Funny Depreciation Debates

Funding of Depreciation is heating up as an issue, with the Auditor-General’s 2004 report to be released only a few weeks before Local Government elections, raising concerns about unfunded depreciation, and naming around 15 Councils who do not fund at least 50% of their deprecation. The 2003 report stated:

A material level of unfunded depreciation may have serious implications for local governments, and significant financial consequences for future generations. Where it is the local government’s policy not to fully fund depreciation, it is recommended that suitable disclosure be made in the notes to the financial statements. Any decision not to fully fund depreciation should be supported by a comprehensive analysis of future asset replacement funding needs coupled with identification of the funding sources.

Even for Councils not named, funding depreciation is a confusing issue. Let’s be clear, funding depreciation is not mentioned in the accounting standards – depreciation just records the consumption of assets, and in the private sector funding of any capital expenditure is based on a financial assessment of the merits of the expenditure, regardless of whether it is a replacement or new asset.

The concept of funded depreciation is a Queensland concept and doesn’t arise in other States. The issue is even more complex since Local Government depreciation is based on the current asset value rather than the historic cost. Therefore it represent the consumption of the current value of the assets, not the amortization of the original amount spent.

In our view, the A-G is focusing on funded depreciation as a way of encouraging Council’s to get more accurate asset valuations and depreciation amounts. We understand that it is unlikely that an audit would be qualified on this issue alone, unless it impinges on overall financial viability.
In many cases, it seems that the funded depreciation ‘issue’ is due to a mismatch between the assumptions behind the asset valuation/depreciation calculation and Council asset management practices. For example, if the top road seals are maintained in excellent order, the underlying road base will last significantly longer, and may depreciate at a very low rate. Therefore, most roads depreciation would relate to the seals, which is likely to equate to the cost of the reseals program.

It is vital that Councils keep the funded depreciation issue in perspective. Insufficient funding of infrastructure replacement will inevitably lead to asset degradation and higher costs for future generations, as occurs in many countries. However, putting aside depreciation funds which are not likely to be used in the foreseeable future is an unnecessary impost on current ratepayers. Therefore a balance is required, so that assets are maintained in good condition, but unnecessarily large cash balances are not accumulated. Hopefully the pendulum will swing back to a balanced common sense approach before long.

By David Spearritt Director ORION

“Many forms of government have been tried and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all wise. Indeed, it has been said that democracy is the worst form of government, except for all the others that have been tried from time to time".Winston Churchill, 1947

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