Unit Standard 116362 – Manage a municipality's assets and liabilities

Group 2: Municipal accounting and Risk management

Module 8: Cash, investment, asset and liability management

Karel van der Molen

Purpose of this Unit Standard

This unit standard is intended for all people who contribute to strategic planning, budgeting and resource use performance related policy – planning processes. Learners completing this unit standard will be able to develop and implement asset and liability management policies for South African municipalities.

On completion of this Unit Standard you should be able to:

• Provide advice to a municipality on optimising relationships with the financial community

• Describe and prepare proposals to accessing bank finance

• Consider the merits of hire purchase transactions and leasing of municipal assets

• Plan for contingent municipal liabilities

• Develop a municipal asset management plan

Chapter 1. An overview of municipal assets and liabilities

Learning outcomes:

• Being able to distinguish between an asset and a liability, and their classification between current and non-current.

• Being able to identify and interpret relevant legislative requirements for management of municipal assets and liabilities.

Definition of Assets

• In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset

• The statement of financial position of a muni records the monetary value of the assets owned. Current assets and non-current assets.

• Intangible assets are for example software, IP

Definition of Municipal Assets

• Resources controlled by a municipality as a result of past events, from which future economic benefits or service potential are expected to flow to the entity.

Assets found at a municipality

MOVEABLE Equipment Machinery

Furniture and fittings

Computer hardware

Motor vehicles

IMMOVEABLE investment

property Land

Buildings Infrastructure

assets Heritage assets

community assets

Computer software

Trademarks Licenses and

patents Capitalized

development costs

tangible intangible

Inventory Receivables

Deposits Cash and bank

Non-current current

ASSETS

Asset types

Current • Will be used (sold or consumed) in the normal

operating cycle • Is held primary for the purpose of being traded • Is expected to be realised within 12 months (after date

of reporting) • Is cash or a cash equivalent asset (per GRAP definition) Non-current • All assets other than above. Includes tangible,

intangible, and financial assets of a long term nature.

Definition of Municipal Liabilities

• A present obligation of the municipality arising from past events the settlement of which is expected to result in a sacrifice of potential service provision or an outflow from the municipality of resources embodying economic benefits.

Liability types

• Current A company's debts or obligations that are due within one year. Current liabilities appear on the company's balance sheet and include short term debt, accounts payable, accrued liabilities and other debts. • Non-current Debt not due to be paid within the next year.

Legislative provisions for asset and liability management

MFMA

Sections: 63,96,14/90,48,75

Sections: 78,84,94,154

Treasury Regulations

Section: 168,173

(pg. 21-27)

Other directives

National Treasury Asset Management guide

Municipal Asset Tender Regulations

Municipal Asset Transfer Regulations

Accounting Standards

GRAP 17

Asset management

Good asset management is critical to any business environment – and more so in the public sector.

Good asset management ensures that the entity obtains the most out of its assets, and that assets are:

• Safeguarded

• Maintained

• Utilised for serving the public

Liability Management

Municipalities require short, medium and long term financing for operations and for the acquisition of assets.

Incurring liabilities may expose the municipality to a number of related risks, which may render a municipality unable to service the debt, repay the capital or comply with the terms and conditions of a loan and rising interest rates.

Liability management will ensure that the municipality has adequate liquidity to meet its operational expenses, repay its short term commitments and service the cost (interest) of the debt.

Chapter 2. Relationship between the municipality and the financial community

Learning Outcomes: • Be able to explain the benefits of a good relationship

between the financial community and the municipality – including all the advantages and disadvantages of that relationship

• Be able to identify the key role players that contribute to important relationships in a municipality’s financial community

• Be able to select and analyse information in terms of a municipality’s credit worthiness

• Be able to prepare a plan to improve the credit rating of a municipality which will enhance the long term borrowing capabilities of that municipality.

Comment

A municipality requires a range of financial services from the financial community.

A municipality collects millions of rands each month and therefore needs access to good banking facilities.

A municipality also sometimes needs to access financing for the construction of or purchase of assets and for short term cash shortfalls

Therefore a municipality needs to have good relations with the financial community.

The relationship

Community Municipality Financial

Community

Rates, Taxes, Service Fees

Deposits & Banking revenue

Banking Facility and Debt

Service Delivery

Financial role players

Discuss:

i. The Role Players

ii. Services offered

Pg. 35-36

Benefits of a good relationship

Access to services Accessing the necessary financial services allow a municipality to function effectively. For example: • Bank accounts • A ”sweeping facility” - to maximise interest

earnings and minimise overdrafts costs.

The range of services from the financial sector/ community pg.. 38

Disadvantages of a poor relationship

• Non responsiveness by the financial community to a municipality’s funding requirements

• A failure to access facilities and loans at good terms and rates

• Receive low interest for its investments

• Restrictions of financial transactions

• High service charges

Key role players – in the relationship

• Bank Managers • Accounts Managers

• Municipal Manager • Mayor • Treasury Department (of the municipality) • Accountants • National Treasury • Development Banks • Credit Rating Agencies • Provincial Government

Determining a municipality’s creditworthiness

A municipality’s ability to raise loans etc. will depend on its creditworthiness.

Creditworthiness is determined by quantitative and qualitative parameters.

Quantitative parameters refers to the ability to pay debt when it is due – which is largely a function of the municipality’s financial position. These are established through :

• Liquidity ratios (pg.. 42-43)

• Other quantitative information

Determining a municipality’s creditworthiness

Qualitative measures. Creditworthiness is also a function of qualitative characteristics. Examples of these:

Commitment to implement and constantly review internal controls

Good governance

Adherence to legislation

Use of sound policies and procedures

Honouring debt commitments – (re credit references)

Having a good relationships with the financial community

Classroom activity

• P48 group work

Credit Rating The credit rating of a municipality is an important factor in assessing long term financing which it may require to acquire assets necessary for effective service delivery. A rating is defined as:

• A credit rating is an opinion with a future focus on the ability and willingness of a debt issuer (borrower) to repay its obligations in full and on time.

• There are a number of local and international rating agencies. (see pg.. 49)

Benefit of Credit ratings

• They assist the CFO to manage any perceptions of risk • They enable a municipality to diversify its funding sources –

causing providers to compete • They strengthen the municipality’s position when

borrowing terms are negotiated • They serve as a benchmark for peers and other competitors

for funds • They can be used as tools for improved communication

with stakeholders • They provide an independent and reliable gauge of the

credit risk of an entity

Improving a municipalities credit rating

To improve its credit rating a municipality should improve its financial position. How should it do this?

– Improve its liquidity or current ratio

– Improve operating surplus or reverse an operating deficit

– Improve the financial community’s perception of the municipality

– Improve financial position pg.. 52-54

Learning Activity

Chapter 3 – Bank Finance Learning outcomes: • Compare bank overdrafts and bank term loans and

identify the benefits and disadvantages of each • Calculate the credit limits a municipality should apply

for considering prevailing financial and economic conditions using internationally recognised methods

• Prepare applications for credit for more than one financial institution including motivations for extending credit

• Describe term structure of interest rate, including the reasons for the term structure

• Compile and analyse information on maturity structure of municipal debt to inform the debt management process.

Comment

All businesses (municipalities) need access to finance to fund short-term cash shortfalls.

Cash flow is essential to the survival of any business (municipality) and failure to access finance when required can have serious consequences.

Bank overdrafts and bank term loans are amongst the most common ways of obtaining short-term financing.

Bank Overdrafts An overdraft occurs when the bank allows withdrawals from a

bank account to exceed the available balance - to a pre-determined amount which is agreed to by the bank. An overdraft facility does not necessarily have to be used – but is available when required. The amount borrowed on overdraft must be paid back together with interest. Other features of an overdraft • Bank account (current) • A requested facility • Security required • High interest – calculated on daily balance • Usually for an undefined period

Bank (term) Loans

With a bank term loan a municipality borrows an agreed sum of money and pays the loan back with interest over a certain length of time. The municipality receives the full amount of the loan upon approval These loans are a common kind of lending for funding capital projects or other long term funding. Banks classify loans into intermediate and long term loans Features of bank loans: • A fixed amount • A fixed period – but can be short, intermediate of long term

loan • A fixed interest rate ( often linked to prime rate) • Borrower receives full amount upon approval of loan. • Security required

Bank Loans

Bank Loans

Intermediate Loans

Run for less than 3 years

Long-term loans

Run for more than 3 years

Overdraft

Current

Comparison between bank term loans and a bank overdraft

See page 62-63

Calculation of interest

• Simple Interest

P x R x T

Calculated on the original principal amount only pg.. 64

• Compound interest

Calculated at the end of each period on the original principal amount plus all interest accumulated to date – and unpaid during past periods pg.. 65

More on Compound Interest

What Does Compound Interest Mean? Interest that accrues on the initial principal and the accumulated interest of a principal deposit, loan or debt. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount. Investopedia

“Compound interest is the most powerful force in the universe” Albert Einstein

Bank Overdrafts vs Bank Loans

• Comparative advantages

• Comparative disadvantages

pg.. 65-68

Credit Limits A credit limit is the maximum amount of credit that a financial institution will extend to a municipality. The limit is based on the municipality’s: • ability to make interest payments • Cash flow and/or ability to repay the principal • Meeting of the credit standards imposed by the lender • Recoverable assets – in the event of default Sometimes it is difficult to access funding – because of the unique risks and circumstances of municipalities, when compared to other borrows. These risks include: • A municipality may need to borrow money when it is

making operating losses • A change is political leadership may cause a loan terms not

to be honoured

Appraisal and lending process

The appraisal process when a municipality wants to apply for funding is underpinned by a credit model which focuses on all the major components impacting the ability of the municipality to meet its commitments to the lender.

Credit evaluation process

Involves assessing the following elements:

Financial viability

Credit Evaluation

process

Socio-economic conditions

Environmental awareness

management economic

Calculating the credit limit that the municipality should apply for

Background:

• Most countries place limitations on the use of debt by local governments

• Municipalities may borrow long-term for capital expenditure which has been budgeted for and approved by council

• Currently there is no limit set in legislation as to the maximum long-term debt that a municipality may occur

Calculating the credit limit that the municipality should apply for

There are a number of numerical guidelines that can be used to identify prudent borrowing ceilings – based on a municipality’s capacity for debt repayment. For example: Calculation of credit limit - based on Total Revenue pg.. 71-73

Calculation of credit limit – based on Projected Surplus pg.. 73-74

Preparing an application for credit

• Short term debt

– MFMA

• Long term debt

– MFMA

– Other MFMA provisions

see pages 74-79

Applying for credit from financial institutions

Before a municipality can approach a financial institution to apply for credit there are procedures to be followed in terms of section 45 and 46 of the MFMA. These include: • A proposal or motivation must be prepared on the need for

the financing • This must then be submitted to Council for consideration

and approval. A Council resolution is required • In the case of long term financing, the accounting officer

make public an information statement on details of the proposed debt – 21 days prior to the Council meeting to approve the proposal.

• Once Council approval is received, applications for the finance can be made to financial institutions.

• Application forms will require information such as financial statements, budgets and cash flow projections, business plans, trade and credit references, etc..

Term structure of interest rates The “term structure of interest rates” refers to the relationship between bonds of different terms. When interest rates of bonds are plotted against their terms – this is called the “yield curve”.

The Yield Curve Economists and investors believe that the shape of the yield curve reflects the markets future expectations for interest rates and other economic conditions. see pg.. 82 What Does Yield Curve Mean? A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

Term structure theories What Does Term Structure Of Interest Rates Mean? A yield curve displaying the relationship between spot rates of zero-coupon securities and their term to maturity. The resulting curve allows an interest rate pattern to be determined, which can then be used to discount cash flows appropriately. Unfortunately, most bonds carry coupons, so the term structure must be determined using the prices of these securities. Term structures are continuously changing, and though the resulting yield curve is usually normal, it can also be flat or inverted. The three main perspectives on term structure are the expectations theory, the liquidity preference theory and the market segmentation theory pg.. 83

Source: http://www.investopedia.com/ accessed on 21 June 2014

• For information only: • There are three main theories that try to describe the

future yield curve: • Pure Expectation Theory: Pure expectation is the simplest

and most direct of the three theories. The theory explains the yield curve in terms of expected short-term rates. It is based on the idea that the two-year yield is equal to a one-year bond today plus the expected return on a one-year bond purchased one year from today. The one weakness of this theory is that it assumes that investors have no preference when it comes to different maturities and the risks associated with them.

For information only

• Liquidity Preference Theory: This theory states that investors want to be compensated for interest rate risk that is associated with long-term issues. Because of the longer maturity, there is a greater price volatility associated with these securities. The structure is determined by the future expectations of rates and the yield premium for interest-rate risk. Because interest-rate risk increases with maturity, the yield premium will also increase with maturity. Also know as the Biased Expectations Theory.

• Market Segmentation Theory: This theory deals with the supply and demand in a certain maturity sector, which determines the interest rates for that sector. It can be used to explain just about every type of yield curve an investor can came across in the market. An offshoot to this theory is that if an investor wants to go out of his sector, he'll want to be compensated for taking on that additional risk. This is known as the Preferred Habitat Theory.

Municipal debt management

What is debt management? • Debt management is the process of establishing and

executing a strategy for managing debt in order to raise the required amount of funding - while achieving the cost and risk objectives.

• Poorly structured debt (in terms of maturity or interest rate composition and large unfunded contingent liabilities) are often important factors in inducing a financial crisis in many public entities.

• The main objectives of debt management is to ensure that the financing needs and payment obligations are met at the lowest possible cost – consistent with a prudent degree of risk.

Risks encountered in debt management Market risk

Refers to risks associated with changes in the market prices, such as interest rate, commodity prices, on the cost of debt servicing. Rollover risk The risk that debt will have to be rolled over at an unusually high cost or, in extreme cases, cannot be rolled over at all. Liquidity risk There are two types of liquidity risk. One refers to the cost or penalty investors face in trying to exit a position when the number of transactions has markedly decreased or because of the lack of depth of a particular market. The other form of liquidity risk, for a borrower, refers to a situation where the volume of liquid assets can diminish quickly in the face of unanticipated cash flow obligations and/or a possible difficulty in raising cash through borrowing in a short period of time

Theories of Debt Maturity Structure Debt Defined A debt is also referred to as a liability and is a loan that an organization must repay. Examples include taxes due, accounts payable and bonds payable.

Debt Maturity Defined Debt maturity is the date on which a liability becomes due for payment. Debt maturity is otherwise known as debt maturity date.

Debt Maturity Structure Defined Maturation of debt is when the debt comes due. Loans can be structured to mature at different times. This is called the maturity structure of the debt. Maturity matching Defined In asset management, the coordination of an organization's cash inflows with cash outflows by matching the maturity of income generating assets (such as certificates of deposit) with the maturity of interest incurring liabilities (debts). pg.. 86 Calculating debt maturity structure pg. 87

Learning activity

Chapter 4 – Leasing and hire purchase contracts for municipalities

Learning outcomes: • Outline approaches to hire purchase transactions and

explain appropriateness for a municipality • Identify municipal assets suitable for purchase and

use through a leasing agreement and give a motivation for the acquisition through leasing

• Identify and explain the risks associated with leasing municipal assets

• Outline and explain the key elements of a lease and hire purchase agreement

• Outline legislative requirements for borrowing and apply these in lease agreement evaluation

The purchase of assets Municipalities do not always have enough cash resources to purchase assets and therefore need to consider financing arrangements. Leasing and hire purchase form part of the financing arrangements available. Leading up to a decision in this regard, there are a few steps to go through – which concern: What to buy? To decide on the best asset for the purposes required How much will it cost? To decide what is affordable and what the budget allows When to purchase it? This concerns giving efficient and effective services How to finance it? To decide while considering issues of timing, cash flow considerations, what makes the most economical sense.

The decision-making process

. Begin

What is the best Asset requirement

Determine the cost

When is the asset required

lease/HP Purchase

End

Financing

Appropriateness of hire purchase contracts for municipalities

• A hire purchase is a legal agreement between the purchaser of an asset and the financial institution which finances the purchase. The financial institution lends the money to the purchaser who repays the financial institution at specified intervals the full amount plus interest. The asset purchased can be used as security by the institution.

• Owner ship of the asset is vested in the purchaser • The useful life of the asset usually exceeds the hire

purchase term – thus a benefit term exceeds the • purchase term • Outright purchase of many assets allows for a standard

warranty/maintenance programme

Appropriateness of hire purchase contracts for municipalities – cont.…

• Hire purchase agreements are less complicated than leasing agreements

• As repayments are usually monthly for the length of the term, cash flow planning is possible

• The interest rate may be fixed or fluctuating • Insurance can be purchased separately or with the

same institution • The purchaser has the right to chose the asset and its

specifications • The repayments can be structured to be escalating or

de-escalating • The asset is disclosed on the balance sheet therefore

giving a better picture than off balance sheet financing

Appropriateness of lease agreements for municipalities

• A lease or a rental agreement sets out the terms between a lessor and lessee during the period of the lease contract.

• It is a legal contract which sets out for how long the lessee will use the equipment, the lease payment, penalty clauses, termination and responsibilities of lessor and lessee. Can include an ownership clause (at the end of the lease)

• The lessor owns the asset and the lessee agrees to use it for a specified period for a specified sum of money. Payments are usually made monthly

Appropriateness of lease agreements for municipalities cont.…..

• Flexibility in assessing need and suitability of the asset. i.e. initially lease on a short term basis.

• Flexibility in assessing obsolescence. The lease conditions can include the upgrading, replacement etc.

• Under some leases the lessor can be responsible for the maintenance of the asset.

• It could be appropriate for a municipality to lease assets where: – The usage period is shorter than the useful life of the asset – There is uncertainty about the assets capabilities and

functionality – Specialised skills are required for repairing and maintaining the

asset – The assets are prone to rapid technological improvements – The assets have low residual values.

Risks associated with leasing municipal assets

OVERALL COSTS These costs include not only the capital amount and interest, but also financing costs and compensation for the lessor taking the risk of continued ownership FIXED COMMITMENT Lease payments have to be made even if the asset is no longer used during the term. NO OWNERSHIP The lessor never owns the asset – but there can be an option to buy it at the end of the lease. OFF BALANCE SHEET FINANCE Both the asset and the liability do not appear on the balance sheet – which gives a less favourable financial picture.

Legislative requirements for borrowing

Section 46 of the MFMA contains provision for long term borrowing. i.e. both leasing and hire purchase

pg.. 99-100

Examples

Study the hire purchase and leasing examples on pages 100 - 102

Chapter 5 – Contingent municipal liabilities

Learning outcomes:

• Identify contingent liabilities facing a municipality

• Estimate the probably financial implications of a municipality’s contingent liabilities

• Recommend changes to policies to limit the financial implications of the contingent liabilities

Defining Liabilities

“Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity - of resources which embody economic benefits or service potential”.

Defining Contingent Liabilities

A contingent liability is a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, or A present obligation that arises from past events but is not recognised because It is not probable that an outflow of resources embodying economic benefits and service potential will be required to settle the obligation, or The amount of the obligation can not be measured with sufficient reliability

Contingent liabilities facing a municipality Municipalities face 4 types of fiscal risks. i.e. explicit vs. implicit and direct vs. contingent: Explicit liabilities. These are specific obligations of the municipality established by a particular law or contract. The municipality is legally mandated to settle the obligation when it becomes due. E.g. loans

Implicit liabilities. The involve a moral obligation or expected responsibility of the municipality that is not established by law or contract – but is based on public expectations, political pressure – and regards the role of government as the public sees it. E.g. disaster relief

Direct liabilities. These are obligations that will rise in any event and are therefore certain. They are predictable and based on specific underlying factors – and are not contingent on any discrete event.

Contingent liabilities. These are obligations triggered by a discrete event that may not occur. The probability of the contingency occurring and the cost of the resultant obligation are difficult to forecast. E.g. a natural disaster

Fiscal risk matrix

See pages 106 and 107

Also study example of “Provisions and contingent liabilities” on pages 107 and 108

Estimating the probable financial implications of contingent liabilities

Why contingent liabilities should be measured. Contingent liabilities can have a significant financial and economic impact of a municipality – by conferring certain rights or obligations that may be expected in the future. If the impact is not known, this could allow for financial difficulties for the municipality. Therefore ways should be sought to put measures in place to limit the impact of contingent liabilities – should these materialise.

Estimating the probable financial implications of contingent liabilities

Maximum potential loss This method values contingent liabilities at full face value. This method tends to overstate the liability as there is no information on the likelihood of the contingent liability.

Expected loss This method tries to estimate the probability that the contingency will occur – and can be used when reliable data is available. The full value of the loss is multiplied by the probability factor.

Use of market information

Option pricing techniques

Disclosure of Contingent Liabilities

Information to be disclosed for each class of contingent liability. Financial statements should disclose contingent financial liabilities that face the entity. The following information must be disclosed for each category of contingent liability. • An estimate of financial effect

• An indication of the uncertainties relating to the

amount of timing or any outflow

• The possibility of any reimbursement

Limiting financial implications of contingent liabilities

To reduce the implication of contingent liabilities-municipality needs to take appropriate measures – to ensure that its programs and its exposure to fiscal risks are consistent with government policies. Below are some of the policy changes that could be implemented to limit the fiscal risks. But before the municipality admits an obligation, its policy considerations/analysis could include:

Limiting financial implications of contingent liabilities

1. Assess how the obligation fits the pronounced role and strategic priorities of the municipality. What types of support the municipality decides to offer both outside or through the budget – define the actual role of the municipality. Before establishing contingent support programmes such as guarantees, the municipality should check whether these fit within their announced role and priorities – and therefore if these justify the potential fiscal costs

Limiting financial implications of contingent liabilities

2. Consider the choices of policies and forms of support relative to the associated financial risks and the municipality’s risk preference and risk management capacity. In addition to using potential cost and benefit considerations, municipalities should also apply the extents of uncertainty around a policy decision which concerns limiting a fiscal risk

Limiting financial implications of contingent liabilities – cont….

3. Define and communicate the standards for and limits of the municipality’s involvement to minimise the moral hazard. The more formally and clearly the municipality defines and communicates its responsibilities, the less of a problem public and market expectations will be as to what amounts to a contingent liability

When the obligation is held, the municipality should:

1. Stick to the preset limits of its responsibilities. The public and market

should come to understand that the municipality will not give support beyond the announced limits.

After the obligation falls due, policy considerations could include: 1. Execute the obligation within its preset limits and identify lessons for

future policy choices. By sticking to its announced obligations and limits, the municipality is more free to reconsider these obligations and limits at the time of the next budget – when revised obligations can be announced

2. If an obligation is implicit, assess whether it coincides with the municipality’s announced role and promotes desired market behaviours in the markets. When a municipality is asked to extend more support than was originally specified policy makers need to consider the implications of this on future behaviour in the markets – and the possible long tem damage it could cause.

Learning activity

Chapter 6 – A municipality asset management plan

Learning Outcomes:

• Develop a project to update and prepare an accurate municipal asset register

• Compile information that can be used to assess asset performance

• Analyse and interpret current asset performance against planned performance to ensure proper utilisation of assets

• Analyse and interpret an asset’s performance against planned performance to validate quality of inputs, processes, and outputs against recognised standards

• Identify principles for managing assets using recognised accounting practices

Asset Management

Asset management is the process of guiding the acquisition, use, safeguarding and disposal of assets – to make the most of their service delivery potential and manage the related risks.

To this end, the role of the asset register is vitally important. Asset registers should properly prepared and should be kept up-to-date. It is also important to conduct assessments of asset performance.

Asset Registers and municipalities

• The importance of keeping good records of public assets – as many of these assets are infrastructural assets with long life spans and enormous capital outlay that are vital to service delivery.

• Proper asset management and control is not possible without an accurate asset register.

• Municipalities are required to maintain an asset register – as part of the accounting system

Asset Registers - definition

• A municipal asset register is the asset database that provides the basis for figures in the financial statements and is maintained in the format that complies with the requirements of GRAP and Treasury Regulations.

Asset Registers – details of each asset

• Date of acquisition (date brought into use)

• Description

• Serial number/bar code – for identification

• Division and department in which the asset is used

• Location

• Original cost

• Revaluation date – if necessary

• Opening accumulated depreciation

• Depreciation for current year

• Closing accumulated depreciation

• Carrying value of the asset (fair value)

• Opening accumulated impairment loss

• Impairment loss for current year

• Closing impairment loss

• Book value

• Useful life (number of years)

• Residual value

• Insurance cover

• If asset is used for the provision of services

• If used as collateral

• Price and date of disposal

Establishing an Asset Register i.e. when migrating from a cash to an accrual system of accounting.

• Physical counting of assets. This includes the existence of the asset, its description, its location, serial number, condition, type, etc. pg.. 120

• Determining the Carrying value. GRAP 17 says that assets must be recognised at cost or revaluation. When using the cost basis, the original invoice amount less the number of years of depreciation should be used. Pg. 121

Asset Performance

Protecting service delivery and addressing health and safety concerns are priorities when making decisions about asset use and maintenance. It is therefore important that be regularly reviewed and evaluated to verify that required outcomes are being achieved. There are a number of methods used to measure asset performance.

per its physical condition. This involves inspecting the asset and comparing it to what it should be and what is required.

per its functionality. This involves monitoring and assessing the effective functionality of the asset in relation to what is required of the asset to support specified activities. It is the appropriate asset for the job?

Asset Performance

per its utilisation. To measure how effectively the asset is being used – against predetermined criteria and benchmarks. The asset might be under or over utilised – for various reasons.

per its financial performance. This must be measured to establish if the asset is providing economically viable services. The current and projected economic return of the asset should be assessed.

Asset Management In order for assets to meet their service delivery objectives

The Asset Life Cycle (4 key phases)

Asset Life Cycle

Planning Acquisition

Disposal Operations, maintenance

Asset Management - continued

Good asset management depends on accurate and up-to-date inventory information Key asset management issues: • Accountability for the proper use and stewardship • Well maintained assets give better service – and visa versa • Growing links between asset management and financial

reporting – as accounting practices change • Increasing emphasis on asset management by other levels

of government • Changes in regulation that require knowledge about assets

to determine compliance.

Asset management and Risks • A risk assessment of a municipality may reveal

significant risks which concern moveable assets. Good risk management practices can put measures and controls in place to eliminate or minimise the risks identified.

• The MFMA requires that a municipality must prepare a Risk Management control plan which includes a strategy through which to eliminate or minimise the impact of identified risks.

A Risk Control Plan • Risk mitigation. Identifying the necessary actions that can

be carried out in advance to reduce (or eliminate) the impact of the risk

• Risk planning. Develop an emergency plan for dealing with significant risks

• Risk monitoring. Monitor and track all the risks identified and manage them o successful resolutions.

• Risk communication. Formally document and communicate the project risks to the project team and project decision makers.

Asset Management Policy

Every municipality must have an asset management policy – to guide its asset management. This is very important if costly mistakes are to be avoided. Policy considerations to mitigate common risks associated with moveable assets. Pg. 129-130

The policy should contain the essential roles, practices and procedures pto

Asset Management Policy - content

• Definition of a fixed asset

• Role of municipal officials

• Format of fixed asset register and classification

• Investment property and fixed assets treated as inventory

• Registration of heritage assets and donated in the fixed asset register

• Safekeeping of assets

• Identification of fixed assets

Asset Management Policy - content • Procedure in case of loss, theft, destruction or

impairment of fixed assets

• Capitalisation criteria: material value and intangible items

• Capitalisation criteria: reinstatement, maintenance and other expenses

• Maintenance plans and deferred maintenance

• General maintenance of fixed assets

• Depreciation of fixed assets

• Amendment of asset lives and diminution in the value of fixed assets

Legislative Requirements Acquisition of assets Municipality shall advertise its intention to acquire/hire assets. If an asset exceeds the market value or is hired at a rental, Council approval is required. Disposal of Assets Many assets are ultimately transferred and disposed of. Municipal transfer regulations prescribe certain principles to be followed. • Valuation principle • Continuity of service principle • Risk transfer principle • Asset preservation principle • Certain other regulations must also be applied pg.. 132

The exam ……

Karel van der Molen

SCHOOL OF PUBLIC LEADERSHIP

Thank you ……