Water Journal : Water Journal May 2015
MAY 2015 water 37 Feature article reports would determine physical deterioration factors, effective remaining lives, residual values, functional obsolescence (excess capacity and over engineering) and economic obsolescence (albeit unlikely in the water authorities’ case given the essential services nature of the asset and service supplied). Additionally, while the International Valuation Standards Council (IVSC) has specific guidelines for measuring assets under the DRC method, given the high level of judgement and assumptions, a number of asset classes may be assessed as Tier Three valuation hierarchy requiring significant levels of increased disclosure and sensitivity analysis in the financial reports. Under a DRC cost methodology, the large number of significant judgements and assessments that would need to be made would also require high levels of extensive and detailed input from water authorities to valuers, which would likely add time and costs to the process. • Income approach takes future amounts, such as income and expenses or cash flows, and converts them to a single value for the present. Widely used within industries with large infrastructure that provide essential services like electricity, gas and water, the income approach tends to be more affordable and can provide greater control over modelling data, since once the discounted cash flow (DCF) model is developed it can be maintained and updated annually in a relatively cost-effective manner. The key to this methodology is the ability to separately identify cash flows associated with the core assets, where those cash flows are set to generate a commercial return for the entity. DCF models are widely used in the Australian market and, as such, they are understood by a number of professionals. Under a DCF model the perpetuity of the asset is assumed (as appropriate) and this is reflected in the terminal calculation that can go into perpetuity to reflect the nature of the essential service and its delivery requirements. If the cash flows relating to the core assets are heavily subsidised, however (due to the essential service nature), then the income approach may not be appropriate, as the “service potential” of the asset may not be recognised, resulting in an undervalued asset. estAblishing A more strAtegic vAlUAtion plAn Based on these factors, which method should water authorities choose? The best strategy might not be an either-or situation, but a hybrid approach, depending on the circumstances of the cash flows and the nature of the assets. For instance, the income approach could be used to test-check the cost model, ultimately resulting in greater accuracy and confidence. A different valuation method might also be appropriate for different types or locations of assets. For example, an authority might select a depreciated replacement cost method for its regional assets and an income approach for its high demand urban assets. Understanding the value of your assets under both approaches is valuable and useful information for management, boards and regulatory authorities, especially when the two valuation approaches may provide materially different outcomes. As a whole, water authorities should evaluate the pros and cons of each method against their cash flow structures and ability to make the judgements required for the cost approach. Only by giving further consideration to alternative models can the industry ensure it arrives at the most appropriate valuation possible. Given the role that knowing the true value of an asset plays in an organisation’s ability to drive growth, raise capital and make strategic business decisions, the time to start investigating the strengths of a hybrid or different approach is now. And with Australia’s urgent need to manage water resources as efficiently as possible, this task has the potential to make a significant impact. WJ the AUthor Anne Lockwood (email: Anne.Lockwood@bdo. com.au) is a Melbourne-based Audit Partner with audit, tax and advisory firm BDO. Anne has more than 22 years of audit and advisory experience, including assisting clients comply with the requirements of Australian Accounting Standards, APRA Prudential Standards, other regulatory requirements and the Corporations Act.
Water and CSG
Water Journal June 2015