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Thelen Reid Brown Raysman & Steiner LLP
What is the value of the infrastructure owned by the City and County of San Francisco? Which streets in Manhattan need repair and when? How much long term debt does the State of Ohio have? How does this debt compare with the assets owned by the State of Ohio? Until a recent change in the accounting rules for state and local governments, these questions were virtually unanswerable. However, starting June 15, 2001, state and local governments will be strongly encouraged to keep careful track of the value of their infrastructure assets. This encouragement comes from the Government Accounting Standards Board (GASB).
GASB is an organization that sets governmental accounting standards. GASB operates under the auspices of the Financial Accounting Foundation, which also oversees GASB's private-sector counterpart, the Financial Accounting Standards Board. Although the standards promulgated by GASB do not have the force of law, governments must follow the standards to be eligible to receive clean audit opinions from their certified public accountants. It is practically impossible for state or local governments to issue bonds to finance infrastructure improvements without clean audit opinions. Thus, most state and local governments are likely to follow the rules promulgated by GASB.
Valuing Prospective Infrastructure Investment
On June 11, 1999, GASB issued Statement No. 34, containing new governmental accounting standards. To comply with Statement No. 34, state and local governments must use the accrual method of accounting rather than the cash method, which they have long used. Moreover, Statement No. 34 changes the way governments account for prospective infrastructure investment.
A before and after example will best illustrate the change resulting from Statement No. 34. Let's say Cincinnati wants to build bridge between Ohio and Kentucky. The bridge will cost $40 million and is anticipated to last 40 years. Cincinnati issues $40 million in bonds to finance the bridge. Under the old system, Cincinnati's balance sheet in the year the bridge was built would reflect the entire cost of the bridge. In every subsequent year, there would be no charges reflected in the city's balance sheet for the cost of the bridge. Thus, under the old system, infrastructure investment was a lumpy procedure with all the investment cost front-loaded. Under the new system, the $40 million cost of the bridge will be depreciated over the life of the bridge. Hence, for each year in the 40-year life of the bridge, the city's balance sheet will reflect a cost of $1 million. In this way the cost of the bridge investment is spread out evenly and predictably over the anticipated life of the bridge.
Valuing Existing Infrastructure
Statement No. 34 also requires state and local governments with assets of more than $10 million to value existing infrastructure projects that were either constructed or under went substantial renovations after 1976. To estimate the value of these projects or improvements, Statement No. 34 requires the use of historical costs. Historical costs are the estimated initial costs of constructing or substantially renovating the infrastructure project. These historical costs then are depreciated over the estimated life of the project or improvement.
For example, let's say Cincinnati built a bridge between Ohio and Kentucky in 1985 when the expected life of the bridge was 34 years and the estimated historical cost of the bridge was $34 million. Under the new standard, the cost of the bridge will be reflected in the city's balance sheet as a cost of $1 million each year until 2019. Moreover, on the asset side of the balance sheet, the bridge in 2001 will be valued at $18 million. That is the $34 million bridge asset depreciated by $1 million each year between 1985 and 2001. Thus, the balance sheet will reflect the estimated value of the bridge in 2001. Under the new standard, interested taxpayers can see that the bridge will be completely depreciated in 18 years. This will provide information useful for planning whether a new bridge will be needed in 2019.
An alternative method to this historical cost capitalization accounting approach is provided for well-maintained infrastructure assets. Under this alternative method, the capital asset is not depreciated over time, but rather the full value of the project is reflected on the asset side of the balance sheet. The liability side of the balance sheet reflects all of the maintenance costs for that capital asset. This alternative method of accounting is significant because to qualify to use it, strict maintenance procedures must be followed. Thus, to avoid depreciating capital assets, government officials must spend money maintaining existing network infrastructure.
Impact of Statement No. 34
Statement No. 34 also will require governments to issue "an objective and easily readable analysis" each year of the government's financial performance. Statement No. 34 has garnered support from a number of sources, including bond rating agencies. Recently, the Governmental Research Association said:
As intensive users of financial information, we believe infrastructure reporting [as found in Statement No. 34] is an essential element in improving the accountability of governments to their citizens by providing better, more accessible information about the condition and costs of state and local capital assets.
In addition, the National Federation of Municipal Analysts said:
By their nature most municipal bonds finance 'capital assets' and, as such the relevance of this information [the value of infrastructure] to public finance professionals is paramount.
Statement
No. 34 also has critics. Before Statement No. 34
was issued, GASB received many letters from local governments
predicating how costly it would be to comply with the requirements
of Statement No. 34. The Government Finance Officers
Association also has opposed Statement No. 34 as costly and
burdensome.
It remains to be seen how this change in governmental accounting
standards will impact infrastructure investment. There
are two principal changes made by the new accounting standards.
First, the cost of infrastructure investment no longer will be
front-loaded into the year the investment is made. Second,
citizens will know how long a particular infrastructure project
is projected to last.
These two changes could increase infrastructure spending for several
reasons. First, a government official no longer will need
to take responsibility for the entire cost of an investment, but
rather will only need to take responsibility for the cost of the
project on a year-by-year basis. This may make infrastructure
investment politically easier to justify. Second, citizens
armed with information about the projected lifespan of the existing
infrastructure may be more receptive to infrastructure improvements
and their cost.
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For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-369-7229 or at pwberning@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©1999 Thelen Reid Brown Raysman & Steiner LLP
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