THE ENVIRONMENTAL THE ENVIRONMENTAL CONSEQUENCES OF CONSEQUENCES OF DISPOSAL OF FIXED DISPOSAL OF FIXED CAPITALCAPITAL

Peter ComisariPeter Comisari

London Group meeting, Wiesbaden London Group meeting, Wiesbaden 30 Nov – 4 Dec 200930 Nov – 4 Dec 2009

Session overviewSession overview

Background / the problemBackground / the problem Position of the SEEA-2003 on terminal Position of the SEEA-2003 on terminal

costs (incl. decommissioning costs)costs (incl. decommissioning costs) position of the 2008 SNAposition of the 2008 SNA other possible optionsother possible options

Further clarifying the revised SEEAFurther clarifying the revised SEEA remedial costsremedial costs terminal coststerminal costs

Background / the problemBackground / the problem

Terminal costs and ownership transfer costs on Terminal costs and ownership transfer costs on disposal of fixed capitaldisposal of fixed capital simply intermediate consumption of the enterprise; orsimply intermediate consumption of the enterprise; or an integral part of the value of fixed capital asset? an integral part of the value of fixed capital asset?

If capital, how to account for decline in asset If capital, how to account for decline in asset value?value? consumption of fixed capital; orconsumption of fixed capital; or other changes in volume? other changes in volume?

Definitions…Definitions…

Terminal costs – those costs incurred to Terminal costs – those costs incurred to prevent environmental problems when prevent environmental problems when production ceasesproduction ceases

Remedial costs – costs incurred when Remedial costs – costs incurred when production has already ceased, and no production has already ceased, and no cost provision made during the production cost provision made during the production phasephase

Terminal and remedial costsTerminal and remedial costs

Key distinctions between these:Key distinctions between these: 1. Timing of cost payment1. Timing of cost payment

Remedial costs incurred Remedial costs incurred afterafter site has closed site has closed 2. Who makes the payment2. Who makes the payment

terminal costs incurred by the owner of the terminal costs incurred by the owner of the associated assetassociated asset

remedial costs incurred by another partyremedial costs incurred by another party

Position of the SEEA-2003Position of the SEEA-2003

Expected terminal costs are part of the Expected terminal costs are part of the value of the associated asset (e.g. oil rig)value of the associated asset (e.g. oil rig) recorded as gross fixed capital formation recorded as gross fixed capital formation

when actually incurredwhen actually incurred but recorded as consumption of fixed capital but recorded as consumption of fixed capital

throughout the life of the associated assetthroughout the life of the associated asset• i.e. the asset is being written off i.e. the asset is being written off beforebefore it even it even

comes into existencecomes into existence

Position of the SEEA-2003, Position of the SEEA-2003, continued…continued…

Remedial costs…Remedial costs… For managed landfill:For managed landfill:

1. Costs to inhibit damage in an ongoing way 1. Costs to inhibit damage in an ongoing way are considered EPE (intermediate expense)are considered EPE (intermediate expense)

2. Where costs are for land reclamation, the 2. Where costs are for land reclamation, the spending will lead to formation of a capital spending will lead to formation of a capital asset (‘land improvement’) asset (‘land improvement’) • (and SEEA EPE accounts need to be consistent)(and SEEA EPE accounts need to be consistent)

What does the 2008 SNA say?What does the 2008 SNA say?

2008 SNA and SEEA-2003 are consistent2008 SNA and SEEA-2003 are consistent But the 2008 SNA clarifies:But the 2008 SNA clarifies:

ownership transfer costs on disposal of fixed ownership transfer costs on disposal of fixed assets – asset life is the expected period of assets – asset life is the expected period of ownershipownership

terminal costs on fixed assets – asset life is terminal costs on fixed assets – asset life is the expected life of the assetthe expected life of the asset

The 2008 SNA, continued…The 2008 SNA, continued…

Terminal costs can be difficult to accurately Terminal costs can be difficult to accurately predictpredict

Where cumulated consumption of fixed capital Where cumulated consumption of fixed capital does not cover all terminal costsdoes not cover all terminal costs terminal costs treated entirely as gross fixed capital terminal costs treated entirely as gross fixed capital

formation at time incurredformation at time incurred Shortfall is recorded as consumption of fixed capital at Shortfall is recorded as consumption of fixed capital at

same time terminal costs are incurredsame time terminal costs are incurred

Other treatment options for terminal Other treatment options for terminal and ownership transfer costs (OTC)and ownership transfer costs (OTC) 1. as an expense1. as an expense 2. as gross fixed capital formation as 2. as gross fixed capital formation as

occurs – write off immediately as other occurs – write off immediately as other volume change (OVC)volume change (OVC)

3. as gross fixed capital formation as 3. as gross fixed capital formation as occurs – write off immediately as occurs – write off immediately as consumption of fixed capitalconsumption of fixed capital

1.Terminal and OTC as an expense1.Terminal and OTC as an expense

These costs look like expenses i.e. they do not create These costs look like expenses i.e. they do not create a store of value; they are not tradeable a store of value; they are not tradeable

In SNA - OTC for financial assets are treated as In SNA - OTC for financial assets are treated as expensesexpenses

Expense treatment avoids potentially significant Expense treatment avoids potentially significant impact on capital stock simply from selling assetsimpact on capital stock simply from selling assets

On the other hand…On the other hand… Contrary to SNAContrary to SNA Capital services provided by asset should cover Capital services provided by asset should cover

purchase price and terminal costs/OTCpurchase price and terminal costs/OTC

2.Terminal and OTC: gross fixed 2.Terminal and OTC: gross fixed capital formation as occur – write off capital formation as occur – write off

immediately as OVCimmediately as OVC Terminal costs and OTC don’t fit SNA definition Terminal costs and OTC don’t fit SNA definition

of Other Volume Change (OVC)of Other Volume Change (OVC) these costs will impact on balance sheet and these costs will impact on balance sheet and

accumulation accounts but by-pass production accumulation accounts but by-pass production and income accountsand income accounts

i.e. capital formation not matched by i.e. capital formation not matched by consumption of fixed capital. Value added consumption of fixed capital. Value added overstatedoverstated

3.Terminal and OTC: gross fixed 3.Terminal and OTC: gross fixed capital formation as occur - write off capital formation as occur - write off

immediately as CFCimmediately as CFC treating as capital formation (= SNA) treating as capital formation (= SNA) consistent with SNA principle purchasers’ pricesconsistent with SNA principle purchasers’ prices consistent with capitalisation of these costs in consistent with capitalisation of these costs in

business accounting, business accounting, But…But… by writing off immediately, we’re effectively saying by writing off immediately, we’re effectively saying

it’s an expenseit’s an expense ‘‘fence sitting’fence sitting’

Recommended treatment of terminal Recommended treatment of terminal costs:costs:

The SEEA Rev should treat terminal costs as capital The SEEA Rev should treat terminal costs as capital formation, CFC written off over expected life of the formation, CFC written off over expected life of the assetasset consistent with 2008 SNA (avoid user confusion)consistent with 2008 SNA (avoid user confusion) workable and defensible solutionworkable and defensible solution not perfect, but none of the other options are perfect not perfect, but none of the other options are perfect

either…either…Q1. Does LG agree that terminal costs should be treated Q1. Does LG agree that terminal costs should be treated as capital formation, CFC written off over the expected life as capital formation, CFC written off over the expected life of the asset?of the asset?

Further clarifying the SEEA RevFurther clarifying the SEEA Rev

Clarifying treatment of Clarifying treatment of remedial costsremedial costs Two distinct classes of remedial costs:Two distinct classes of remedial costs:

1. to restore land for some alternative use (GFCF)1. to restore land for some alternative use (GFCF) 2. to ‘lock up’ harmful contaminants within a site2. to ‘lock up’ harmful contaminants within a site

Require a treatment for the second classRequire a treatment for the second class Suggest these costs be treated as intermediate Suggest these costs be treated as intermediate

consumption (no store of value, no use in production, consumption (no store of value, no use in production, cannot be on-sold, no property income derived etc.)cannot be on-sold, no property income derived etc.)

Q2. Does LG agree with this suggested treatment?Q2. Does LG agree with this suggested treatment?

Further clarifying the SEEA Rev Further clarifying the SEEA Rev continued…continued…

Clarifying treatment of Clarifying treatment of terminal coststerminal costs SEEA-2003 recommends that where no estimate of SEEA-2003 recommends that where no estimate of

terminal costs has been made during the life of the terminal costs has been made during the life of the asset, terminal costs incurred are treated as:asset, terminal costs incurred are treated as: 1.Capital formation, and instantly written off (para 6.73);1.Capital formation, and instantly written off (para 6.73); OR 2. Intermediate consumption (para 6.74)OR 2. Intermediate consumption (para 6.74)

SEEA Rev must adopt singular recommendation:SEEA Rev must adopt singular recommendation: Option 1. (capital) – consistent with 2008 SNAOption 1. (capital) – consistent with 2008 SNA

Q3 Does LG agree with this suggested treatment?Q3 Does LG agree with this suggested treatment?

Further scenario re terminal costs…Further scenario re terminal costs…

Terminal costs are anticipated and provisions Terminal costs are anticipated and provisions put in place put in place butbut enterprise ultimately avoids enterprise ultimately avoids responsibility for these costsresponsibility for these costs Scenario not considered in SEEA or SNAScenario not considered in SEEA or SNA Recommendation: when it is clear that costs will Recommendation: when it is clear that costs will

not be incurred by the enterprise, full amount of not be incurred by the enterprise, full amount of cumulated consumption of fixed capital (CFC) be cumulated consumption of fixed capital (CFC) be reversed with a negative CFC entryreversed with a negative CFC entry

Q4 Does LG agree with this recommendation?Q4 Does LG agree with this recommendation?

Terminal costs are anticipated Terminal costs are anticipated and provided for and provided for butbut enterprise enterprise

ultimately avoids responsibility for ultimately avoids responsibility for these costs (these costs (continued…continued…))

if government assumes responsibility for terminal if government assumes responsibility for terminal costscosts

there is no longer an asset ‘associated’ with the there is no longer an asset ‘associated’ with the decommissioning / terminal costsdecommissioning / terminal costs

so these expenses are treated as remedial costs so these expenses are treated as remedial costs (described earlier) undertaken by government(described earlier) undertaken by government

Summary of questionsSummary of questions

Does London Group agree:Does London Group agree: that terminal costs should be treated as capital that terminal costs should be treated as capital

formation, CFC written off over the expected life formation, CFC written off over the expected life of the asset?of the asset?

agree that terminal costs to ‘lock up’ harmful agree that terminal costs to ‘lock up’ harmful contaminants within a disused site be treated as contaminants within a disused site be treated as intermediate consumption?intermediate consumption?

Summary of questions, Summary of questions, continued…continued…

Does London Group agree that:Does London Group agree that: Q3 where no estimate of terminal costs has Q3 where no estimate of terminal costs has

been made during the life of the asset, such costs been made during the life of the asset, such costs are always treated as capital formation?are always treated as capital formation?

Q4 when it is clear that terminal costs will not be Q4 when it is clear that terminal costs will not be incurred by the enterprise, full amount of incurred by the enterprise, full amount of cumulated consumption of fixed capital (CFC) be cumulated consumption of fixed capital (CFC) be reversed with a negative CFC entryreversed with a negative CFC entry