The Line Item Nobody Talks About
Municipal utility leaders spend a lot of time thinking about rates. Revenue requirements, cost of service, customer class allocation — these are the big-ticket conversations that fill board meetings and rate hearings. But there's a foundational piece of the puzzle that doesn't get nearly the attention it deserves: depreciation.
Depreciation is how your utility recovers the cost of its infrastructure over time. Every pipe in the ground, every transformer on a pole, every treatment plant and pump station — all of it is being consumed through service, and depreciation is the accounting mechanism that ensures you're setting aside enough revenue to replace those assets when the time comes. Get it right, and your rates accurately reflect the true cost of service. Get it wrong, and the consequences compound quietly for years.
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's not just about things breaking — it's about recognizing that every asset your utility owns has a finite useful life, and the cost of that asset needs to be recovered from the customers who benefit from it during that life.
For a municipal utility, this has direct implications for rates. Depreciation expense is a component of your revenue requirements. If your depreciation rates are too low, you're not recovering enough revenue to replace aging infrastructure, which means future ratepayers get stuck with the bill. If they're too high, today's customers are overpaying. Either way, the result is a fairness problem — and for a municipal utility answerable to its community, fairness isn't optional.
Many municipal utilities are operating with depreciation rates that haven't been updated in a decade or more. Over that time, asset conditions change, retirement patterns shift, and the gap between book values and reality widens. By the time someone notices, the financial hole can be significant.
What Happens Inside a Depreciation Study
A depreciation study isn't just an accounting exercise. It's a comprehensive analysis that blends engineering judgment, statistical modeling, and deep knowledge of how utility infrastructure actually behaves in the field. Here's what the process looks like when it's done right.
It Starts with Your Plant Records
Every depreciation study begins with a thorough review of the utility's plant accounting records. This means examining your capital asset ledger account by account — production plant, transmission, distribution, general plant — and understanding what you own, when it was installed, what it cost, and what's happened to it since. The quality of this data matters enormously. Analysts look for gaps, inconsistencies, and reclassifications that could distort the results.
Estimating How Long Assets Actually Last
The core of any depreciation study is life analysis — determining the estimated service life for each category of plant. This isn't guesswork. Depending on the type of asset, depreciation experts use different analytical methods to arrive at defensible life estimates.
For large, single-location assets like a generation unit or treatment plant, analysts typically use a forecast method, estimating a specific retirement date based on engineering assessments, operational plans, and technology trends. For mass property accounts — the thousands of poles, meters, pipes, and transformers that make up the backbone of a distribution system — 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 reason: they capture not just the average life of an asset class, but the dispersion of retirements around that average.
Getting the survivor curve right matters because it determines how quickly or slowly you're recovering costs. If the curve says your distribution transformers have an average service life of 35 years, but actual experience suggests 30, you'll have unrecovered costs sitting on your books when those units retire.
Iowa Survivor Curves: How Retirement Patterns Shape Depreciation
Iowa Survivor Curves model how groups of similar assets retire over time. Right-modal curves (like R2) are most common for utility distribution plant — most units survive well past 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 has to account for what happens when the asset is finally retired. That's 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 far exceed salvage value, resulting in negative net salvage. That means your depreciation rate needs to recover more than 100 percent of the original cost to fully fund the eventual retirement.
This is an area where many utilities underestimate costs. Removal expenses for underground pipe, asbestos-containing materials, or large structural assets can be substantial, and if your depreciation rates don't reflect that reality, you'll face an unfunded liability when the time comes.
Field Reviews: Where the Data Meets the Dirt
The best depreciation studies don't stop at the accounting records. They include on-site field reviews where analysts inspect actual plant conditions, interview operations and maintenance staff, and develop a firsthand understanding of how equipment is aging. These site visits often reveal things that don't show up in the books: assets that have been replaced but not retired in the records, equipment nearing the end of its useful life that still shows a long remaining life on paper, or capital projects that fundamentally changed the expected retirement date of existing plant.
Putting It All Together: The Remaining Life Calculation
Once life estimates and net salvage assumptions are established, the annual depreciation accrual rate for each account is calculated using what's known as the remaining life method. In simple terms, the formula asks: given what this asset originally cost, what we expect net salvage to be, and how much depreciation we've already accumulated, how much do we need to recover each year over the asset's remaining life to make it all come out right?
This is a forward-looking calculation. It automatically corrects for past over- or under-recovery. If previous depreciation rates were too low and the reserve is behind where it should be, the remaining life method increases the annual accrual to catch up. If rates were too high, it eases back. That self-correcting quality is one of the reasons the remaining life method is the standard approach recommended by NARUC.
The depreciation accrual rate directly feeds into your revenue requirements calculation. When a depreciation study recommends changes — sometimes adjustments of millions of dollars annually — those changes flow through to the rates your customers pay. Getting this number right is fundamental to setting rates that are fair, defensible, and sufficient to maintain the system your community depends on.
The Landscape Is Shifting — And So Should Your Assumptions
Even utilities that conducted a solid depreciation study five or ten years ago may find that the assumptions behind it no longer hold. 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 alone have increased 30 to 50 percent, with lead times stretching well beyond a year. For depreciation purposes, this means the net salvage assumptions baked into your current rates — particularly the cost-of-removal component — may already be significantly understated. When removal costs climb but your depreciation accruals don't keep pace, the gap shows up as an unfunded liability the next time those assets retire.
Technology Is Compressing Asset Lives
Traditional utility meters lasted 40 years or more. Smart meters and AMI systems? The industry is finding that useful lives of 10 to 15 years are more realistic, driven by software obsolescence, cybersecurity requirements, and evolving data needs. That's a fundamentally different depreciation profile than what most utilities have in their books. Any asset class with a significant technology component — SCADA systems, communication networks, automated controls — faces similar pressure. If your depreciation study doesn't account for technology-driven obsolescence, you're almost certainly under-recovering on these accounts.
The Energy Transition Is Creating New Questions
For municipal electric utilities, the shift toward renewable generation is introducing asset classes that didn't exist a generation ago. Solar arrays, battery energy storage systems, and wind installations all have different life characteristics than traditional generation plant. Battery storage systems in particular present a challenge: useful life estimates range from 10 to 25 years depending on the technology, cycling patterns, and maintenance strategy. Meanwhile, conventional generation assets may face earlier-than-expected retirements as the generation mix evolves, potentially leaving unrecovered plant balances on the books.
Water and Wastewater Infrastructure Is Aging Fast
The numbers here are stark. The EPA estimates the country needs over $625 billion over the next 20 years just to maintain existing water systems. For municipal water and wastewater utilities, much of the buried infrastructure — mains, service lines, collection systems — was installed decades ago during periods of rapid growth. These assets are now reaching the end of their service lives in clusters, and the cost to replace them in today's construction environment is multiples of what they originally cost. A depreciation study that reflects current replacement realities and removal cost experience is essential to preparing rates that can actually fund the work ahead.
The Cost of Doing Nothing
It's tempting to put off a depreciation study. The existing rates seem to be working. Nobody's complaining. There are more urgent things to spend staff time and budget on. But every year a utility operates with outdated depreciation rates, the misalignment compounds.
Assets that were expected to last 40 years may now be facing retirement at 30 due to changing environmental regulations or technology shifts. Infrastructure installed during a boom period may all be reaching end of life at the same time, creating a replacement wave that today's rates aren't prepared for. Meanwhile, removal costs — especially for underground infrastructure in urban areas — keep climbing.
The result is a growing gap between what's on your books and what it will actually cost to maintain and replace your system. By the time that gap becomes visible in a rate case or a bond rating review, the adjustment required can be large enough to cause rate shock — exactly the outcome municipal utilities work hardest to avoid.
How Often Should You Do a Depreciation Study?
Industry best practice is to conduct a full depreciation study every three to five years. Some utilities with large, complex systems or rapidly changing asset bases do them more frequently. The key is not to let the study become stale. Conditions change — new assets come online, old ones get extended or retired early, removal cost experience evolves — and your depreciation rates need to reflect current reality, not the world as it existed a decade ago.
For municipal utilities preparing for a rate case, a current depreciation study is especially important. It demonstrates to your governing body, your ratepayers, and any reviewing parties that the depreciation component of your rates is based on rigorous, up-to-date analysis rather than inherited assumptions.
When It's Time to Take a Closer Look
A depreciation study is one of those foundational analyses that doesn't make headlines but quietly underpins everything else your utility does financially. It protects intergenerational equity. It supports defensible rates. It ensures that when the time comes to replace critical infrastructure, the money is there.
If it's been more than a few years since your last study — or if you've never had one done — the gap between your current depreciation rates and reality may already be larger than you think. The good news is that a well-executed study doesn't just identify the problem; it provides a clear, defensible path to correcting it.
NewGen's depreciation team has conducted studies for utilities of all sizes, from large municipal electric and gas systems to smaller water and wastewater operations. If you're wondering whether your current depreciation rates still reflect the condition of your system, we'd welcome the conversation.