Equipment Appraisal Blog | Understanding Machinery Appraisals

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

Posted by Equipment Appraisal Services on Tue, Jan 30, 2018 @ 04:03 PM

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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.

Tags: appraisal depreciation, functional obsolescence

Understanding Functional Obsolescence in Personal Property Assets

Posted by Equipment Appraisal Services on Mon, Nov 09, 2015 @ 03:30 PM

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How can a piece of equipment be called functionally obsolete is if it something that you use every day? Learn about functional obsolescence in the machinery and equipment appraisal market to make the right decisions about your existing equipment. 

Understanding Functional Obsolescence

A machine appraiser may very well understand what this term means, but the average individual does not. Luckily, the concept is a fairly simple one to understand, even if you are not an equipment appraiser. 

The idea of functional obsolescence originally comes from real estate, although it has spread to other markets like the equipment appraisals market. An item can be said to be functionally obsolete if it is less useful or desirable than it was before. Anyone who has ever upgraded their iPhone to the latest model should understand this concept. 

An item that is obsolete usually has an outdated design feature that cannot easily be changed. In real estate, an example might be a one-bathroom house, when neighboring homes all have 2 baths. For personal property such as a car or truck, an outdated feature might be an early generation personal navigation system that is not as robust as present models of dashboard navigation. 

When there are like items on the market that have newer features and are more desirable, demand for the old item wanes as demand for the item item increases. As more people buy the new item, the value of the old one will continue to decline. 

This has a range of implications for the property owner. A store owner could get stuck with lots of old inventory if he or she invested heavily in an item that has been replaced by a newer model. A landlord could be forced to make costly repairs to an apartment if tenants did not want to rent the unit due to old, less desirable features. Or the items could be sold for reduced profit, with the decreased equipment value cutting into the business's bottom line. 

How to Determine Functional Obsolescence

While you may suspect that something is becoming obsolete, only a machine appraisal can confirm this lowered value for you in terms of real dollars. During the machinery valuation process, an appraiser will review the piece of equipment, compare it to similar inventory, note its condition, and look at other market factors that may effect the equipment or machinery valuation.

Let's say an appraiser was looking at a bottling line that was supposed to bottle 2 units per second. If the unit could not be operated at its full capacity due to external factors, or if the unit required a tune-up and could not operate efficiently, it would not be used at its full capacity and would thus take on a degree of obsolescence. A tune-up may restore the unit to peak operating condition; however, when obsolescence becomes so large, it may be more cost effective to replace the unit than repair it. 

A machine appraiser can examine the equipment and determine the presence of obsolescence. Lowered equipment values could mean a greater tax deduction for the business. Alternately, a lower value could help the company decide to sell the equipment and invest in better technology or realize that a tune-up will save money over purchasing a replacement bottling line. 

Equipment appraisers who specialize in the niche you serve are best qualified to gauge obsolescence. When it comes to valuing the equipment you use every day, trust the experts at Equipment Appraisal Services. 

Tags: appraisal depreciation, functional obsolescence