Plant and Equipment Valuations
The valuation of plant and equipment is considered a specialised field of valuations and somewhat set apart from the valuation of immovable property. The discussion below highlights some of the differences and challenges associated with the valuation of plant and equipment.
The plant and equipment valuer must take the following into consideration:
Firstly: Whereas in the valuation of immovable property Market Value has a very limited value range, the value range for plant and equipment can be much broader especially when a production plant is to be valued.
6-Tiered Market Value
There are currently six recognised tiers or levels of market value which can be applied to plant and equipment:
Highest Value v Mortgage Value
While a valuation done under the conditions outlined in level 1 above will return the highest value for the plant and equipment, a lender will be more interested in the value of the plant and equipment under the conditions as set out under level 6. “Level 1” valuations are normally done for financial statement purposes, buying, selling or for mergers. This value therefore reflects the price that a purchaser would pay to acquire the manufacturing/industrial facility, wired up, plumbed in and bolted to the floor, together with all ancillary loose plant, equipment and plant services located at the premises which the hypothetical purchaser will occupy.
Comparable Sales Approach
Secondly: The South African courts have indicated that the comparable sales method is the most acceptable approach for the valuation of fixed and moveable assets. The method is however only applicable to assets for which there is an active market with several transactions from which supply and demand trends can be analysed.
Experience have shown that due to the uniqueness of production facilities in layout, equipment configuration and many other factors, there will exist very few direct comparable transactions. In this scenario the Depreciated New Replacement Cost approach is considered. Normally this approach is considered as an approach of last resorts when the comparable and income approaches cannot be used.
International Valuation Standards Council
According to the International Valuation Standards Council (IVSC) “The cost approach provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk or other factors are involved. The approach provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for physical deterioration and all other relevant forms of obsolescence.” (IVS2017).
Depreciation - Accounting
It is important to understand that the word “depreciation” is used in a different context in valuation compared to financial reporting or tax law. In financial reporting depreciation is a charge made against income to reflect the use of an asset. This charge is spread on a systematic basis over the useful life of the asset to the entity. Certain tax regimes also provide for “depreciation charges” to be offset against taxable profits. These are distinct usages of the word and are subject to specific definitions and procedures set out in the relevant accounting standard or tax law.
Depreciation – Asset Valuation
In the context of the Depreciated Replacement Cost method as defined by the IVSC (2017), depreciation refers to adjustments made to the cost of an equivalent asset to reflect any comparative obsolescence that affects the subject asset and has no regard to the accounting policies or tax profile of the owner or potential owner.
In asset valuation terms the Depreciated Replacement Cost method is used to calculate the net current replacement cost (NCRC) of equipment and this is done in a two-stage operation:
A residual or salvage value for the equipment at the end of its useful life is also taken into consideration. For some equipment this value can represent a “scrap” value, while for other equipment this value can be up to 20% of its original cost price. This value depends on the market for secondhand equipment and the extent to which a piece of equipment can be economically refurbished to a more current functionality.
PPE Valuations have created various depreciation models which return an S –curve (polynomial) depreciation profiled.
This profile allows for a gradual depreciation over 70% of the asset’s life with a sharp increase in the rate of depreciation occurring during the remaining 30% of the asset’s life.
This profile furthermore best describes the depreciation of an asset under normal maintenance conditions. A further deduction can therefore be made for poor maintenance conditions.