‘Time passing’ and measuring
depletion
London Group
Brussels, September/October 2008
Peter Comisari
Australian Bureau of Statistics
Overview
Natural
resources: asset values; depletion and
‘time passing’.
Is
‘time passing’ a holding gain for the owner of
the natural resource?
Does
‘time passing’ arise from production? If
not, could it nevertheless be considered ‘income’
by following a Hicksian notion of income?
Implications
of proposal…
Measuring the value of natural
resource assets and their depletion
Where market values unavailable, natural
resource assets can be valued using NPV.

Asset value = NPV of expected stream of
benefits (resource rents) flowing from developing
the natural resource.

But resource rents are not observable and must
instead be inferred from reported gross operating
surplus (GOS) of the extractive industry.

Measuring the value of natural resource
assets and their depletion, continued…
Depletion is the decline in value of the natural
resource as a result of its physical extraction.

Depletion could be thought of as the amount we
need to set aside from present operating surplus
to allow replacement of the natural resource.


What price should apply to the natural resource?
Extraction of the natural resource
When natural resource extraction takes place, the
below-ground resource changes into an aboveground resource. They are different products.
Extractive activity causes the change.

Extraction
takes place on the assumption that the
price above-ground will exceed that below-ground.
The
depletion charge seeks to replace the natural
resource at its below-ground price.
Resource rent is based on ‘above
ground’ prices
60
50
40
Below ground value
30
20
Above ground value
(resource rent)
Depletion
10
0
-10
Income
-20
-30
Different products
Components of
resource rent
Extraction of the natural resource,
continued...
Typically, as we move forward one accounting
period, operating surplus (containing the resource
rent) is earned from production
- we need to capture depletion

We
must estimate (and remove) the income element
of the resource rent to derive depletion.
But
we only know opening asset value (V1) and the
resource rent (RR)
Extraction of the natural resource,
continued...
So the income component of RR must be calculated
as:
income = RR – V1 * r
(where r is the expected return on the natural
resource asset)

i.e.
as production proceeds, we ‘release’ one year of
RR value from the asset stock – we must also
estimate the income component to derive depletion.
‘Time passing’
‘Time passing’ is the unwinding of the income
component of the natural resource asset value.

It is the r * V1 component of the equation
depletion = RR – r * V1
It
is an essential component of our NPV model
But
income earned from extractive activity is
captured through our regular income sources and
methods
‘Time passing’, continued…
‘Time passing’ effect is not an issue where
market values are available.

It is a feature of the NPV model, but we do not
have to explicitly articulate ‘time passing’ when
accounting for changes in asset stock values.

In
the production and income accounts,
depletion-adjusted operating surplus needs only
to identify the depletion variable
- No need to also show resource rent and ‘time
passing’ elements (already included in GOS)
‘Time passing’ in the SNA
‘Time passing’ effect has been known about for
many years in the derivation of consumption of
fixed capital.

Where NPV is used to derive SNA consumption
of fixed capital, conventional practice is to simply
net-off ‘time passing’ against capital services.

SNA
produced capital :: consumption of fixed
capital
SEEA natural capital :: depletion (consumption of
fixed capital)
SNA treatment of consumption of fixed
capital (CFC)
Value V1
20,000
Gross operating
surplus (GOS) 6,000
CFC 4,000
•
Net operating
surplus (NOS) 2,000
Value V2
16,000
SNA treatment of consumption of fixed
capital (CFC)
Value V1
20,000
•
GOS 6,000
CFC = ??
NOS = ??
SNA treatment of consumption of fixed
capital (CFC)
Value V1
20,000
•
GOS 6,000
CFC 4,000
NOS 2,000
Income & CFC = 6000
CFC = GOS –r.V1
= 6000 - 10% * 20000
i.e. CFC = 4000
SNA treatment of consumption of fixed
capital (CFC)
Value V1
20,000
•
GOS 6,000
CFC 4,000
NOS 2,000
Income & CFC = 6000
CFC = GOS – r.V1
= 6000 - 10% * 20000
i.e. CFC = 4000
Value V2
16,000
SNA treatment of consumption of fixed
capital (CFC)…..not…
Value V1
20,000
•
GOS 6,000
less capital services
6,000
Plus ‘time passing’
2,000
Equals NOS 2,000
Value V2
16,000
SNA: possible reasons for asset
value change…
Essentially, change in value of an asset is
accounted for in one of three ways in SNA:
- 1. stock change due to consumption within
productive process. Or acquired / disposed of in
transactions with other economic entities
- 2. changes due to events not related to economic
events e.g. catastrophic events.
- 3. changes due to asset price changes. These
holding gains/losses recorded in revaluation account

SNA:
depletion recorded in the first grouping.
Is ‘time passing’ benefit a holding gain?
Because the ‘time passing’ effect increases the
(NPV) modeled value of the natural resource (and
this happens even if no production occurs), surely
this must be a holding gain?

But this effect occurs independent of any
observable price change. A holding gain without
price change?

NPV model operates on an assumed expected
production schedule. Results are usually useful and
intuitive - but not always!

‘Time passing’ as a holding gain…
Assume that we decide to treat the ‘time passing’
effect as a holding gain, what are the implications?

Depletion
equals entire resource rent i.e. we now
make provision to replace not only the natural
resource, but also the income earned from using the
resource.
But
we only do this where NPV technique used.
Where market values available, we calculate depletion
as decline in asset value due to extraction.
‘Time passing’ as a holding gain,
continued…
Where NPV valuation used, depletion-adjusted
operating surplus for extractive industries would
largely disappear.

This
ignores realities of potentially substantial
income (and tax revenue) derived from extraction.
Fundamental
principles.
change in our basic accounting
‘Time passing’ as income (redefined,
Hicksian)
Problems
in previous slides are placated by treating
‘time passing’ as a redefined (Hicksian) income.
i.e. that ‘time passing’ does not arise from
productive activity but nevertheless gives rise to
income.

Creates
a major difference in the accounting
principles applying to SNA and to SEEA.
‘Time passing’ as Hicksian income,
continued…
would for example lead to different treatments in SNA
and SEEA for the same natural processes

e.g. Natural growth of forests: for plantation
(cultivated) forest is ‘production’ in SNA; but not
production in SEEA. But income arises in both cases.

Would
require re-think of treatment of new discoveries
and reclassifications of natural resources. Can these
give rise to income directly, i.e. in absence of any
productive activity?
Questions…
Natural resource assets will change in value over
time. How do we best explain ‘time passing’ in this
context?

Is
it simply an input to our (modeled) measure of
depletion? Or is it a holding gain?
If the latter: Are we comfortable in creating
fundamental differences in accounting principle
between SNA and SEEA?

If
the former: Do we still consider NPV approach
appropriate for valuing natural resource assets?