Water Environment Federation (WEF)

Implications of Asset Management on Capital and O&M Financing

Asset management is often used to assess asset repair and replacement (R&R) costs and project timing. However, asset management can also be used to reduce overall asset life cycle costs, from creation through disposal. For example, by purchasing technologically advanced assets today, an agency can greatly reduce operations and maintenance (O&M) costs. Although the capital costs of technologically advanced assets may be higher than standard assets, the longterm savings in O&M costs can outweigh the initial increased capital investment, and, over the lifetime of the asset, reduce life cycle costs.

“What-if” analyses concerning timing of capital projects, O&M efforts, and repair/replacement decisions can be used to determine the optimal scenario for project implementation. Other “what-if” scenarios can be evaluated, also based on forecasting the optimal asset replacement point, such as determining the time in the asset’s life cycle in which O&M investments should be decreased to reduce the overall life cycle costs of the asset. These time influenced O&M strategies, in collusion with the use of energy efficient assets, greatly reduce O&M costs, thereby increasing the agency’s future savings.

In June 1999, the Government Accounting Standard Board’s Statement No. 34 (GASB 34) was implemented which requires the value of capital assets be reported in the annual balance sheets and income statements of government entities. GASB 34 requires the asset values to be reported in one of two ways: 1) by performing a straight-line depreciation of historical acquisition costs or 2) by implementing an asset management program. To comply with these regulations, many government entities have adopted asset management programs which demonstrate that either maintenance spending is adequate to prevent infrastructure deterioration or that infrastructure asset condition is being maintained above minimum acceptable standards.

One of the first steps in determining the current value of infrastructure assets as part of an asset management program is to evaluate the existing condition of the asset. Another critical step is to determine the current replacement cost of the asset. Used in conjunction with one another, the current asset replacement cost and the existing asset condition can provide a very accurate assessment of the current value of the asset. The advantage in using this methodology, rather than the historical cost valuation, is that costs relating to technological advances and compliance with increased regulatory requirements are included in the current asset value. Additionally, there is a general consensus among industry professionals that using historical costs and straightline depreciation for valuing infrastructure assets is often an inaccurate representation of the actual value of the assets. This consensus has formed due to inaccuracy in 1) bid-tab costs, such as “front-loading,” which can artificially weight asset costs, and 2) the straight-line depreciation of historical costs, which provides a very conservative approximation of the asset’s current value.

Current value can be developed using the replacement cost of the asset, which accounts for recent technology improvements, as well as the direct, indirect, and soft costs associated with the project. The current value should be updated over time to account for inflation, and changes in material costs and labor costs. The asset’s current condition can be related to the amount, or percentage, of repair that is needed to restore the asset to new condition. These two factors (current condition and current value) can be used to determine the evaluated value of the asset, which provides a more accurate assessment of the overall value of the asset, by incorporating the total costs to replace the asset, modified to account for changes in asset condition over time.

An example of calculating evaluated value is presented in Table 1. As shown in the table, although the current value of the asset is increasing due to increasing material costs, inflation, and other factors, the evaluated value of the asset is decreasing based on the deterioration of the asset over time. The evaluated value is therefore a more accurate representation of the real value of the asset.

The difference between the current value and the evaluated value of the asset is the expected amount that needs to be reinvested in the asset to bring it back to new condition. This will allow an agency to plan for future fiscal needs in a more effective manner, and can assist in attaining “buy-in” from City Council, utility customers, and bond rating agencies because the agency has developed and documented a comprehensive evaluation of their future fiscal needs.

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