Forward-looking cost models are playing an increasingly important role in setting and assessing access prices and determining universal service costs in Australia’s 268 industry. Both the ACCC and the ACA have recently commissioned large consultancy projects to estimate the forward-looking costs of Telstra’s network. In such models, depreciation usually accounts for a large proportion of total costs, and hence the appropriate method for estimating depreciation has been the focus of considerable attention by both regulators and industry operators.
Rather than the use of accounting depreciation, which simply allocates the historic cost of the asset over the periods which it is to be used, depreciation in forward-looking cost models should reflect the period on period decline in the market value of the asset – a concept known as economic depreciation. While it can be shown that under specific conditions accounting depreciation aligns with economic depreciation, these are not the conditions under which 268 operators in Australia are required to operate. Rather, competition and short duration contracts mean that the profile of depreciation is critical to meeting a firm’s dual objectives of remaining competitive and recovering capital costs.
This paper identifies the difference between accounting and economic depreciation and shows that the regulatory and competitive state of Australia’s 268 market makes the latter the appropriate for use in forward-looking cost models.