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Accounting for infrastructure damaged by natural disasters

Purpose

The 2010-11 financial year has seen all areas in Queensland impacted by natural disaster.

Section 2 of the Auditor-General of Queensland Report to Parliament No. 2 for 2011: Results of local government audits, discusses the impacts of the natural disasters in Queensland and provides advice about the issues local governments need to consider.

This Bulletin provides local governments with further guidance on accounting for infrastructure assets damaged by natural disasters. These issues will be of particular relevance for Queensland local governments in preparing financial statements for the year ended 30 June 2011.

Scope

This bulletin applies to Queensland local governments. It contains the requirements of the relevant Australian Accounting Standards that apply to not-for-profit entities.

Where a local government has established a for-profit subsidiary, then the subsidiary will need to apply the for-profit requirements of the relevant standards. On consolidation into the accounts of the local government, a consolidation adjustment will be required to ensure the assets of the subsidiary are accounted for using the not-for-profit policies of the parent.

This bulletin mainly discusses the impairment requirements of Accounting Standard AASB 136 Impairment of Assets, together with relevant sections of AASB 116 Property, Plant and Equipment. Local governments need to be aware that there may be other Australian Accounting Standards that apply to infrastructure assets in certain circumstances, for example assets classified as held for sale (or included in a disposal group that is classified as held for sale), and investment property measured at fair value in accordance with AASB 140.

This bulletin does not discuss the requirements of those standards.

Overview of the relevant requirements of AASB 116 Property, Plant and Equipment and AASB 136 Impairment of Assets

When accounting for infrastructure damaged by natural disasters local governments need to refer to the requirements of AASB 116 and AASB 136. In particular whether an asset or component of an asset needs to be written off, ensuring that any damage to the asset which remains at 30 June is reflected in the asset value (for assets held at fair value) and whether there is an impairment loss.

Working through the following steps will ensure that damaged assets are appropriately accounted for in accordance with the Australian Accounting Standards.

Step 1: Consider degree of damage to asset
Local governments should consider the degree of damage to the asset in question and whether there will be any future economic benefits expected from its use. Where appropriate, assets should be written off (de-recognised) prior to 30 June.
Step 2: Has restoration/repair work taken place during the year?
If restoration/repair work has taken place during the year, local governments need to consider whether that work should be expensed or capitalised. The extent of restoration will also impact upon step 3.
Step 3: For assets held at fair value consider the revaluation requirements
If the damaged asset was previously recognised under the revaluation model, local governments should consider whether the asset's value will need to be written down at 30 June. The fair value of such assets at 30 June must reflect the condition of the asset at that time.
Step 4: Consider impairment
Local governments should consider whether an impairment loss will need to be recorded against the asset. Note for assets that are recorded at depreciated replacement cost it is unlikely that an impairment loss will occur.

Step 1: Consider degree of damage to asset

When an event has taken place that may be an indicator of impairment (such as natural disaster), it is important to note that rushing to record an impairment loss against the asset in question, may not be the correct approach.

Local governments must (in accordance with AASB 116, paragraph 67b Property, Plant and Equipment) first consider whether the damage to the asset is so severe that future economic benefits can no longer be expected from its use.

Where no future economic benefits are expected from the damaged asset’s use, the asset must be written off and derecognised, rather than impaired. Incorrectly recording an impairment in this instance could result in the asset’s value being over-stated, which may adversely impact the audit opinion of the financial statements.

Where part of an asset is to be replaced (e.g. a section of a road) then that part can be written off, even if not separately depreciated.

Example 1
The Tropical Shire Council area has been extensively damaged by flooding. The performing arts facilities owned and operated by council was severely damaged and council estimates that it may not be financially feasible to repair the facilities.

The facilities have a carrying value of $1.2 million. It has accumulated depreciation of $600,000 recorded against it. Given the specialised nature of the facilities, there are no alternative uses for the facilities.

As substantial damage has taken place and no future economic benefits are expected from the asset, council must write-off the asset and de-recognise it as an asset.

The appropriate entry would be:
Dr Loss on disposal of assets $600,000
Dr Accumulated depreciation - performing arts centre $600,000
Cr Performing arts centre $1,200,00

Step 2: Has restoration/repair work taken place during the year?

If restoration/repair work has taken place during the year local governments need to consider whether that work should be expensed or capitalised.

This will require judgement and an assessment of the damage to the asset. If the damage is minor and does not really impact upon the future economic benefits that the asset will provide, the cost of repairs should be expensed.

If the restoration/repair works represent a capital enhancement to the condition of the asset then it may be more appropriate to record them as an asset.

Essentially, those costs which do not increase the service potential of the asset, should be expensed and not capitalised.

Local governments should note that not all costs associated to the repair of the asset can be capitalised. AASB 116 paragraphs 16, 17 and 19 provide guidance on what costs can be capitalised.

If an asset has previously been written down (e.g. re-valued downwards) then the costs of subsequently restoring the asset to its previous state should be capitalised.

Step 3: Revaluation considerations

Where an asset is measured under the revaluation model (as opposed to the cost model) and future economic benefits are still expected from the damaged asset's use, local governments will need to take into consideration the condition of the asset when assessing its fair value as at 30 June.

Local governments using this model have to make an assessment of each asset’s fair values at balance date every year. Generally this is done by performing comprehensive valuations periodically and applying indices in the intervening years. Where the condition of the asset is materially different to the condition at balance date last year (as in this case where assets have been damaged by the natural disasters) the mere application of indices will not be sufficient to meet the requirements of the standard. There may be a need to obtain an independent valuation from a registered valuer at the end of the reporting period and adjust the recorded value.

Example 2
The Tropical Shire Council area has been extensively damaged by flooding. The performing arts facilities owned and operated by council was severely damaged. However, council has indicated that it intends to repair the facilities in the next financial year.

The facilities have a gross value of $1.2 million with accumulated depreciation of $600,000 recorded against it. An independent valuer was engaged and determined that the fair value of the damaged asset at 30 June is $500,000 comprising $1 million replacement cost and $500,000 accumulated depreciation. Given the specialised nature of the facilities, there are no alternative uses for the facilities in the immediate term.

Despite the fact that there are no immediate alternative uses for the asset, there are reasonable grounds to expect that future economic benefits will flow from the asset once repaired. As such, the asset does not need to be written off.

The appropriate entry for the current financial year would be:

[Journal 1: Record downward revaluation of the asset]

Dr Accumulated Depreciation - Performing Arts Centre $100,000
Dr Asset Revaluation Surplus - Performing Arts Centre $100,000
Cr Performing Arts Centre $200,000

In the next financial year, as repairs are carried out on the asset, the appropriate entry would be:

[Journal 1: Record improvements to asset]

Dr Performing Arts Centre $XX
Cr Cash / Payable $XX

Where "XX" denotes the value of improvements to the assets

Local governments should note that not all costs associated to the repair of the asset can be capitalised. AASB 116 paragraphs 16, 17 and 19 provide guidance on what costs can be capitalised.

Essentially, those costs which do not increase the service potential of the asset, should be expensed and not capitalised.

Step 4: Consider impairment

At the end of each reporting period all non-current assets, whether held at cost or fair value, must be assessed for indicators of impairment in accordance with AASB 136 unless specifically covered by another standard, for example inventories and biological assets (see paragraph 2 of AASB 136).

Where an asset has been damaged by natural disaster and has not been restored at 30 June an indicator of impairment exists. In such cases a local government must then calculate and account for any impairment loss. Note, where the asset is valued at depreciated replacement cost it is unlikely that an impairment loss will exist (see example below).

For assets valued at depreciated replacement cost the fair value as at 30 June, which reflects the condition of the asset at that date, will account for any damage to the asset.

An impairment loss occurs when an asset's carrying amount exceeds its recoverable amount. When this occurs the asset must be written down to its recoverable amount and an impairment loss recorded for the difference.

Materiality should be considered when applying AASB 136 by referring to AASB 1031 Materiality. In determining materiality for not-for-profit entities, impairment amounts must be tested against revaluation surpluses, impairment loss expense and net operating result.

Determining recoverable amount for impairment testing

Recoverable amount is the higher of the fair value less costs to sell (FVLCTS) and the value in use (VIU).

Fair value less costs to sell

Fair value less costs to sell (FVLCTS) is the amount obtainable from the sale of an asset in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal. Paragraphs 25-28 of AASB 136 prescribe how FVLCTS is to be determined.

Costs of disposal refer to those costs directly attributable to the disposal of an asset (excluding finance costs and income tax expense). Paragraph 28 of AASB 136 provides examples of costs of disposal.

The concept of FVLCTS is closely related to the selling price of the asset, which is best represented by a binding sales agreement. In instances where no agreement exists, a market price where the asset is traded within an active market is suitable.

Sometimes it is not possible to determine the FVLCTS of an asset because:

  • it is not traded in an active market
  • there is no basis for making a reliable estimate of the amount obtainable from the sale of the asset in an arm’s length transaction between knowledgeable and willing parties.

In such cases the recoverable amount can be determined by:

1. referring to recent transactions for a similar asset
2. referring to the asset's VIU.

For example it is not possible to determine the FVLCTS of road assets. Therefore the recoverable amount of road assets is their VIU. Generally this will be the depreciated replacement cost of those assets (see further information below).

Value-in-use

Value-in-use (VIU) is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.

For not-for-profit entities, where the future economic benefits of an asset are not primarily dependent on the asset's ability to generate net cash inflows (i.e. a commercial return) and where the entity would, if deprived of the asset, replace its remaining future economic benefits, value-in-use is determined as the depreciated replacement cost of the asset.

The future economic benefits of the assets of local governments have been determined, in most instances, to be held to provide a community service, and not to generate a commercial return. However, where a local government entity is not using an asset and has made a formal decision not to reuse or replace the impaired asset, the value-in-use would be the present value of net disposal proceeds.

In the rare instance that a local government holds an asset for its ability to generate a commercial return, the value-in-use will be the present value of the future cash flows expected to be derived from the asset.

Calculating the impairment loss

The amount of impairment loss is calculated by deducting the recoverable amount of the asset from its carrying value. This has to be performed on an individual asset basis.

In many cases the recoverable amount will be the depreciated replacement cost of the asset. This can be confusing because most local governments measure their assets at fair value using depreciated replacement cost (as outlined in AASB 116). Therefore, the carrying amount of the asset is usually already reported at depreciated replacement cost and this should not differ to the depreciated replacement cost used to determine the recoverable amount.

Consequently, it should be rare for property, plant and equipment assets of a local government which are measured at fair value, to be impaired. Instead, the carrying amount of these assets should be adjusted via a revaluation decrement rather than impairment.

Recording an impairment loss

An impairment loss is recognised immediately in the statement of comprehensive income, unless the asset is carried at a re-valued amount. When an asset is measured at a re-valued amount, the impairment loss is to be treated in the same way as a revaluation decrement and offset against the asset revaluation surplus first to the extent available.

For not-for-profit entities an impairment loss on a re-valued asset must be offset against a revaluation surplus for the same class of asset. Following the recognition of an impairment loss, the depreciation/amortisation charge for the asset is to be adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.

Example 3
The local road network within the Tropical Shire Council area was extensively damaged by flooding in December 2010, with 75 per cent of the Sunny Street section of road pavement needing replacement, with the remaining portion of the road still safe to use.

At 31 December 2010, the sunny street section of road is included on the Council’s asset register at a carrying value of $145,000 and is measured under the revaluation model. The gross value of the asset is $190,000 with $45,000 worth of accumulated deprecation recorded against it. Repair works are scheduled to take place after 30 June 2011.

Given the severity of the damage to the asset, council engaged an independent valuer to assess the fair value of the road pavement in its current condition at 30 June 2011, who determined the fair value to be $37,000 ($49,000 replacement cost and $12,000 accumulated depreciation).

In order to ensure that the asset's value is correctly accounted for, we will apply the four step process outlined previously.

Scenario A: Where the 75 per cent damaged section of Sunny Street is a separately identifiable part.

Step 1: Consider the degree of damage to asset
Whilst the Sunny Street section of road pavement has been severely damaged, Council expects that future economic benefits will flow from the use of 25 per cent of the pavement that is still fully functional. Thus, this part of the asset should not be written off. Council should consider writing off the 75 per cent as a part that is to be replaced since it is a separately identifiable part.

At 31 December 2010 council could derecognise this part of the road by processing the following entry:

Dr Loss on disposal of assets $108,750
Dr Accumulated depreciation - Road Infrastructure $ 33,750*
Cr Road Infrastructure Assets $142,500*
*75% of carrying amount of $145,000
Step 2: Consider revaluation of the asset
The remaining 25 per cent, which is now a separately identified section of road in the asset register may need to be re-valued at 30 June, depending upon the local government’s circumstances and the condition of that section.
Step 3: Consider impairment
Given the asset is measured under the revaluation model, at depreciated replacement cost there will be no impairment loss in this instance. Also the damaged part has been written off.
Scenario B: Where the 75 per cent damage to Sunny Street is not a separately identifiable part.
Step 1: Consider the degree of damage to asset
Since the damage is not just to a separately identifiable part of the road the Council is not able to write off a part of the Sunny Street section.

Step 2: Consider revaluation of the asset
As the asset is measured under the revaluation model (depreciated replacement cost), at 30 June, Council will need to ensure that the asset is recorded at fair value.

The fair value of the road section at 30 June 2011 has been determined by an independent valuer and the downwards revaluation should be recognised as follows:

[Journal 1: Record downward revaluation of the asset]

Dr Asset Revaluation Reserve - Road Infrastructure $108,000
Dr Accumulated depreciation - Road Infrastructure $33,000
Cr Road Infrastructure $141,000

Step 3: Consider impairment
Given the asset is measured under the revaluation model, at depreciated replacement cost there will be no impairment loss in this instance. The damage to the asset will have already been taken into account as part of the assessment of the asset's condition during the revaluation process.


Useful life and residual value

It is important to review the useful life and residual values of the assets that have been damaged and restored. Damage may result in a reduced useful life, and restoration of an asset to its original state may result in an extension of the useful life of the asset.

Changes in useful life are considered changes in accounting estimates, which is covered by AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors.

For example if Tropical Shire Council had a two-lane road that was half-way through its useful life that is reduced to a one-lane road as a result of a natural disaster, it is easy for the council to use the grant funding to restore the one-lane road back into a two-lane road. However, a new road (or at least a new lane of a road) will have a greater useful life than the road it replaced. As a result, the future economic benefit of that asset would have been increased simply by restoring it to its original condition – a one-lane road being restored to a two-lane road.

Where useful lives and residual values have changed, the local government will need to:

1. Record depreciation expense for affected asset(s) at the new rates in current and future periods.
2. Disclose the nature and amount of the change in accounting estimate (useful life of asset).

If the work performed results in the asset effectively becoming a brand new asset at the beginning of its useful life, the Local Government should consider derecognising the damaged asset prior to recognising the new asset.

Disclosure

Local governments need to make disclosures in relation to revaluation and impairment in accordance with the standards. The Tropical Illustrative Financial Statements for 2010-11 provide example disclosures, however, these will need to be tailored by each local government to completely and accurately disclose the particular circumstances regarding any impairment.

Local governments should consider making additional disclosures where necessary to explain the effect of the natural disasters on the financial statements.

Documentation

It is extremely important for local governments to maintain documentation to support revaluation, new estimates of useful lives and residual values and any impairment losses. This will help ensure that the auditor is satisfied with the processes and methodology used.

Documents need to be kept for every step of the process, including:

  • Evidence of the state of the affected assets at 30 June such as photographs of assets, engineer’s reports, condition assessments and documentation that has been submitted for NDRRA claims.
  • Methodology used for any revaluation
  • Details of impairment loss calculations the basis for estimating FVLCTS and VIU.
  • How the local government has assessed materiality.

Having a robust asset management system in place that includes regular condition assessments will assist with supporting entries made in the accounting system.

If local governments engage the services of an independent valuer, it must ensure that adequate documentation to support the valuation and any subsequent impairment calculation is kept and made available to the Auditor. This will include written evidence of any instructions provided by the council to the valuer in terms of the methodology to be adopted and key assumptions used in providing the valuations.

Documentation should cover:

1. Actual methodology adopted in valuing the asset, including:
(a) how the methodology complies with the requirements of AASB 116
(b) whether any alternate methodologies for valuing assets were considered.

2. Key assumptions used in developing the valuation:
(a) clear evidence supporting the assumptions used, such as:
i. market assessments
ii. management information relating to actual and intended use of the asset
iii. other evidence used by the valuer to support key assumptions

(b) how those assumptions meet the requirements for determining fair value under AASB 116

Management's assessment of the valuation obtained including:
(a) discussions / meeting with the valuer
(b) formal acknowledgement of management's understanding of the approach adopted by the valuer and the key assumptions used in undertaking the valuation
(c) management's assessment of the methodology
(d) management's assessment of the key assumptions used by the valuer and support for those assumptions
(e) formal acknowledgement of management's acceptance of the valuation methodology and key assumptions used
(f) formal review of the asset valuation by an appropriate governance committee (eg. Audit and Risk Management).

AASB 136 extracts:

25 The best evidence of an asset's fair value less costs to sell is a price in a binding sale agreement in an arm's length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset.

26 If there is no binding sale agreement but an asset is traded in an active market, fair value less costs to sell is the asset's market price less the costs of disposal. The appropriate market price is usually the current bid price. When current bid prices are unavailable, the price of the most recent transaction may provide a basis from which to estimate fair value less costs to sell, provided that there has not been a significant change in economic circumstances between the transaction date and the date as at which the estimate is made.

27 If there is no binding sale agreement or active market for an asset, fair value less costs to sell is based on the best information available to reflect the amount that an entity could obtain, at the end of the reporting period, from the disposal of the asset in an arm's length transaction between knowledgeable, willing parties, after deducting the costs of disposal. In determining this amount, an entity considers the outcome of recent transactions for similar assets within the same industry. Fair value less costs to sell does not reflect a forced sale, unless management is compelled to sell immediately.

28 Costs of disposal, other than those that have been recognised as liabilities, are deducted in determining fair value less costs to sell. Examples of such costs are legal costs, stamp duty and similar transaction taxes, costs of removing the asset, and direct incremental costs to bring an asset into condition for its sale. However, termination benefits (as defined in AASB 119) and costs associated with reducing or reorganising a business following the disposal of an asset are not direct incremental costs to dispose of the asset.

Non-current asset policies for the Queensland public sector - Chapter 4.3

Queensland Treasury measuring fair value in not-for-profit entities

Assets where no market price exists – asset not held to generate cash inflows

In some instances, there will be no market information on which fair value can be estimated e.g. infrastructure assets such as roads.

Where there is no market price for assets similar in type and condition and the asset is not dependent on generating net cash inflows, the fair value of the asset is the cost of replacing the future service potential embedded in that asset, adjusted to reflect the condition of the asset being currently valued. This value is the depreciated replacement cost.

Depreciated replacement cost can be determined in one of two ways:

  • as the cost per unit of service potential of the most appropriate modern replacement facility, adjusted for any differences in future service potential (i.e. quality and quantity of outputs, useful life and over-design/over-capacity) of the asset being valued
  • as the cost of reproducing or replicating the future service potential of the asset.

Assets where no market price exists - asset held to generate cash Inflows

Where there is no market price for an asset, its value will be either the net present value of the cash flows associated with the asset or the current replacement/reproduction cost.

Where a number of assets work together to generate cash flows for a not-for-profit agency, the assets shall be valued in accordance with the following section related to for-profit agencies with assets with no market price.

See Appendix 1: Accounting for infrastructure assets damaged by natural disasters, decision making flowchart, local governments (non profit entities only) (PDF icon 18 KB).

Further information

For further information, contact the department.

For a copy of the Standard visit the AASB website, under Quick Links - Table of Standards.

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