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Case Study: Financial Asset Valuations vs CAPEX Renewals Modelling

The Problem

Since the introduction of IPWEA’s Practice Note 3 for buildings, government bodies have increasingly been attempting to pair financial asset valuations with asset management renewals modelling to save consulting costs. However, whilst high-level replacement modelling can be conducted from the financial asset valuation, additional costs are associated when renewing asset components due to variable service level expectations, lowered quantities of scale, restricted access to components, and costs associated with removal and disposal of failed components.

Because of this, rather than a straight line (used to account for depreciation/valuation), renewals modelling more commonly adopts a degradation curve to reflect asset life.

The Councillor Guide to Valuation and Depreciation Asset Accounting in Local Government (LGAQ, March 2008) clearly explains the conundrum as follows:

  • Depreciation is not a method of determining funding for renewal or replacement of assets. this is one of the great misconceptions of accounting depreciation. The expectation that accounting depreciation should equal the annual renewal or replacement cost of an asset is incorrect.
  • The financial consumption of an asset in no way mirrors the operational consumption of an asset. However, over the life of an asset, the accumulated depreciation and renewals cost should come close together. The difference is that depreciation measures the annual consumption of an asset, so that the run down in its value is accounted for as its consumed.

Case Study

In 2010, the Queensland Department of Justice and Attorney-General (DJAG) commissioned ROCHE Legal’s registered valuer to assess the condition and value each of State Government owned courthouse and associated land parcel. In total, there were 67 court house complexes including high-rise CBD structures such as the new Brisbane Magistrates Court and the current Supreme and District Court Complex.

The major objective of the report was to meet the statutory obligations under the Accounting Standards and the Queensland Treasury Financial and Economic Policy. DJAG requested asset componentisation to the elemental level defined by the Australian Cost Management Manual (ACMM) Volume 2. This manual forms the backbone of the construction industry’s language and classifications, and defines the elemental components for all new courthouse construction tender requests.

The Department was provided with the following:

  • An asset register for courthouse assets componentised to a level appropriate to financial reporting (10 elements);
  • An asset register for courthouse assets componentised to a level appropriate to asset management, maintenance and renewals planning (46 sub-elements);
  • A list of reliable unit rates and replacement costs for buildings, elemental condition ratings, and elemental asset lives;
  • The current market value of the land upon which the buildings were situated;
  • A review of town planning constraints such as heritage status and land ownership issues;
  • Deterioration curves based on the inspection and condition assessment as well as a theoretical analysis.

To comply with relevant Accounting Standards, the financial asset valuation was conducted with each building broken down into 10 elements of the ACMM, whereas the asset renewals planning breakdown had to be expanded further (to 46 sub-elements) to allow for realistic and more accurate capital expenditure. A major difference between assessing a building over 10 or 46 elemental levels is the consideration of a practical assessment of useful lives and remaining useful lives, as well as the added costs of replacing only particular elements individually as they begin to fail.

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About the Author:

This post was authored by one of the Solicitors at ROCHE Legal. Should you have any questions, please contact our office.
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