2. Literature Review section

2.1 User Cost Accounting and Sustainable Income

The concept of sustainable income is grounded in the idea of Hicksian income, the maximum amount one can consume in a period without reducing the ability to consume the same amount in the future. For an economy or a firm that relies on depleting natural resources, true income must exclude the portion of revenue that comes from consuming those resources. Salah El Serafy’s “user cost” method formalised this idea for non‑renewable resources by splitting each period’s resource revenue into two parts: (1) a true income component that can be safely consumed, and (2) a user cost component that represents the depreciation of natural capital and must be reinvested to sustain future income. In other words, El Serafy’s method “splits the revenue from the sale of an exhaustible resource into a capital element (or ‘user cost’) and a value‑added element representing true income.” The income portion is what the firm or economy can count as profit without impoverishing future periods, while the user cost portion is reserved to maintain future income streams once the resource is depleted.

The basic logic can be illustrated simply: when a company sells a barrel of oil or a ton of copper ore, it is partly drawing down its wealth. Only some of the revenue from that sale is analogous to an income or yield on capital (which can be consumed); the remainder is akin to liquidating an asset. If sustainable income is the goal, a portion of the proceeds must be set aside and converted into another form of capital so that when the resource is gone, the company can still generate income at the same level. This is analogous to the famous Hartwick rule at the micro level, ensuring that resource rents are not simply treated as windfall profits but are used to secure the future.

2.2 El Serafy’s Formula

El Serafy (1989) provided a simple model to determine the split between true income (X) and user cost (R − X) for a depleting resource. The model assumes a non‑renewable resource will generate a constant net revenue (rent) R each year over a finite horizon of n + 1 years (years 0 through n, inclusive). In practice, one might use a proxy like Earnings Before Interest, Tax, Depreciation, Depletion & Amortization (EBITDDA) for R, to represent the net cash flow from the resource. After year n, the resource is exhausted and produces no further revenue. A constant discount rate r is used, representing the return on investment at which saved user cost will grow.

Under these assumptions, the sustainable income portion each year is given by:

\[ X = R \times \left(1 - \frac{1}{(1+r)^{n+1}}\right) \]

and the corresponding user cost (depletion charge) each year is:

\[ \text{User Cost} = R - X = \frac{R}{(1+r)^{n+1}} \]

The fraction of revenue that can be considered true income is therefore \( 1 - \frac{1}{(1+r)^{n+1}} \), and the fraction that must be reinvested as user cost is \( \frac{1}{(1+r)^{n+1}} \). For example, if the time horizon is 25 years (n = 24) and the discount rate is 5 percent, roughly 38 percent of each year’s revenue would need to be reinvested and about 62 percent could be treated as income. If r is lower or n is longer, the required reinvestment fraction increases, because it’s harder to sustain the same level of income when either growth is slow or the resource lasts fewer years.

This user cost approach has been influential in the field of environmental and resource accounting. It operationalizes the Hicksian income concept in practical terms and has been applied primarily in national accounting to adjust GDP or NDP (Net Domestic Product) for resource depletion. For example, the World Bank’s concept of Adjusted Net Saving (also known as genuine saving) incorporates a deduction for the depletion of natural resources, inspired by methods like El Serafy’s [20]. By separating income from depletion, one can measure what some have called sustainable yield or permanent income from resource extraction [6][10]. Studies have shown that ignoring this separation leads to significant overestimation of income [23]. Yaduma et al. note that standard national accounts count natural resource rents as income “without making a corresponding adjustment to the depleted natural capital stock,” thereby producing misleadingly high GDP figures [24]. In fact, treating the entirety of resource revenue as income is equivalent to a country (or company) selling off its assets and calling the proceeds profit. A number of empirical studies underscore the magnitude of this overstatement. For instance, in Brazil and Indonesia, early applications of the user cost and related approaches revealed that a substantial portion of what was recorded as mining income would need to be set aside to preserve wealth . In Peru, it was estimated that during 1992–2006 the conventionally measured mining GDP was overstated by as much as 31–51% once the loss of mineral wealth was accounted for . Similarly, Mardones and del Rio (2019) find that for Chile (1995–2015) proper depletion accounting would reduce measured mining-sector GDP by nearly 98% (almost wiping out the measured mining GDP growth) . The World Bank (2006) reported that after deducting resource depletion, countries like Bolivia saw their genuine savings rate turn negative, meaning they were on an unsustainable development path despite positive GDP growth [24]. These findings highlight that a significant share of extractive revenues is not income at all, but rather running down capital. In corporate terms, failing to account for this means that firms could be paying out dividends from what is effectively capital liquidation, thus undermining their long-term financial health. To address these issues, the user cost concept in corporate reporting would treat a portion of revenues as a provision for capital maintenance. This is analogous to depreciation but for natural capital. There is an important connection here to classical economics and the work of John Maynard Keynes: the term user cost in fact originates from Keynes (1936), who used it in the context of the cost of using up capital equipment. In our context, the “equipment” is a mineral reserve or oil field [9]. By reviving this concept, modern sustainability accounting is essentially extending traditional accounting’s accrual logic (which matches the consumption of produced capital over time via depreciation) to natural capital. If adopted, user cost accounting would ensure that a company’s financial statements reflect the true, maintainable earnings. Only the portion of revenue that can be earned indefinitely (through reinvestment of the rest) is counted as income, aligning financial reporting with the Hicksian income ideal.