The Line Item Nobody Talks About
Leaders at municipal utilities, cooperatives, water supply corporations, and special utility districts devote significant attention to rates. Revenue requirements, cost of service, and customer class allocation are big-ticket conversations at board meetings and rate hearings. However, depreciation—a foundational piece of the puzzle—does not get nearly the attention it deserves.
Depreciation enables your utility to recover the original cost of infrastructure over its useful life. Every pipe in the ground, transformer on a pole, treatment plant, and pump station are consumed through service, and depreciation allocates these costs to the customers who benefit. Accurate depreciation ensures rates reflect the true cost of service, while errors can lead to compounding consequences over time.
Why Depreciation Matters More Than You Think
The National Association of Regulatory Utility Commissioners (NARUC) defines depreciation as the loss in service value of utility plant not restored by current maintenance. That "loss in service value" comes from everywhere: wear and tear, decay, weather, obsolescence, changing regulatory requirements, and shifts in demand. It is not just about things breaking, but about recognizing that every asset your utility owns has a finite useful life. The cost of that asset needs to be recovered from the customers who benefit from it over its life.
For municipal utilities, depreciation directly affects rates. Depreciation expense is a component of revenue requirements. If rates are too low, current customers do not cover their share of asset consumption, setting up future rate shocks and increased regulatory or oversight scrutiny. This pattern has played out across the water industry. If rates are too high, customers overpay. In both cases, this creates an equity issue, which, for a municipal utility answerable to its community, is not optional.
Many municipal utilities are operating with depreciation rates that have not been updated in over a decade. During this period, asset conditions and retirement patterns change, widening the gap between book values and actual conditions. By the time someone notices, the financial hole can be significant.
What Happens Inside a Depreciation Study
A depreciation study is more than an accounting exercise. It is a comprehensive analysis that incorporates engineering input, professional judgment, statistical modeling, benchmarking, and practical knowledge of utility infrastructure performance. The following outlines the process when it is done right.
It Starts with Your Plant Records
Each depreciation study begins with a thorough review of the utility's plant accounting records. This involves examining the capital asset ledger by account, and, if necessary, by specific line items such as production, treatment, transmission, distribution, collection, and general plant. Understanding asset ownership, installation dates, costs, and subsequent changes is essential. Data quality is critical; analysts identify gaps, inconsistencies, and reclassifications that could distort the results. Material record-keeping issues are reported with study findings so they can be addressed before impacting future analyses.
Estimating How Long Assets Actually Last
The core of any depreciation study is the life analysis, which determines the estimated service life for each plant category. This isn't guesswork. This process relies on analytical methods tailored to asset type and historical experience, ensuring defensible life estimates.
For large, single-location assets such as a generation unit or treatment plant, analysts typically use a forecast method to estimate a specific retirement date based on engineering assessments, operational plans, and technology trends. The specific approach depends on the depreciation system the utility currently employs. For mass property accounts with thousands of poles, meters, pipes, and transformers making up the backbone of transmission, distribution, or collection systems, the approach is more statistical. Analysts use survivor curve analysis, a method developed at Iowa State University that models the pattern of retirements across a group of similar assets over time. These Iowa Survivor Curves have been an industry standard for decades, and for good reasons: they capture not just the average life of an asset class, but the dispersion of retirements around that average.
An accurate survivor curve is crucial, as it determines the rate of cost recovery. If the curve estimates an average service life of 35 years for distribution transformers, but actual experience is 30 years, unrecovered costs may remain when those units retire.
Iowa Survivor Curves: How Retirement Patterns Shape Depreciation
Iowa Survivor Curves illustrate how groups of similar assets retire over time. Right-modal curves, such as R2, are most common for utility distribution plants. Most units remain in service well beyond the average service life, with retirements concentrated in later years.
Accounting for What's Left at the End
Life analysis tells you how long an asset will serve. But depreciation also must account for what happens when the asset is finally retired. That is where net salvage analysis comes in. Net salvage is the gross salvage value you receive from retiring an asset — what you can sell it for or recover from it — minus the cost of removing it. For many utility assets, especially underground infrastructure, removal costs often exceed salvage value, resulting in negative net salvage value. That means your depreciation rate must recover more than 100 percent of the original cost to fully fund the eventual retirement of assets.
This is an area where many utilities underestimate costs. Removal expenses for underground pipes, asbestos-containing materials, or large structural assets can be substantial. If depreciation rates do not account for these expenses, the utility may face unfunded liabilities at asset retirement.
Field Reviews: Where the Data Meets the Dirt
The best depreciation studies do not stop at the accounting records. Comprehensive depreciation studies also include on-site field reviews, during which analysts inspect plant conditions, interview operations and maintenance staff, and gain firsthand insight into equipment aging. These visits uncover discrepancies such as assets replaced but not retired in records, equipment nearing the end of its useful life despite a long remaining life on paper, or capital projects that alter the expected retirement date of the existing plant.
Putting It All Together: The Remaining Life Calculation
After establishing life estimates and net salvage assumptions, the annual depreciation accrual rate for each account is calculated using the remaining life method. This approach determines the annual recovery needed based on the asset's original cost, expected net salvage, and accumulated depreciation over the asset's remaining life.
This forward-looking calculation corrects for past over- or under-recovery. If previous depreciation rates were too low and reserves are insufficient, the remaining life method increases annual accruals to catch up. If rates were too high, it would reduce them. This self-correcting feature is why the remaining life method is NARUC's recommended approach. Depending on the asset class and the utility's circumstances, analysts may also use techniques such as the whole life method, equal life group procedures, or amortization accounting for short-lived assets to achieve more accurate or defensible results.
The depreciation accrual rate directly impacts revenue requirements. When a depreciation study recommends changes—sometimes amounting to millions of dollars annually—these adjustments affect customers' rates. Getting this number right is fundamental to setting equitable, defensible, and sufficient rates to maintain the utility system your community depends on.
For cash-basis utilities, many municipal systems set rates on a cash rather than utility basis, so depreciation does not directly affect revenue requirements. Even so, a current depreciation study remains essential. These studies inform capital planning, support bond disclosures and rating agency reviews, and document the plant's true consumption for GASB financial reporting. Utilities that have set depreciation aside, believing it does not affect rates, have still faced significant adjustments that affect reported financial health, as several Texas municipal utilities have experienced in recent years.
The Landscape Is Shifting — And So Should Your Assumptions
Even utilities with recent depreciation studies may find that prior assumptions are now outdated. Several forces are reshaping how utility assets age, what they cost to remove, and how long they remain useful.
Inflation Is Rewriting Removal Cost Estimates
Construction and material costs have surged in recent years. Transformer prices, for example, have increased by 30 to 50 percent, with lead times stretching well beyond a year. As a result, net salvage assumptions—especially the cost-of-removal component—may be significantly understated in current rates. If depreciation accruals do not keep pace with rising removal costs, unfunded liabilities can emerge when assets retire.
Technology Is Compressing Asset Lives
Traditional utility meters often lasted 40 years or more. In comparison, smart meters and AMI systems now have more realistic useful lives of 10 to 15 years due to software obsolescence, cybersecurity requirements, and evolving data needs. This represents a fundamentally different depreciation profile from previous assumptions. Asset classes with significant technology components, such as SCADA systems, communication networks, or automated controls, face similar pressures. If depreciation studies do not account for technology-driven obsolescence, under-recovery is likely.
The Energy Transition Is Creating New Questions
The shift toward renewable generation introduces new asset classes for municipal electric utilities that did not exist a generation ago. Solar arrays, battery energy storage systems, and wind installations have different life characteristics compared to traditional generation plants. Battery storage systems, for example, have useful life estimates ranging from 10 to 25 years depending on the technology, cycling patterns, and maintenance strategy. Conventional generation assets may also retire earlier than expected as the generation mix evolves, potentially resulting in unrecovered plant balances.
Natural gas utilities face a similar but more urgent challenge. A growing number of states and municipalities are adopting building electrification policies and moratoriums on new gas service, which can shorten the useful lives of gas distribution assets. For affected utilities, depreciation studies must consider accelerated retirement scenarios and appropriate recovery mechanisms to avoid stranded investment.
Water and Wastewater Infrastructure Is Aging Fast
The numbers here are stark. The EPA estimates that over $625 billion will be needed in the next 20 years to maintain existing water systems. Much of the buried infrastructure (mains, service lines, collection systems) in municipal water and wastewater utilities was installed decades ago and is now reaching the end of its service lives in clusters. Replacement costs in the current construction environment are several times the original investment. A depreciation study that reflects the current replacement realities and removal cost experience is essential for preparing rates that can fund upcoming infrastructure needs.
The Cost of Doing Nothing
It can be tempting to delay a depreciation study when existing rates appear sufficient, and there are competing priorities for staff time and budget. However, each year a utility operates with outdated depreciation rates, the misalignment compounds.
Assets once expected to last 40 years may now retire after 30 years due to changing regulations or technological advances. Infrastructure installed during periods of rapid growth may reach end of life simultaneously, creating a replacement wave that current rates cannot accommodate. Removal costs, particularly for underground infrastructure in urban areas, continue to rise.
This leads to a growing gap between book values and the actual costs of maintaining and replacing your system. When this gap becomes apparent during a rate study, rate proceeding, or bond rating review, the necessary adjustment may be substantial enough to cause rate shock, which municipal utilities strive to prevent.
How Often Should You Do a Depreciation Study?
Industry best practice recommends conducting a full depreciation study every three to five years. Utilities with large, complex, or rapidly changing asset bases may require more frequent studies. The key is not to let studies become outdated, as asset conditions, retirements, and removal costs evolve. Depreciation rates should reflect current realities.
For municipal utilities and other public power entities preparing for a rate study, cost-of-service review, or formal rate proceeding, a current depreciation study is especially important. It demonstrates to governing bodies, ratepayers, and reviewers that depreciation rates are based on rigorous, up-to-date analysis rather than outdated assumptions.
When It's Time to Take a Closer Look
A depreciation study is a foundational analysis that, while often overlooked, underpins all financial aspects of utility operations. It protects intergenerational equity, supports defensible rates, and ensures funding is available for critical infrastructure replacement.
If it has been several years since your last study, or if one has never been conducted, the gap between current depreciation rates and actual conditions may be larger than anticipated. A well-executed study not only identifies issues but also provides a clear, defensible path to resolution.
NewGen's depreciation team has experience conducting studies for utilities of all sizes, including large municipal electric and gas systems, cooperatives, water supply corporations, special utility districts, and smaller water and wastewater operations. If you are uncertain whether your current depreciation rates reflect your system's condition, we welcome the opportunity to discuss your needs.
