When discussing hard assets, there are various categories, such as furniture, fixtures, and equipment; vehicles or rolling stock; inventory (both for resale and parts for everyday repairs); leasehold improvements; and licenses, patents, and trademarks. Each category of assets has to be analyzed individually, and some research is required. Keep in mind that, in addition to the fair market value of each item, you may have to arrive at the "value in use" of the equipment. Value in use is defined as: "The value of an economic good to its owner/user is based on the production (privacies in income; utility or amenity form) of the economic good to a specific individual. This is a subjective value, however, and may not necessarily represent market value." It is crucial to determine the value prior to an asset sale.
Furniture, Fixtures, and EquipmentWhen appraising furniture, fixtures, and equipment, several things can happen when trying to research the values. For instance, you will usually encounter one of two scenarios when discussing with different people, such as used equipment dealers, the occasional auctioneer (although you are mainly looking for fair market value, auction value is the market in some cases), and trade association magazine classified ads, as well as the owners and owners of similar businesses. The first type of evaluation is that everyone seems to know the value of the various pieces of equipment; the second is that no one can give you a straight answer until they see the equipment and its condition.
In most cases, it is wise to research these items or to have a competent equipment dealer come out and value each piece separately. This will give you the tangible asset value. There is usually a nominal fee for a value per item, estimated at a retail-selling price.
Once this process is completed, you can adjust the equipment on the balance sheet by adding to or deducting from depreciation to reflect the fair market value of the assets. This gives you an economic adjustment that is based on fair market value rather than a taxed-based value as set forth by IRS schedules, which are usually only for tax purposes and generally do not reflect the true value of the equipment.
Remaining Useful Life (RUL) Appraisal
The cases in which hardly anyone knows the value of the equipment until they see it is an indication that age, condition, and model have a significant impact on value. Although each dealer or contact (including the owner) may not be sure what the equipment is worth, all can definitely calculate how long each piece of equipment will last. This is where the remaining useful life (RUL) method applies.
Keep notes that record whom you talk to and their estimate of useful life for each piece of equipment. Based on a range of life expectancy, you can deduct a fair and reasonable remaining time frame for each piece of equipment. The calculations are a simple mathematical method of re-doing the depreciation schedule that an accountant has used.
Sometimes, you will find that the depreciation schedules that an accountant has previously applied still accurately represent the true life expectancy of the equipment and, therefore, do not need adjusted. This is often true in hi-tech electrical or computerized equipment, but in most cases, schedules fluctuate and a new depreciation schedule must be established from the research collected.
An example of the methodology and calculations used to determine the value (or change it into an economic depreciation) is shown in the following example: In a restaurant, an accountant has used a seven-year life on a stove, when the true life expectancy of that stove is at least 15 years and the original cost was $2,000. Therefore, if the owner paid $2,000 and has used it for five years, then this piece of equipment has a remaining useful life of 10 more years. The calculations are as follows: $2,000 divided by 15 years = $133.33 per year in loss of value. With 10 years left, it is a simple calculation: the stove is worth $1,333 ($133.33 x 10 years = $1,333). Since the accountant's value on the books is $750 ($2,000 divided by 8 years x 3 more years of life, or $2,000 - $750 = $1,250 in depreciation), you can add back $583 to the $1,250. This will add a positive $667 to reflect a depreciation of $583 to the minus $1,250. Therefore, $2,000 (original cost) minus $667 is $1,333.
This simple mathematics must also be influenced by the condition of the equipment. The preceding example assumes that the equipment is in good condition and has been maintained routinely. However, some equipment may have been severely abused or neglected and have no ongoing maintenance program in place, thus forcing the appraiser to lower the remaining useful life. Although this seems extremely subjective, the following criteria, based on common sense should be helpful in determining condition.
Terms of Evaluation
Definitions of Conditions
The following definitions of conditions have been developed for use in Business Evaluation Systems' appraisals. They are intended to promote a good understanding of the conditions that are assigned to items and an effective means of communicating the impact of condition on value. Care must be taken in assignments of condition ratings to accurately reflect the impact on value.
- Excellent: Product is in new, near new, or practically new mechanical condition with extremely low hours of use, no defects, and is often still under warranty.
- Very Good: These assets are in exceptionally well-maintained condition. Many have just recently been completely overhauled or rebuilt with new or almost new materials and/or have had such limited use that no repairs or worn part replacements are necessary. They have very low hours of use.
- Good: Asset is in complete operating condition. No known or obvious mechanical defects but may have some parts with minor wear that will need repair or replacement in the near future. Many have high hours of use but no defects are obvious.
- Fair: Product has very high hours or extensive use. Defects are obvious and will require repair or general rebuild soon. It is not 100% functional or efficient; it may be operational or functional but is questionable.
- Poor: Product has seen very hard and long hours of service. It requires rebuild, repair, or overhaul before it can be used. It is not operational or functional.
- Scrap: The cost of repair exceeds the value or cost of replacing it with similar equipment. It is past useful or functional life and should be sold as scrap.
Condition codes are as follows: (E) (V) (G) (F) (P) (S)
It should be noted that, when determining conditions, the appearance of the particular item should be taken into consideration. However, the equipment must be judged on mechanical and electrical working conditions and not solely on aesthetic value. Paint, lubrication, and general clean-up should be part of general maintenance and should not be used to cover up defective equipment. The appraiser must use experience and first-hand knowledge of the equipment to make accurate judgments for condition ratings.
The physical condition, deterioration, depreciation, or state of repair is a major factor in values. Loss of value due to curable or incurable depreciation is a consideration of market value.
Please keep in mind the element of common sense, and if possible, obtain a repair schedule or a maintenance schedule. For example, take the case of oil field equipment. Although an engine or draw on a rig may appear to be in severe need of repair, if you check with the head of maintenance, you may find that the piece of equipment is pulled and completely rebuilt from time to time, and the parts are in the warehouse, ready for this repair. What you have is an engine that is currently in "poor condition," but all of the new parts are in the warehouse, and it is scheduled to be completely rebuilt soon. This is a normal expense represented in the profit and loss statements and treated as a normal cost of doing business. How would you rate this?
Your answer should be "good": It is running, the parts to rebuild it are already in the warehouse, and labor is an everyday function of the repair department.
Be extremely careful when valuing leasehold improvements. Buyers will not pay for used leasehold improvements if they can get a new "build out" for free, in a similar space. Also, if the owner didn't pay for improvements, then neither should the buyer. Assuming the current owner paid for leasehold improvements and the local lease market is not providing spaces built to the tenant's specifications, use the following schedules:
A. Long-Lived Improvements (10 to 25 year life)
Walls, electrical wiring, and plumbing can be valued at the original cost of installation with no deduction for depreciation. (Inflation rates will compensate for depreciation.)
B. Intermediate Lived Improvements (5 to 10 year life)
For signs, water heaters, air conditioners, air compressors, furnaces, etc., use a straight line depreciation based on actual useful life.
C. Disposable or Fashionable (0 to 5 year life)
Carpeting, blinds, draperies, etc. are subject to rapid wear and fashion trends. They will be worth:
- 75% of original cost if in new condition
- 50% of original cost if in good condition
- 25% of original cost if in fair condition
- 0% of original cost if in worn condition
Vehicles or Rolling StockIn the case of vehicles or rolling stock, there are three good sources for price information:
A. Blue Book ValueThis guide is available at many book stores for a nominal fee and is extremely reliable.
B. Classified AdsMany local publications and newspapers advertise vehicles, and the average price from a number of ads will represent the prevailing market.
C. Depreciation Schedule Model
Minimum value is 20% of original cost. First, enter Mechanical Equipment original value, then deduct accumulated depreciation. The total is the mechanical equipment value. Remember 20% of cost is the minimum.
Asset ValueEvery business has some inventory of stock for internal use or resale. The actual value of stocks or inventory is usually determined by a physical inventory, completed the day the business sale is consummated. You can use the following sources for information:
- Have a professional inventory service determine the market value.
- Use last year's tax statement to find your ending and beginning inventory.