Accounting problems in the valuation of infrastructure assets in New South Wales local government

Abstract

Local government authorities in NSW manage a significant pool of infrastructure assets in order to serve community needs. These assets usually comprise roads, bridges, the water and sewerage network, stormwater drainage, buildings, and other infrastructure. Infrastructure assets represent a major proportion of the total asset base of every NSW council. All local councils in NSW are required to measure their infrastructure assets at fair value and revalue them every five years. However, there are many problems with the valuation of infrastructure assets in local government. Problems arise mostly as a consequence of the unique characteristics of public sector infrastructure assets; in particular, the assets have long and sometimes uncertain lives, there is no market into which they can be sold and - unlike commercial assets - local government urban infrastructure is not operated to make a profit. This makes the valuation and revaluation of these assets for financial reporting purposes a technically complicated exercise. The aim of this study is to (a) investigate whether NSW local government councils comply with the Australian Generally Accepted Accounting Principles (GAAP) in performing the revaluation of their infrastructure assets and (b) to assess any consequences for the reliability of financial reporting in NSW local government. Using road assets as an example, we analyse the results of revaluations of road assets undertaken by 89 NSW councils as reported in their financial statements during the period from 2013 to 2016. In this analysis we focused on the effect of a change in accumulated depreciation as a percentage of the gross replacement cost of the revalued assets. The analysis revealed that in most cases this effect is significant: 36 councils reported a decrease of between 10% and 53%; 5 councils reported increases of between 10% and 31%; and others fell within a 10% range. In absolute terms, these are substantial changes. However, the accounting and reporting of this effect is strikingly inconsistent between the councils. This forms the rationale for this thesis. Based on the analysis of revaluation of roads, the study finds that the main reason for these significant changes arises from the change in the estimates of the remaining useful life of the assets at the time of revaluation. It is most unlikely that asset condition can have such a significant effect on many councils all at the same time. Furthermore, we concluded that the changes in estimates of the remaining useful life is the result of non-compliance with the requirements of AASB 116 to have the useful life reassessed at the end of each reporting period (i.e. each year). Instead, councils wait five years and undertake the next reassessment of the useful life at the time of the comprehensive revaluation. This leads us to a conclusion that, if material, the effect should be treated as an error based on the requirements of AASB 108. If councils did follow requirements of AASB 116 by assessing the useful life at the end of each year, then the effects would be unlikely to be material at the time of the comprehensive revaluation. Only 12 councils out of 89 reported this effect as an error. However, even these did not fully comply with the requirements of AASB 108 in presenting the effects of the error in the financial statements. All other councils did not report or disclose anything about this effect in their revaluation adjustment, regardless of the significance of that effect. There are two main conclusions of the thesis. First, most councils did not comply with the Australian GAAP in accounting, reporting and disclosing the effects of their asset revaluations. Second, there is a high risk that depreciation expense, operational results and financial ratios were materially incorrect in the years preceding each comprehensive revaluation. The latter makes the financial reporting in NSW local government unreliable for decision-making purposes for the users of financial reports. Our study has examined only roads assets in detail. If similar deficiencies in procedures were to exist in the treatment of other local government assets, then summed over all assets, the unreliability of the financial reports could be significantly greater.