Equipment Appraisal Blog | Understanding Machinery Appraisals

When equipment you've invested in has become obsolete, it can wreak havoc on your business' accounting, especially when it has not yet been fully depreciated. How do you deal with economic obsolescence in your company? Here's a quick look at what it is and how to best deal with it when it happens in your business.

How equipment appraisal helps you deal with economic obsolescence

I remember the first time I ran into a case of economic obsolescence in a piece of business equipment. Back in 1992, my parents invested in a 286 computer for their business, to run accounting and correspondence. Several years later, I found them a newer computer for the business, so the older desktop came home. Following a number of creative hacks to try to keep the system running for nearly 18 years, my mother finally asked, "That old computer probably isn't good for much more than a boat anchor anymore, is it?" The rejoicing at that point, albeit quietly in my head, was epic.

When equipment is no longer able to be updated to remain useful, it's said to have become obsolete. Economic obsolescence is the point at which it costs more to try to maintain older equipment than to replace it. Unfortunately, this can cause some serious problems with your company's books, especially if the machinery is not yet fully depreciated.

One industry where this regularly happens is IT. Because of the rapid progression of computer technology, it can seem as though every week a faster processor, bigger hard drive or a larger memory stick is coming out. Software from three years ago is no longer being supported by the developer, making it impossible to take care of security issues. When these assets are not yet fully depreciated, they still show value on the books even though they have become completely unusable in daily operations. 

That doesn't mean you won't get any money for it in a sale, but it would require spending time, effort and money to find the right buyer. Some computer companies build their own testing labs by purchasing older systems that may be used by their clients, but these labs are not where the company makes money as much as where they provide customer support and service to ensure the product they're developing will work well on the client's system. Though it has some value for the company, it's not in the profit sector of the company, so is often disregarded in terms of value.

For this reason, an equipment appraisal can help fix this problem. Because a certified equipment appraiser should have experience in the industry in question, they typically have a good grasp of when a technology or piece of equipment is no longer able to remain competitive in the real world. They can help provide a value for the equipment that is realistic, and their appraisal is well documented.

When you have a situation of economic obsolescence in your company, one of the best options to record the loss of machinery value is through an equipment appraisal. When you work with a certified appraiser, they have a good grasp of your industry's rate of progress and understand when certain classes of machinery become obsolete. Because they use standardized methodologies, their appraisal report will stand up well to scrutiny from outside interests, whether it's the legal system, a tax agency, an insurance company or a financial institution.

As a business, your investment in your equipment is a large part of your overall assets. Knowing how long that equipment will continue to operate is an important piece of information to help you plan your company's future expenditures. But the remaining useful life can be hard to determine. Fortunately, there's a way to get around the difficulty in determining this expected lifespan. Machine appraisers spend all day looking at and appraising equipment, so they not only have experience in how to calculate the estimated remaining lifespan but also know how to recognize signs that may extend or shorten machine lifespan. Here's a quick look at the overall process and what aspects may impact your equipment's estimated remaining life.

How does a machine appraiser determine remaining useful life?

Machines, like people, can age at different rates. Imagine a two-pack-a-day smoker with bad genetics who has done heavy construction and drinks a six pack every evening, before taking a ride down into some scary parts of town while never going to the doctor. If this individual made it past 50, it would be a miracle. The health guru with perfect genetics, a stress-free life and a love for fitness who regularly has health screenings may expect to live past the century mark at this point. Much like people who do or don't take care of themselves, machines can fail at different rates.

One area that can quickly impact machine lifespan is the environment in which it is used. Much like the smoker, a piece of equipment that is kept in a damp, dirty environment with extreme temperatures will tend to degrade much faster than one kept in a clean, dry environment with regulated temperatures. The bad genetics would represent the expected overall lifespan of a specific model of equipment, such as a model known for issues that will not last as long as similar models because of poor manufacturing, materials or mechanical problems. At the same time, the heavy construction background represents hard use of the machine. Equipment that has been used at the very top of its range of specifications, received hard use in a short period of time or otherwise abused will have a much shorter lifespan than may otherwise be expected.

When an equipment appraiser looks at a piece of machinery, there are a number of clues they can take into account. In addition to already knowing a rough range of estimated overall lifespan, the appraiser can look at the exterior for signs of abuse, including dents, bends or evidence of poorly-made repairs to determine any excessive use the equipment may have received. A look at internal components may reveal failing mechanisms that could cause a serious failure down the road. Checking out the environment may lead to details about whether a fresh coat of paint may stop corrosion or if the rust may cause a premature failure.

The process of estimating remaining useful life can be a daunting task, but with an equipment appraiser taking over the process, you'll quickly have the information you need for your business planning purposes. Be sure to check whether your equipment appraiser is certified, as the methodologies used by certified equipment appraisers have stood up to strong scrutiny in a wide range of situations. This means the remaining equipment lifespan they estimate for you is much more likely to be a good tool for your business planning needs.

We've all heard of problems businesses may have due to obsolete equipment. But what many companies don't realize is that there is a big difference between a piece of equipment being economically obsolescent and reaching functional obsolescence. But what's the overall difference between these two major types of obsolescence and what do you do when you have equipment that breaks down or wears out and becomes functionally obsolete? Here's a quick look at how it works out in equipment appraisal.

Used up and worn out: Dealing with functional obsolescence in equipment

Functional obsolescence is defined as the loss of value and usefulness of a piece of equipment which is caused by the machinery's lack of efficiency, inadequacies or high cost of maintenance and repair. In general, it's typically reached when a piece of equipment becomes more expensive to repair or maintain it than to replace it. But how does that work?

As a quick example, consider a vehicle. It's purchased with the understanding that at some point it will need to be replaced. As the years roll by, more repairs are required to keep the vehicle operating reliably. Eventually, the cost of these repairs will exceed the cost of purchasing a newer vehicle.  Another example could entail the need for a more fuel-efficient vehicle. If the current vehicle only gets five miles per gallon and a newer model would get 20 miles per gallon, the cost of operation is the key factor in terms of when to replace the equipment for a more efficient model. 

But what causes machinery to become functionally obsolete? Newer, more efficient technology may gain ground and come down in price, making the cost of acquisition much lower than in the past. This makes it possible to replace the equipment because of the reduced cost of waste. If it's caused by machinery breaking down, that can be caused by operating it in a state of over capacity, which wears the machinery at a faster pace than normal. In general, this is caused by purchasing machinery that is not suited to the task at hand or having to make increased demands on it after the initial investment. If innovations in the market provide new features that become necessary for modern operation practices, this can also make the machinery functionally obsolete.

Unfortunately, when you have a piece of equipment that has become functionally obsolete, it can create problems with your business' accounting and overall financial standing. If the machinery has not yet been fully depreciated, it may be showing a higher value than what it's actually worth at this point. If you have to deal with legal issues, the other side of the case may look at these values and claim that your company has a higher value than is reasonable. Having an equipment appraisal helps you document the machinery's actual value.

Though having equipment reaching functional obsolescence isn't a goal any business tends to make, it's one that many companies end up facing at some point or another. By taking the time to learn how to deal with the issue when it arises, you can make better decisions for your company and your remaining assets. Being able to document the final value of functionally obsolescent machinery can make a huge difference on your accounting and helps provide a more accurate overall picture of your business' financial health.

Your workshop catches fire and burns the equipment that was stored or used within. A hurricane floods your office and destroys both the maintenance records and the vehicles that were kept on site. A vandal breaks in and causes irreparable damage to your machinery over a late night or long weekend. Whatever situation you find yourself in, one of the thoughts that may raise your stress levels is how to prove the value to your insurance company. Here's a look at how retrospective appraisals can help in these difficult circumstances.

Dealing with a Business Loss: Retrospective Appraisals

How can an appraiser determine the value of equipment that has been significantly damaged? Though some of the process may involve some level of educated estimation, most of it is grounded solidly in appraisal practices and methods. Some information will be easily obtained, while other information will require careful study of what's left and any paperwork that is left after a disaster.

Let's take the example of a cargo van that has been burned in a warehouse fire and had significant damage due to the heat involved. Most business owners and equipment operators, even many mechanics, would only see the burned shell of the van. Fortunately, equipment appraisers take a different view of the machinery they're appraising.

To start, the appraiser will work with any paperwork and information that is available.  The original purchase paperwork, maintenance logs, receipts from repairs: all these papers paint a picture of what kind of van it was, the care it was given over the years and possibly a record of how many miles it had on it at the time of the loss. This information allows the appraiser to calculate the cargo van's value in general terms, based on the market conditions and demand for that type of vehicle.

But what if the van had been poorly used over the years? What if there was unrepaired body damage or significant problems with its mechanical systems due to being neglected or abused? On the other hand, what if it had much lower miles than most vehicles of that age and was maintained in impeccable condition? What if the business had added machinery or options to the vehicle that would increase its overall value? These are all aspects the equipment appraiser must take into account when calculating the value of a piece of equipment after a loss.

Another area to consider is when the damage took place. If the van was stored at a remote site and the damage was discovered months after the fact, how do you determine value? What if the bottom has fallen out of the van market in the intervening weeks and months? Should the van be appraised at the value it held when the damage was discovered or at the estimated time of the the loss? An equipment appraiser can retroactively value the machinery to the loss date using verified, tested appraisal methods.

Having to deal with a business loss is stressful, but having the option of getting retrospective appraisals performed on damaged equipment helps reduce the load. Whether you're claiming a loss on tax returns or pursuing compensation from your insurance company for the damage, a retrospective appraisal can help your business get back on its feet faster. Make sure you work with certified equipment appraisers, as the methodologies they use will hold up well against scrutiny in court, insurance and tax agency circles.

Effective age is defined as the difference between the overall economic life and the remaining economic life of a piece of equipment, a structure or similar asset. Though that provides you with a basic overview of the concept, it can often seem much more complicated than that. How is it determined? How will it impact your company's bottom line? Do you really need to know this detail for your machinery? Here's a quick look at those questions and more.

What is effective age and why does it matter for your business?

Though the above definition of effective age seems rather dry, it does cover the basics. Imagine that you've purchased a cargo van for your company. Purchased new, the expected lifespan is about five years with your expected annual mileage. But what if you found a great deal on another vehicle after a couple years of ownership? By spreading the work between the two vehicles, you may then expect the cargo van to last longer, but exactly how long? That's where effective age comes into play.

If machinery is abused or used in a harsh environment, it may age at a rate faster than would otherwise be considered normal. Salt water, moisture, humidity, sand, grit, dirt, acids: all of these factors can make a piece of machinery age at a much faster rate than would normally be expected, often because they cause excessive wear and tear on the machine's components. If you were considering using machinery like this as collateral in a bank loan, you may find it isn't considered to be worth as much as you might expect.

In both of these cases, the machine itself can be expected to last a longer or shorter time period than may have been originally expected based on the appraiser's prior knowledge of the equipment. Because a machine appraiser spends all day looking at equipment, they have a good eye for when a machine is in exceptional condition and will last significantly longer than expected. For example, a well-maintained piece of equipment that is kept in an ideal environment and worked well below its top specifications can be expected to last much longer than a piece of machinery that is poorly maintained in a bad environment and regularly worked at the very top of its expected performance will. 

When you have a machinery appraisal performed on your equipment, you're able to discover about how much longer it can be expected to perform economically for your company. Having this information available makes it much easier to determine when you'll need to purchase replacement equipment. You'll have more time to shop around, learn about the best new features and decide exactly what type of machinery you need and what budget you can afford to spend on the right equipment. That's always a much better option than being forced to quickly replace failing equipment with machinery that won't meet your needs.

By knowing your machinery's effective age, you can better plan for your company's financial needs in the future. This allows you to spread any equipment purchases out over time without having to worry about your equipment failing before it's paid off. By knowing this figure, you can ensure that your company has the means in line to replace the equipment when the time comes without exposing the business to excessive risk.