Inconsistent Depreciation Practice and Public Policymaking: Local Government Reform in New South Wales

Abstract

Public policy based on numerical indicators -a form of 'public management by numbers' -has become commonplace across the world. Whereas a good deal is known about the deleterious effects of this type of policymaking -including ratcheting, output distortion and 'gaming' -unfortunately little attention has focused on the adverse local government policy consequences of inconsistent depreciation accruals by local authorities. This paper seeks to address this gap in the empirical literature on local government performance. After examining the use of accounting data by local government policymakers, the paper reviews available empirical evidence of inconsistent depreciation practice both in Australia and abroad. We then consider the recent New South Wales (NSW) Independent Local Government Review Panel's use of accounting ratios as supporting evidence for boundary change in local government as a case study of the adverse impact of inconsistent depreciation practice. The NSW experience clearly demonstrates the distortionary effects of empirical evidence resulting from significant variation in depreciation accruals by individual local councils. The paper concludes with an assessment of the options available to local government policymakers wishing to obtain more accurate accounting accrual data for policy formulation purposes.

What Determines Efficiency in Local Government? A DEA Analysis of NSW Local Government

“…A positive association for the depreciation regressor suggests that efficient councils ceteris paribus tend to allocate the value of non‐current assets over shorter effective lives. Given the high degree of discretionary latitude embodied in depreciation estimates (TCorp, ; Pilcher & Van Der Zahn, ), the results seem to support the assertion that efficiency creates “room” in financial statements for more realistic depreciation schedules (consistent with the argument of Pilcher, and more recent evidence from Drew & Dollery, ), although this requires further investigation. An alternate explanation may be that efficient municipalities are managed professionally and effectively and that management of this type would generally be expected to competently run their portfolio of non‐current assets.…”

“…Capital costs do not include depreciation for a number of reasons. In the first place, there is evidence accrued over a number of years which strongly suggests inconsistent depreciation practice between councils (see, for example, Pilcher & Van Der Zahn, ; Drew & Dollery, ). Second, the Australian Accounting Standard (AASB 116) allows for an infinite number of methods to estimate depreciation – including straight line, diminishing balance (a geometric progression algorithm), units of production and fair value (“the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms‐length transaction” (AASB 116)).…”

Peas in a Pod: Are Efficient Municipalities also Financially Sustainable?

“…In this case municipalities coming off a low infrastructure base may perform better in terms of asset maintenance and liquidity sustainability measures for any given level of efficiency. Rates of depreciation of non‐current assets may also disproportionately affect sustainability in at least two ways: (i) there is considerable discretionary latitude in depreciation methods and this raises the possibility that operating results may in some instances be more a reflection of depreciation parameters than actual performance (see, for example, Pilcher ; Pilcher and Van Der Zahn ; Drew and Dollery ); and (ii) where a local council has serially under‐depreciated assets, financial sustainability may be adversely affected when adjustments are subsequently made (when, for instance, an asset is revalued or is sold well below book value).…”

Less Haste, More Speed: TheFit for the FutureReform Program in New South Wales Local Government

“…It is possible that the FSRs, capital expenditure, and cash expense ratios were abandoned in response to criticism, such as Drew and Dollery (, ), regarding lack of transparency, logical errors, and the corrosive effects of unreliable accrual data on these measures of municipal performance. On the other hand, relinquishing the remaining two ratios appears to be a pragmatic response to the near‐universal achievement of the respective thresholds: in 2011 only 12 councils failed to meet the unrestricted current ratio, whilst just 8 councils failed to achieve the benchmark for the interest cover ratio (notably the four omitted ratios had a combined weighting of 32.5% in the original TCorp () FSRs).…”

“…However, there is substantial risk of ‘gaming’, given that 2013 and 2014 financial year report data are used, because these reports were compiled after the March 2013 TCorp Financial Assessments and the April 2013 ILGRP report. The opportunities for gaming include depreciation accruals (Drew and Dollery ; Pilcher and van der Zahn ), estimates on required maintenance, and the cost to bring assets to a satisfactory standard contained in Special Schedule 7. These estimates and accruals directly affect four of the retained ratios (Infrastructure Backlog, Operating, Asset Renewal, and Asset Maintenance ratios).…”