Weighing in on infrastructure valuation

Since its inception in 1999, GASB 34 has loomed like a monolith before public finance officers. The requirements for compliance — especially those related to valuation of infrastructure assets — appeared steep indeed.

This year, high-revenue cities and counties are leading local governments in complying with the statement. Reports from the summit suggest that infrastructure accounting — from choosing a valuation method and taking inventory to reconciling records and computing final values — is a lengthy and intensive process, though not the nightmare many people predicted.

A demand for time

GASB 34 changes traditional government accounting to give readers of government financial reports a more-complete picture of management, holdings and fiscal health. The statement establishes a financial reporting model based on full accrual accounting, requiring state and local governments to establish a dollar value for current and long-term assets, and track depreciation.

The fear surrounding compliance stems chiefly from the requirements for valuation of infrastructure assets. (GASB 34 defines infrastructure as “long-lived capital assets that normally are stationary in nature and normally can be preserved for a significantly greater number of years than most capital assets. Examples of infrastructure assets include roads, bridges, tunnels, drainage systems, water and sewer systems, dams and lighting systems.”) Because public finance officers were not required to account for infrastructure previously, they typically do not have immediate access to comprehensive inventories or the records necessary to compute depreciation.

Recognizing that obstacle, GASB 34 extends the infrastructure reporting period for Phase I and Phase II governments. (See the table on page 48 for a schedule of phases.) Valuations for infrastructure placed in service during the first GASB 34 reporting year must be included in that year’s report, while valuations for infrastructure placed in service prior to that year can be reported over the next four years. (Phase I and Phase II governments are not required to report valuations for infrastructure placed in service prior to 1980, and Phase III governments are not required to report infrastructure placed in service prior to their initial GASB 34 reporting year.)

Is sooner better than later?

Despite the extra time allowed for infrastructure reporting, some Phase I governments are opting for full reporting in the first year. “We think the report won’t be meaningful unless it includes all infrastructure assets,” says LaVerne Lovett, finance director for Newport News, Va., which is issuing its first report under GASB 34 this month. “We elected to look at all of our infrastructure from the start.”

“GASB 34 calls for a report comparing assets to liabilities,” explains Paul Gruenwald, vice president for Milwaukee-based American Appraisal Associates. “If you don’t book infrastructure, you have a good chance of having more liabilities than assets, which doesn’t look good on a financial statement.”

Beverly Hills, Calif., got an early start on GASB 34 compliance and issued its first report last year. Its balance sheet listed total assets of $600.3 million against $271.5 million in liabilities. Net infrastructure values — the cost less accumulated depreciation — totaled $68.3 million.

As of mid-April, assets for Newport News totaled approximately $300 million, while liabilities approached $400 million. Assets included values for 95 percent of the city’s infrastructure, and Lovett notes that, when the remaining infrastructure figures are incorporated, the gap between assets and liabilities will close.

Which method to choose?

When establishing value for infrastructure assets, governments must choose between the depreciation method and the modified method, as specified by GASB 34. Governments using the depreciation method must compute the historical cost of a given asset and apply a straight-line, or accumulated depreciation, formula to arrive at the asset’s current value. (See the accompanying tables for average life spans of infrastructure elements.)

Under the modified method, governments must place a current value on a given infrastructure asset and commit to maintaining that asset at a specified level. “GASB 34 has left [the maintenance level] up to governments, saying only that levels must be established,” says Scott Smith, director of internal audits for Beverly Hills. “You might create a scale of one to 10 or one to 100, with perfect conditions being at one end of the scale and complete disrepair at the other.”

Governments choosing the modified method must employ an asset management system to track the condition of a given asset over time. They must produce annual estimates of the funds necessary for maintaining that asset, and they must document their maintenance work, showing that the asset is being preserved as promised.

Governments satisfying those and other requirements of the modified method account for infrastructure spending as expenses, just as they have done traditionally, without applying depreciation. However, if they fail to meet the requirements, they must convert to the depreciation method, counting maintenance costs as expenses and improvements as capital expenditures.

“I don’t like the modified approach,” Lovett says. “It requires a lot of documentation outside the realm of a financial accountant. For example, I would have to rely on condition assessments conducted by others. If those assessments fail to meet the standards of the modified system, I would have to revert to depreciation, which is a lot of work. Most cities I have talked to are using the depreciation method rather than the modified approach.”

How intensive does it get?

In addition to choosing a valuation method, governments must inventory all infrastructure assets — a task that is complicated by the fact that some items fall into more than one category. For example, city-owned parking lots, sidewalks and pedestrian paths might be considered land improvement assets or infrastructure assets. How is a distinction made?

According to Gruenwald, sidewalks draw the dividing line in those cases: If the asset is inside the sidewalk, it qualifies as a land improvement; if it is outside the sidewalk, it qualifies as infrastructure. For example, if a city-owned building faces a sidewalk and roadway, the sidewalk and roadway are considered infrastructure assets. However, a driveway crossing the sidewalk onto the city-owned property is considered a land improvement asset.

Even those governments that master the task of defining infrastructure risk getting bogged down in detail. For example, when reporting roadways, they might choose to describe them as a single item, including pavement, curbs, gutters, lighting, guardrails and signage. Or they might choose to report subsystems such as pavement, including curbs and gutters. Or they may want to report each item individually. “The most common method for reporting roadway infrastructure is by subsystem,” Gruenwald says. “That provides a level of detail sufficient for describing the components.”

Beverly Hills and Newport News each hired a consultant to assist with planning and conducting infrastructure valuations. “Our consultant sent employees to our site to perform physical inventories, or counts, and valuations of assets in all categories,” Lovett says. “At first, we expected the consultant to physically examine all the infrastructure assets as well. But it was impossible to do this, given the number of streets, streetlights, sidewalks and so on.”

While inventory and valuation took two months in Newport News, the process took three weeks in Beverly Hills. There, the consultant physically examined assets in some cases, but when possible, it obtained inventory and valuation information from records provided by the city’s Public Works and Engineering departments. “In cases where we had confidence in our records, we used the records instead of a physical inventory,” Smith explains.

The consultant provided the city with a draft report covering the assets it inventoried and valued. Smith then worked with the consultant to reconcile the report with city records.

“Reconciliation is fundamentally important to the whole process,” Smith says. “We had to compare the data developed [by the consultant] with our existing records. In some cases, assets in our records didn’t exist anymore. In other cases, the values [in our records were different than the values assigned by the consultant], and they needed to be reconciled.” Beverly Hills’ reconciliation took three months, Smith notes.

‘Painful but worthwhile’

Although some governments may be fortunate enough to have most of the necessary records at hand, many will not be that lucky. “Most governments have some records detailing how they spent their money,” Smith says. “But historically, cities have not had to capitalize infrastructure assets. Accordingly, most governments will [not have complete records and will have to] estimate historical costs of their infrastructure.”

To accomplish that, the government has to calculate the current replacement cost of the infrastructure asset, including the costs of materials, equipment and labor used for construction. It then must apply historical consumer price index values, deflating the current value and estimating the cost of the asset at the time it was placed in service.

That task gets even more difficult when no one knows the in-service date. In that case, condition assessments are required to estimate the asset’s age.

For Beverly Hills’ valuations, Smith applied straight-line depreciation schedules to the reconciled data. He estimates that the entire accounting process cost the city approximately $140,000, including $40,000 for the consultant’s services. Newport News spent less on consulting fees, partly because it chose to handle reconciliation tasks in house.

In the end, GASB 34 was “painful but worthwhile,” Smith notes. “We ended up needing to put together a lot more detailed information than we anticipated. While we have a good system of record keeping here, it required us to do a lot of digging, to break out details.

“But the process of gathering all this information is important,” he says. “The reporting work gives management a better understanding of the assets a city has; what condition those assets are in; and what the government’s ongoing needs might be. This allows for more realistic planning and budgeting.”

Michael Fickes is a Baltimore-based freelance writer.

Average Life Cycles For Depreciated Infrastructure Assets

Milwaukee-based American Appraisal Associates has established the following benchmark life cycles for depreciating a variety of infrastructure assets. Company officials caution that the benchmarks may vary between jurisdictions based on differences in climate and use. In addition, the estimates of average asset lives assume that normal maintenance is performed on the assets.

Implementation of GASB 34 is scheduled in three phases:

Phase I

Governments with total annual revenue of $100 million or more apply GASB 34 for periods beginning after June 15, 2001.

Phase II

Governments with total annual revenue of at least $10 million but less than $100 million apply GASB 34 for periods beginning after June 15, 2002.

Phase III

Governments with total annual revenue less than $10 million apply GASB 34 for periods beginning after June 15, 2003.