This section discusses how to calculate a set of performance measures related to asset value: the cost to maintain current value, asset consumption ratio, asset sustainability ratio, asset renewal funding ratio, and net present value. For each a definition of the measure is provided, along with guidance for calculating the measure and a discussion of the measure’s strengths and limitations.
Note the definitions presented in this guide are similar to those presented in other related guidance, most notably the Institute of Public Works Engineering Australasia (IPWEA) Australian Infrastructure Financial Management Manual (AIFMM) (9). However, these have been adapted and revised for U.S. agency use and to reflect the range of different valuation approaches presented here.
The cost to maintain current asset value helps answer an important question any asset owner is inclined to ask: “how much money do we need to spend?” FHWA requires that State DOTs quantify this value for their NHS roads and bridges in their NHS TAMP. The definition of this measure is shown in the call-out box.
Average annual asset preservation, rehabilitation and replacement funding which, if spent over a specified period, is predicted to result in an ending asset value equal to the value at the start of the period.
One can approximate the cost to maintain current value by determining annual depreciation for a system. If an agency spent this amount on its system in a given year, then all things being equal, the new spending would offset the annual depreciation, with the result that current value maintained.
However, while this approach to calculating the measure is quite tidy, it suffers from being potentially inaccurate. For complex assets the treatment requirements and costs required for an asset – and to maintain service while the asset is being treated – may bear little resemblance to the cost of constructing a new asset used in the asset value calculation. Also, in many cases the asset value calculation excludes the cost of treatments that impact asset condition. Further, when one bases the estimate on annual depreciation, this provides little basis for further detailing how the cost, if spent, would actually need to be distributed between different assets or treatments.
To address these issues, an agency should ideally calculate the cost to maintain asset value by utilizing its asset management systems. With this approach, asset managers define different potential investment scenarios and identify the least expensive scenario that will maintain or improve average asset conditions and asset value. The reported cost should include all of the costs modeled in the agency’s management system used to determine the cost to maintain, which may include other treatments not modeled in the agency’s calculation of asset value.
One challenge in using this measure is that the cost to maintain assets’ current conditions may be very different from that which an agency needs to spend to maintain its assets in their desired state of good repair. For very new assets, it is inevitable that the asset inventory will initially decline in condition somewhat. For a deteriorated system, it may be necessary to maintain and improve conditions and value.
The Asset Sustainability Ratio (ASR) is the ratio of annual asset expenditures to the cost to maintain current value. If the ratio is 1, then annual expenditures are sufficient for maintaining value. If the ratio is less than 1 the system is likely to lose value, and if it is greater than 1 the system is likely to gain value.
The ratio of annual asset expenditures, omitting improvements, to the cost to maintain current value. All types of expenditures included in the cost to maintain current value should be included in the calculation of asset expenditures.
The measure has been in use in Australian financial reporting since the early 2000’s as described by the Local Government Association of South Australia (LGASA) (41). Also, it is included as one of the key measures in the AIFMM (9).
ASR is a valuable measure for summarizing trends in asset spending. Like the cost to maintain current value, it helps identify areas where more spending is needed. Also, given it is a somewhat standardized measure, one can use it to compare asset maintenance methods and asset condition across different systems, assets and agencies.
In using ASR it is important to be clear about which costs are included in the calculation of current expenditures and the cost to maintain current value. The Australian definition relies on data available in a financial report: it is the renewal cost divided by annual depreciation. Here it is recommended that all expenditures included in the cost to maintain current value be included in the calculation, though some applications narrow the definition to include only asset renewals, or widen it to include all asset-related work. Further, here it is recommended that the cost to maintain current value be used in the denominator. This may or may not be equal to annual depreciation, depending on the approach used.
The basic challenge in interpreting ASR is the same as that described for the cost to maintain current value. That is, while it is generally desirable to maintain value, there may be cases where some loss of value is acceptable (implying ASR should be less than 1) or where value needs to be increased (implying ASR should be greater than 1). For example a new asset would be expected to lose value initially even if well maintained. Conversely, if a system is in a poor state of repair, then simply maintaining current conditions may not be desirable.
The Asset Consumption Ratio (ACR) quantifies the portion of the asset that remains after accounting for depreciation. That is, it indicates what percentage of an asset remains to be consumed. This measure ranges from 0 for an asset that is fully depreciated (completely consumed) to 1 (100%) for a new asset. Like ASR, ACR has been used in Australian financial reporting since the early 2000’s (41).
The ratio of current asset value to the initial value of an asset when purchased or constructed.
Note this measure is meaningful only in cases where current replacement cost is used as the basis for measuring value, and where some form of depreciation is calculated.
ACR is valuable as a means for summarizing the relative condition of the asset inventory. It can be a valuable measure for helping summarize trends over time and/or for comparing different asset classes that are otherwise measured using different quantities and scales. However, some asset managers may find it superfluous if they already have well-established approaches for quantifying asset condition.
A challenge in interpreting ACR is in determining what is meant if the ACR is 0 for an asset. Does this mean the asset has failed or still operating but in need of replacement given it has reached its economic useful life and/or is now obsolete? Presentations of ACR should be supplemented with supporting details concerning the assumed useful lives and how these were derived.
The Asset Funding Ratio (AFR) is measure of whether an agency’s planned investments are sufficient for achieving and maintaining the agency’s desired state of good repair over a 10-year period. If this measure is 1 then planned expenditures are equal to the expenditures needed to achieve and maintain the desired state of good repair. If AFR is less than 1, then planned expenditures are insufficient, and it is likely that the desired state of good repair will not be maintained. A 10-year horizon is recommended to provide a comprehensive view of how an agency’s assets are performing over time.
The ratio of asset preservation, rehabilitation and replacement funding planned over a 10-year period to the total funding required over the same period to achieve and maintain the agency’s desired state of good repair.
AFR differs from ASR in what value is used for the denominator of the calculation: funding needed to achieve and maintain the desired state of good repair rather than the cost to maintain current value. In the case that the desired state of good repair is to maintain current conditions, AFR and ASR measure the same thing. However, in other cases AFR better accounts for situations described above that ASR does not address, where the desired condition of the asset inventory is different from current conditions. Note that AFR, as defined, is similar to the Asset Renewal Funding Ratio defined in the AIFMM (9) and the Asset Sustainability Index as defined by FHWA (42).
The challenge in using AFR is that it requires an organization to define its “desired state of good repair.” FHWA requires that State DOTs quantify this state for their NHS roads and bridges in their NHS TAMP. Also, agencies using the GASB 34 modified approach must define a similar concept, the target level of service for their infrastructure assets. However, it can be difficult to define this desired state or target level of service. Even if it is well defined, it may be difficult to make comparisons between different agencies using the measure, as they are likely to define their desired state differently. Thus, AFR is a valuable measure for showing whether a given agency is achieving its goals, but of more limited value for making comparisons over time or between agencies.
The final measure of interest related to asset value is Net Present Value (NPV). This measure is defined in Chapter 4 as the difference between total discounted benefits of an asset and total discounted costs. When economic value is used as the basis for calculating asset value then the resulting value of an asset is its NPV. If the NPV is positive then the asset or investment is considered worthy of investment. If the NPV is negative then the converse is true, and the cost of the asset is greater than the benefits it is expected to yield to society.
The difference between total discounted benefits and total discounted costs of an asset or investment.
Where some other basis is used for calculating value, the resulting asset value is analogous to NPV, but cannot be considered to be the same. However, one can still use asset value to support the calculation of NPV when comparing two potential life cycle alternatives. Asset value can support the NPV calculation in two basic ways:
- First, the change in asset value at the end of an analysis period – with discounting applied – can be used to represent the benefits of one investment strategy compared to another.
- Second, the depreciation of an asset each year can be used as a proxy for the benefits consumed by the asset. This can be significant if one has established a non-linear pattern of benefit consumption as described in Chapter 6, or if an asset is fully depreciated in one of the alternatives being evaluated (in which case it yields no benefits compared to an asset with remaining value).
Table 7-4 illustrates the use of asset value in an NPV calculation. The table shows the NPV of an improved asset management strategy, Strategy B, compared to a base case, Strategy A. In Strategy B treatments are performed over the life of an asset, resulting in an increase in cost. With discounting applied, this increased cost total $82 million over 20 years. While Strategy B costs more, it results in greater value at the end of the analysis period: $320 million for Strategy B versus $0 for Strategy A. Applying discounting, the increased value of Strategy B is $146 million. The NPV of Strategy B compared to Strategy A is $64 million, the difference between the increase in value of $146 million and increase in costs of $82 million.
In this example depreciation is assumed to be linear, and thus the same in each alternative. The example excludes consideration of additional factor which may further support an improved asset management approach, such as the increased maintenance cost or potential for asset failure in the case of Strategy A.
Table 7-4. Example NPV Calculation (values in $ millions)
|Year||A: Base Case||B: Improved Asset Management||Discount Factor (4% Annual Discount Rate)||Discounted Change in Costs (B-A)|
|Treatment Cost||Asset Value||Treatment Cost||Asset Value|
|Discounted Change in Treatment Cost (B-A)||82|
|Discounted Change in Asset Value (B-A as of the end of the analyis)||146|
|NPV of Improved Asset Management (Increase in Asset Value – Change in Cost)||64|
For some applications it can be useful to present a set of multiple measures from the set described above, along with additional context concerning how the measures are defined and should be interpreted. Table 7-5 provides an example set of calculations.
In this example, an asset inventory has an initial value of $120 million. Accumulated depreciation is $30 million, resulting in a current value of $90 (the initial value less depreciation). Based on these figures the ACR is 0.75, or $90 million divided by $120 million.
It is further assumed the $5 million is required annually to maintain value, while $60 million would be required over a 10-year period to achieve the desired state of good repair for the agency. The cost to achieve the desired state of good repair averages $6 million per year. This is higher than the cost to maintain value, which would be expected if current conditions were somewhat less than the desired state of good repair. If projected expenditures are $5 million per year, then the ASR is 1.00 and the AFR is 0.83. ASR is calculated by dividing the annual expenditures by the cost to maintain, while ASR is calculated by dividing 10-year expenditures ($50 million) by the 10-year cost to achieve the desired state of good repair.
Table 7-5. Calculation of Value-Related Measures
|1||Initial Asset Value ($M)||120|
|3||Current Asset Value ($M)||90||Row 1 minus Row 2|
|4||Cost to Maintain Value ($M)||5||Can be calculated based on annual depreciation or using management systems|
|5||Cost to Achieve the Desired State of Good Repair Over 10 Years ($M)||60||Should be calculated using the agency’s management systems|
|6||Projected Annual Expenditures||5||Can be calculated based on annual depreciation or using management systems|
|7||Projected Expenditures Over 10 Years ($M)||50||Should be based on the agency’s financial plan|
|8||Asset Sustainability Ratio (ASR)||1.00||Row 6 divided by Row 4|
|9||Asset Consumption Ratio (ACR)||0.75||Row 3 divided by Row 1|
|10||Asset Funding Ratio (AFR)||0.83||Row 7 divided by Row 5|