Reserve Data Analysis, Intl.
 
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Calculating the Ideal Level of Reserves

 

prepared by

 

Edwin G. Edgley, CEO/Founder

Reserve Data Analysis, Intl.

June 13, 2010

 

Given that the basis of funding for reserves is to distribute the costs of the replacements over the lives of the components in question, it follows that the ideal level of reserves would be proportionately related to those lives and costs.  If you have a component with an expected estimated useful life of 10 years, you would set aside approximately one-tenth of the replacement cost each year.  At the end of 3 years, one would expect that three-tenths of the replacement cost would have accumulated, and if so, you would be "ideally funded."  This model is important in that it is a measure of the adequacy of an association's reserves at any one point of time, and is independent of any particular "method" which may have been used for past funding or may be under consideration for future funding.  The equation is based on current replacement cost, and is a measure in time, independent of future inflationary or investment factors:

 

        Ideal Level of Reserves  =  Age of Component  ÷  Useful Life  ×  Current Replacement Cost

           

The RDA Reserve Management Software program performs the above calculations to the very month the component was place-in-service.  It also allows for the accumulation of the necessary reserves for the replacement to be available on the first day of the fiscal year it is scheduled to be replaced.

 

As an example, given an association has a calendar fiscal year, If you had a component that was placed-in-service  April 1, 1995, and had a useful life of 5 years, then the program will calculate the contribution necessary in order to have the funds available for replacement by January 1, 2000, and not April 1, 2000. 

 

In this example, on January 1, 1998 the component would be 2 years and 9 months old (33 months) and the effective useful life of the component would be 4 years and 9 months (57 months).  The ideal level of reserves at that point in time would be 33 ÷ 57 x the current replacement cost.

  

Edwin G. Edgley is the CEO and founder of Reserve Data Analysis, Intl.  Mr. Edgley is a published author, routinely lectures at a national level, and teaches on the subject of reserves and reserve analysis preparation.  He is the author of the RDA RESERVE MANAGEMENT SOFTWARE program, and is actively involved as an expert witness in his field.  This document may be freely quoted, copied, reproduced and/or distributed, in whole or part, for non-commercial purposes, provided all credits and copyright information remain intact.

 

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