting in: Shortened useful lifes (impact s/b “a/c for” in I. Deficit) Greater on-going costs, or Lowered service levels

Growth and New Asset Needs

Identify Asset Categories of most concern

Identify potential need for new debt and how much “tax room” this will take up


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Step 2: Communicate Issue to Council and Public

Do this in partnership with the departments Identify Immediate Strategy

Establishment of Policy Increase in Capital Funding levels (“plant the seed”)

Identify Short/Mid-Term Strategy What current systems and resources do you have? What asset categories appear to be of most concern? Based on above, and other considerations, identify some first steps

Identify Long-Term Strategy Move to Full Asset Management

Need for condition and risk assessments for assets Need for asset management plans (maintenance, renewal and

replacement plans) based on asset condition and risk assessments and set service level

Development of related Long-Term Funding/Sustainability Plans


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Step 3: Improve, revise and refine annually

This is not an over-night solution…


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Dealing with Resistance to Increasing TCA Funding

Ensure LG Sustainability Have $ when need it… fundamental services and

safety/liability issues

Lowest cost approach (save $$) Cost avoidance – avoid extra costs (and poor service) resulting

from inadequate asset maintenance Earn interest on savings No debt expenses – interest, issue expense, staff and council

time


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If we tax today’s taxpayers to build/purchase the asset (or incur debt to do) AND also tax to put $ in reserves for replacement, are we not double taxing?

Theory “NG” – When construct/purchase a new municipal asset the taxpayer’s share of that expense increases their property value. If the LG then taxes for asset consumption (amortization) and holds this money for future replacement when required, than the increased value in the property is fully maintained. Thus, if the taxpayer sells s/he receives 100% of the asset value back in the sale price, meaning that s/he would only have paid for actual consumption duing h/er time in the home.


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Debt for all Replacements is simply NOT an alternative Debt is limited, some funding must come from existing

taxpayers/reserves Even if Debt was not limited and could choose debt for all

replacements, the maximum debt term is 30 years (BC) vs asset useful life of 50-100 so would still not be charging those “benefiting from” the asset


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The bottom line – What LG have been doing is not working…. Another approach is needed!

Taxing now for future replacement means that over-time the cost to replace TCA will be less for ALL and we will be assured that critical assets will be replaced when necessary, maintaining our quality of life…


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Tips

Get a “comfort level” with the numbers… do more in-depth calculations as required (time value money concepts, actual cash flows by asset category etc.)

BUT, ONLY do as much work as you need to do (unless automated) at least initially…

Be careful not to “scare Council into taking no action” Identify the magnitude of the GAP, but focus on what can be

done to close it Approach increasing (tax) funding incrementally Focus on closing the Gaps that are most meaningful, and

make the impacts of closing, or not closing, real to Council


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Key Points

Spend the time and money up front to identify the TCA alternative that has the lowest life-cycle costs

Maintain your TCA (infrastructure) Investment

Seek out cost effective ways to extend the TCAs useful life

External/Grant funding for TCA Works in the future will be tight given high Demand

Start saving NOW! Develop and implement TCA replacement and funding plans

KIAZEN!!!


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Policy Options & Considerations


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General Comments on Policy

Policy is set by Council Policy leads/directs actions… resource allocation

Policy is developed within the LG existing Policy Framework

“Good” Policy Clear as to what the policy is (keep concise!) Can be translated into actions Is reviewed and confirmed, or revised, at periodic pre-set dates

Policy Options and Considerations

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Financial Policy Related to Asset Management and Long-Term Capital Planning

Where?

Incorporate in overall “Financial Policy” if you have one

New Policy “Financial Sustainability Policy” (see Maple Ridge, BC sample policy)


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What?

1. Establish, build and protect Capital Funding

2. Improve Capital Budget Decision Making

3. Promote Effective Debt Management


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What?


Set base Capital Funding Envelope (“CFE”) for each major asset category, or for all in total (maintain “sharing” ability without interest charges regardless)

Set a minimum annual increase in each CFE equivalent to related cost inflation, tie to a specific index (ENR, CPI etc.).

Ideally, set a further annual increase for Replacement/Renewal to account for lack of savings.


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What?


Pay as You Go - Commit to funding HC Lifecycle Renewal/Replacement Costs (R) in the 1st year following acquisition for all New or Replaced TCA

All TCA Sale Proceeds to capital reserve

Commit to using CFE money ONLY for capital purposes (ie if not spent in year goes to capital reserve for future use)


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What?


Capital Budget submissions must:

Identify Lifecycle Costs considering planned maintenance as known (purchase/build, annual operating, renewal/replacement)

Describe the service level provided by the asset. Minimum level as required by current health and safety standards? Premium? Could reference to existing standards (ex. buildings, Leed Silver)


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What?


Capital Budget submissions must:

State that the proposal made minimizes the asset’s lifecycle costs for the chosen service level

Prioritize capital submissions based on established criteria that can be applied across all asset categories


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What?


Prioritization Criteria – some thoughts

Criticality Rating – considers risk of failure in relation to the cost of such failure Cost vs. Benefit Environmental, Social, Economic Impacts Cost/Benefiting Taxpayer Core services, maintain and replace what have before new services


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What?


Internal Debt

Establish a process to internally borrow from own funded Reserves, with interest, providing for the debt to be repaid when required for its original purpose

Establish a “perpetual” Reserve Fund for this purpose if possible (use of land sale monies as “seed” money)


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What?


External Debt

Establish a Debt Servicing Limit – Rating agencies see annual debt servicing costs of 15% or less as worthy of a high credit rating and costs of 25% or more as a liability

Consider limiting the maximum debt term


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What?


Qualify and Prioritize Access to Debt

Capital Project prioritization criteria from the Budget Process will effectively prioritize the projects for debt consideration

For administrative ease, limit debt for projects (or groups of “like” projects) having a value of greater than $X (a large amount)


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Asset Management Policy

The future will mean more focus on the development of Asset Management Plans because:

Make good business sense May eventually become a requirement for grant funding, or

for safety/health or political reasons

Adopting an Asset Management Policy recognizes the value of asset management and officially recognizes it as a priority of Council… sets direction… creates action…

A greater focus on Asset Management will mean better financial information for long-term planning and will support staff in complying with your (Finances) capital budget submission requirements...


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By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee


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DRAFT Policy By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee


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DRAFT Policy By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee


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Expanded Tangible Capital Asset Reporting

(SORP-3, Nov/2008)


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47Expanded TCA ReportingSORP-4 Purpose and Scope

Provides guidance to LG that choose to prepare and present a report on the physical condition of their TCA

Provides a “framework” for such reporting

Extent of reporting will vary… all/some, replacement costs, condition assessments or beyond (funding plans) etc.

Timing and type of reporting will vary… Special Purpose Report, appended to Audited Financial Statements or Annual Budget

48Expanded TCA ReportingSORP-4 Why?

To promote a better understanding of a LG TCA beyond that attainable in the audited financial statements

Reporting on physical condition and replacement cost assists the users in assessing:

Trends in physical condition Adequacy of existing maintenance, replacement and

renewal funding Extent of current and future revenues needed to maintain,

renew and replace TCA Potential impacts on service level

49Expanded TCA ReportingSORP-4 General

Must tie/reconcile the audited financial statement TCA numbers into the Report

Information to embody the basic qualitative characteristics of the PSA Framework, PS1000 (relevance, reliability, comparability, understandability)

TCA Assessed Report should state the rational for why certain TCA, or TCA

categories, where selected for assessment, and why others where not

LG should establish Selection Criteria, could include: Health and safety Economic growth Environment etc.

50Expanded TCA ReportingSORP-4

Presentation

Report should provide the following information for each category of TCA:

Net carrying amount or cost (tie to audited F/S) Average* physical condition rating** Average* age and useful life Nature and extent – quantity and major components

* Calculate averages using the quantity (unit of measure) as the weight when is the same for all assets in the category. Don’t use Historical Cost as will bias average to the value for newer assets as have a higher HC.

** Ideally convert asset category condition ratings to a common condition index for all assets included in the Report for ease of understanding

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TABLE III

This Table illustrates a comprehensive report. In this illustration, the government has chosen to report on all categories of tangible capital assets and include the tangible capital assets of its government business enterprises. It has adopted a common condition index A, B, C, D, and F where A is an excellent or a new condition and F is a failure condition.

Government reporting entity

Category

Net carrying amount ($ millions)

Average condition index

Average age (years)

Average remaining useful life (years)

Quantity

20X8 20X8 20X8 Unit

Roads 6,568 C 25 20 1,829 kms

Sewers 9,345 B 35 40 3,795 kms

Water 7,465 C 55 20 3,845 kms

Transit 1,118 C 5 10 1,225 vehicles

Buildings 981 C 30 15 150 facilities

Recreation 798 B 20 10 320 facilities

Equipment 550 C 5 10 1,421 units

Waste 185 B 10 30 200 units

Unreported (a) 1,790 n/a n/a n/a

Total per financial statements

28,800

=====


Presentation

Report should consider providing a further break-down for each TCA category on how the assets are classified across the Condition Index, showing:

Quantity Percentage of total Average age and useful life

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TABLE IV

This Table illustrates a further breakdown of the overall average condition index by each classification in the condition index based on the information in Table III.

Asset Category — Roads

Condition index Quantity (lane kms)

Percentage Average age (years) Average remaining useful life (years)

20X8 20X8

A 274 14% 5 yrs 40 yrs

B 366 18% 12 yrs 33 yrs

C 640 32% 23 yrs 22 yrs

D 458 23% 32 yrs 13 yrs

F 91 5% 45 yrs 0 yrs

Total rated 1,829 92% 20 yrs 25 yrs

Unreported (a) 155 8 %

Total 1,984 100 %

==== ===

(a) Represents tangible capital assets on which an assessment has not been completed as at the financial statement date.


Presentation

Other Information to consider including in the Report Current cost of replacing the TCA Desired or targeted asset condition level assessments

55Expanded TCA ReportingSORP-4 Narrative Disclosure

The Report should discuss: Trends in changes in physical condition Any effects of known plans on the changing physical

condition The basis of the measurements and calculations

Methodologies and assumptions used, including any changes to Sensitivity of the assessment of physical condition (or other

values) to assumptions made Description of condition management system used and of the

condition index Definitions of terms that may not be generally accepted

terms

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Q&A and Discussion

Where do we go from here? Your

thoughts…

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End of Presentation

tangible capital assets beyond psab 3150

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