1. 1 Tangible Capital Assets Beyond PSAB 3150 Nancy Gomerich, BBA, CA www.ngconsulting.ca 604-463-9845

2. 2 SESSION 2 Source: David Watt, Senior Asset Management Specialist Associated Engineering Tangible Capital Assets Beyond PSAB 3150

3. 3 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?

4. 4 Lifecycle Funding – Funding R Example

5. 5  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. Lifecycle Funding – Funding R Example

6. 6  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 Lifecycle Funding – Funding R Example

7. 7  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. Lifecycle Funding – Funding R Example

8. 8  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) Lifecycle Funding – Funding R Example

9. 9  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 Lifecycle Funding – Funding R Example

10. 10  Annual CFE Calculation - Current Cost Model  RL = 1 st 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 Lifecycle Funding – Funding R Example

11. 11  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 Lifecycle Funding – Funding R Example

12. 12 Lifecycle Funding – Funding R Example

13. 13  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 Lifecycle Funding – Funding R Example

14. 14  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 Lifecycle Funding – Funding R Example

15. 15  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 Lifecycle Funding – Funding R Example

16. 16  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 Lifecycle Funding – Funding R Example

17. 17  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 R RC Model – Short cuts?

18. 18  RC Model Extreme Example of why Short-Cuts can be risky!! Lifecycle Funding – Funding R RC Model – Short Cuts?

19. 19 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 R Presentation Model – Annual Funding Target R

20. 20 Long Term Capital Planning Conclusions Tangible Capital Assets Beyond PSAB 3150

21. 21 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 Long Term Capital Planning Conclusions

22. 22 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 Long Term Capital Planning Conclusions

23. 23 Step 3: Improve, revise and refine annually  This is not an over-night solution… Long Term Capital Planning Conclusions

24. 24  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 Long Term Capital Planning Conclusions

25. 25  Dealing with Resistance to Increasing TCA Funding 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. Long Term Capital Planning Conclusions

26. 26  Dealing with Resistance to Increasing TCA Funding 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?  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 Long Term Capital Planning Conclusions

27. 27  Dealing with Resistance to Increasing TCA Funding 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?  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… Long Term Capital Planning Conclusions

28. 28  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 Long Term Capital Planning Conclusions

29. 29  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!!! Long Term Capital Planning Conclusions

30. 30 Policy Options & Considerations Tangible Capital Assets Beyond PSAB 3150

31. 31  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

32. 32  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) Policy Options and Considerations

33. 33  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 1. Establish, build and protect Capital Funding 2. Improve Capital Budget Decision Making 3. Promote Effective Debt Management Policy Options and Considerations

34. 34  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 1. Establish, build and protect Capital Funding  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. Policy Options and Considerations

35. 35  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 1. Establish, build and protect Capital Funding  Pay as You Go - Commit to funding HC Lifecycle Renewal/Replacement Costs (R) in the 1 st 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) Policy Options and Considerations

36. 36  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 2. Improve Capital Budget Decision Making  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) Policy Options and Considerations

37. 37  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 2. Improve Capital Budget Decision Making  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 Policy Options and Considerations

38. 38  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 2. Improve Capital Budget Decision Making 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 Policy Options and Considerations

39. 39  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 3. Promote Effective Debt Management  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) Policy Options and Considerations

40. 40  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 3. Promote Effective Debt Management  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 Policy Options and Considerations

41. 41  Financial Policy Related to Asset Management and Long-Term Capital Planning What? 3. Promote Effective Debt Management  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) Policy Options and Considerations

42. 42  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... Policy Options and Considerations

43. 43  Asset Management Policy By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee Policy Options and Considerations

44. 44  Asset Management Policy DRAFT Policy By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee Policy Options and Considerations

45. 45  Asset Management Policy DRAFT Policy By: The Local Government Asset Management Working Group of BC, Asset Management Sub-committee Policy Options and Considerations

46. 46 Expanded Tangible Capital Asset Reporting (SORP-3, Nov/2008) Tangible Capital Assets Beyond PSAB 3150

47. 47 Expanded TCA Reporting SORP-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

48. 48 Expanded TCA Reporting SORP-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

49. 49 Expanded TCA Reporting SORP-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.

50. 50 Expanded TCA Reporting SORP-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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52. 52 Expanded TCA Reporting SORP-4  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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54. 54 Expanded TCA Reporting SORP-4  Presentation Other Information to consider including in the Report  Current cost of replacing the TCA  Desired or targeted asset condition level assessments

55. 55 Expanded TCA Reporting SORP-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

56. 56 Q&A and Discussion Where do we go from here? Your thoughts…

57. 57 End of Presentation