PLANT AND MACHINERY VALUATION PRACTICE

BY CHUDI NGWULUKA, ANISV RSV Secretary NIESV Plant and Machinery Faculty Email:chudi@chudingwuluka.com ABSTRACT Valuation of plant and machinery is an area of valuation which requires a high level of expertise and experience. It is indeed a specialized aspect of valuation and requires robust understanding of machines, tools, equipment etc and especially industrial plant and machinery. This aspect of valuation is probably the least known discipline within the profession. It has produced more uncertainty for even experienced valuers than any other aspect of valuation. This is because of the complexity of some plants, poor market information, inability of valuers to apply the appropriate valuation method etc. This study therefore outlines the principal knowledge required in valuing plant and machinery; information and market survey, valuation approaches, assumptions and report writing. It is hoped that this will reduce the knowledge gap and encourage valuers to be more involved in plant and machinery valuation. The demand for plant and machinery valuation services is increasing and suitably qualified valuers are needed to carry out these services. INTRODUCTION The Iron Age marked the beginning of man s greatest achievement in departing from his crude way of life to full scale development of machines. This period brought in the beginning of industrial revolution with greater reliance placed on the use of heavy industrial machines. According to the Guidance Notes on Valuation of Assets (RICS 1979), the practice of plant and machinery valuation came to life in the middle of the 19th century and was largely based on the textile industry in the North of England. The pace of globalization of investments markets coupled with the vast advances in high technologies all underscore the need for highly specialized skill in plant and machinery valuation that meets internationally accepted standard. Plant and machinery valuation is a generic specialization within the general valuation discipline much like internal medicine, surgery, gynecology etc are specializations within medicine. When one pauses to reflect upon the immense variety of plant and machinery at work in our factories, the prospect of becoming a plant and machinery valuer becomes both

challenging and exciting. How many careers offer one the opportunity of unlocking the doors contained within factory walls and inspect without encumbrances the detailed workings of the plants and machineries that produce a Nations wealth? According to IVSC Guidance Note 3 2005, plant and machinery assets have particular characteristics that distinguish them from most types of real property and that influence both the approach to and reporting their values. Plants are typically capable of being moved or relocated and often will depreciate at a significantly faster rate than real property. Frequently, the value will differ notably depending on whether an item of plant or equipment/machinery is valued in combination with other assets within an operational unit or whether it is valued as an individual item for exchange and where it may be considered as either in-situ (in place) or for removal. DEFINITIONS: International Valuation Standard Committee (IVSC) Guidance Notes 3, 2005 defines plant, machinery and equipment as follows: Plant: The assemblage of assets that are inextricably combined and that may include specialized buildings, machinery and equipment. The combination of such assets may be achieved by means of integrated support structures, cladding and staging that are incapable of being separated from the assemblage. Machinery: Individual machines or collections of machines. A machine is an apparatus using or applying mechanical power, having several parts each with a definite function and together performing certain kinds of work. Equipment: Ancillary assets that are used to assist the function of the enterprise/entity. According to Kuye Olusegun the dividing line between plant, machinery and equipment is that, while a plant could be just one item such as a generator, or several items (machines) working in consonance with each other for one purpose, a machine or equipment can only be one item performing one or two functions which are never enough to achieve the objective of the business. CLASSIFICATION OF PLANT AND MACHINERY Belo, M.A. classified plant and machinery with regards to their functions; (a) Power plants: Used mainly or exclusively in connections with the generation, storage, primary transformation and transmission of power. This could just be the generator and or transformer in some industries.

(b) Service plant:

Used mainly in connection with the heating, cooling, ventilating, lighting, draining or supply of water. Air conditioners, water pumps, hydrants, water heaters, treatment plants are examples. All vehicles owned and registered by the company. Items that provide for movement of materials and products around the premises of the industry. used for the purpose of production of the main line of business of an industrial concern and is not an item in the nature of a structure or building. Used for lifting passengers or goods. Examples are lifts and elevators in the form of conveyors. Used for the conveyance of anything on the premises except drains or sewers example is pipe for the exclusive supply or Petroleum products to the industry. These are hand tools used for various functions mostly in maintenance departments.

(c) Vehicles: (d) Access plant:

(e) Process plant:

(f) Lifting plant:

(g) Pipeline:

(h) Loose tools & equipment:

VALUATION INSPECTION The amount of work involved depends on the size of the plant. Considerable preparation is necessary before the physical inspection can be undertaken. A detailed checklist should be used to take down the necessary information from the documents provided and physical inspections. Plants and machineries are usually not the same. There may be differences in designs, standards, technologies, sizes, capacities, makes, applications, maintenance requirements et.c. The valuer must note all these. There are old and new plants, idle plants, imported plants, indigenous plants and fabricated plants. Standard of installation, availability of spare parts, life expectancy of plant and its economic viability all play major roles in valuation. The valuer must therefore access these information during inspections. The valuer assesses the value of the plant and machinery by conducting a factory floor inspection and detailed survey of all the physical assets so as to record the nature, extent, condition and subsequently to determine plant and machinery on site as against

the client s own records/register. The valuer must therefore create a plant and machinery register for the plant being valued. INFORMATION AND MARKET SURVEY For the valuer, substantial information comes in from the client. The documents and information available with the accounts department such as: list of plants and machines, purchase bills, balance sheets, year of purchase, engineers certificate, addresses of manufacturers (for taking the new machine prices), life of machines indicated by manufacturers, installation costs, duties paid, exchange rates, technical specifications of plant and machinery etc can give lots of useful information for the valuation work. More information comes from the physical inspection of plants and machines i.e. information on the name plates, environment, maintenance schedules, level of operation (in operation or idle), type of installation, physical existence, technology etc. A representative or staff of the client usually helps around in inspecting and collecting the necessary information. Valuers must not be shy to ask questions. The information and factors needed to be considered during the analysis and work out are listed as follows: Purpose of valuation, description of plant and machinery, model no, serial no, country of manufacture, purchased new or used, year of manufacture, year of purchase or fabrication, year of installation, cost of comparables, cost index in the year of purchase, cost index on the date of valuation, number of years used, import duties at the time of purchase and on the date of valuation, exchange rates at the time of purchase and on the date of valuation, life and accurate estimate of residual value of plant and machines to decide on the depreciation rate. FEATURES OF PLANT AND MACHINERY AFFECTING VALUE According to International Valuation Standard Exposure Draft 2010; when undertaking a valuation of plant and equipment assets, the following considerations may be appropriate depending on the nature of the plants and equipment assets and the purpose of the valuation: Costs of installation and commissioning where plant and equipment assets are valued in-situ. Costs of decommissioning and commissioning, removal and possible reinstatement following removal and which party is to bear those costs where plant and equipment assets are valued for removal. Finite sources of raw materials

Limited life of the building in which the assets are situated. Limited tenure of the land and building housing the plant Statutory restrictions Environmental legislation VALUATION APPROACHES In the valuation of plant and machinery, basis of valuation vary in accordance with the purpose of valuation. The purpose of valuation includes financial, insurance, open market, compensation and rating. Valuation of plant and machinery is a specialized field of valuation. It is the estimation of rental or capital value of plants and machinery for a particular purpose at a given time. According to IVS 102 exposure draft 2010, the valuation of plant and machinery can be carried out through the adoption of any of the three main valuation approaches; Direct Market Comparison Approach Income Capitalization Approach Cost Approach DIRECT MARKET COMPARISON APPROACH The direct market comparison approach is a comparative approach that considers the sales of similar or substitute assets and related market data. In general a plant or machine being valued is compared with similar ones that have been transacted in the market or that are listed or offered for sale, with appropriate adjustment to reflect different properties or characteristics. INCOME CAPITALIZATION APPROACH The income capitalization approach considers the income that a plant or machinery generates over its remaining useful life and estimates value through a capitalization process. This process applies an appropriate yield or discount rate to the projected income stream to arrive at a capital value. The income stream may be derived from the profit generated from either the use of or holding of the plant or machinery. The income capitalization approach can be applied where an all risk yield is applied to a fixed income stream, where the cash flows for future periods are discounted to a present value or to liabilities by considering the cash flows required to service a liability until it is discharged.

(a)

(b)

(c)

COST APPROACH The cost approach applies the basic 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, risk, inconvenience or other factors are involved, the price that a buyer would pay for the plant being valued would not be more than the cost to acquire or assemble a modern equivalent. Often the plant or machinery being valued will be less attractive than the cost of a modern equivalent because of depreciation. Where this is the case, adjustments will need to be made to the cost of the modern equivalent. This adjusted figure is known as the Depreciated Replacement Cost. HIERARCHY AND MULTIPLE USE OF APPROACHES: Where directly observable prices for identical or similar assets are available at or close to the valuation date, the direct market comparison approach is generally preferred. Where this approach cannot be applied reliably because of either an absence of price information or because the asset is unique or has features that make it materially different to other plants of a similar type that are being transacted at or close to the valuation date, the income approach or the cost approach may be more appropriate. At sometimes it will be appropriate to use more than one approach or method in order to arrive at the valuation estimate, especially where there are insufficient factual or observable inputs to fully support the use of one method. Where alternative approaches and methods are used, these should be weighed and reconciled into a final value estimated. ASSUMPTIONS For many purposes, including compliance with IFRS, the most appropriate basis of value is Market value. However, market value simply stipulates that an exchange is assumed to take place on an arm s- length basis between knowledgeable and willing parties, it is silent as to how the particular asset is to be presented for sale or any of the other specific circumstances that could have a fundamental effect on the valuation. When undertaking a valuation of plant and machinery, the valuer must therefore establish and state the additional assumptions that are appropriate, having regard to the nature of the asset and the purpose of the valuation. These assumptions may include the state of the business in which the plant and equipment are currently utilized, or the extent to which individual items are aggregated with other assets. Examples of assumptions that may be

appropriate in different circumstances or for different valuation purposes include; - that the plant and equipment are valued as a whole, in situ (in place) and as part of the business as a going concern; That the plant and equipment are valued in-situ but on the assumption that the business is closed; or That the plant and equipment are valued as individual items for removal from their current location.

For assets in the public sector, the assumptions equivalent to a business continuing as a going concern is that the public sector assets will continue to be used for the provision of the relevant public goods or services. The list of assumptions above is not comprehensive due to the diverse nature and transportability of some plant and machinery. Market value will need appropriate qualifying assumptions to describe the state and circumstances in which the asset is offered to the market. These assumptions should be discussed with the client and must be included in the report. ADHERENCE TO HIGHEST STANDARDS Every valuer must arm himself with current editions of International Valuation Standards. The International Valuation Standard ensures an accurate and efficient plant and machinery valuation/appraisal. Valuers must therefore adhere to the highest level of appraisal standards by conforming to the uniform standards of professional appraisal practice. The valuer s commitment to this standard will no doubt earn him respect from clients and the industry. REPORT WRITING The valuation report on plant and machinery include a register showing items of plant and machinery, grouped either by physical location, brief technical description, price of each item on the basis of definition such as cost of replacement new, market value, forced sale value and scrap value. The report will also contain the basis of valuation, purpose of valuation, extent of investigation, nature and sources of information, assumptions, valuation approach, date of valuation, date of inspection, publication restrictions,

confirmation that the valuation has been carried out in accordance with the International Valuation Standards (IVS) et.c. In addition to the requirement in IVSC 2010 under 105 (valuation reporting), IVS 2010 302.01 states that a valuation report on plant and equipment assets shall include comment on such of the following as is relevant to the purpose of the valuation; the impact on the value of the real property if the plant and equipment assets connected with the provision of services to a building are valued separately from the real property. the impact on the value of the plant and equipment assets attributable to the existence of any intangible assets.

The final step in the valuation process lies in communicating the value to the commissioning party and any other intended users. It is essential that the valuation report communicates the information necessary for proper understanding of the valuation. A valuation report should not be ambiguous or misleading and should provide the intended reader a clear understanding of the valuation provided. CONCLUSION A valuer for plant and machinery must keep himself updated on new technologies, manufacturers and sources of old and new plant and machinery in Nigeria and abroad, import regulations and duties, standards, installations, maintenance, economics, life of plant and machinery etc. Major parts of plant and machinery consist of mechanical and electrical machines and equipments. Knowledge of automation, controls, and electronics is also important. The plant and machinery valuer s knowledge and expertise builds up slowly with each valuation and other research sources. For the valuer to assert himself as the appropriate professional to value plant and machinery, there is a great need for continued professional development, trainings and certification in the field. REFERENCES Alico, J. (1989). Appraising machinery and equipment. In J. Alico (Ed) textbook Committee of the American Society of Appraisers. New York: Mc (Graw-hill Book Company). Belo, M.A. (2003). Guide to plant and machinery valuation. London: Armitage Books Guru PR.

Budhbhatti, K. (1999). Valuation of plant and machinery: Theory and practice. India: Grahpic Printers, Gujarat. Egolum, C.C. (1991). Valuation of plant and machinery, practice and methodology. The Estate Surveyors and Valuers, Journal of the Nigerian Institution of Estate Surveyors and Valuers, Vol 15 No 2. Ifediora, G.S.A. (1988). Valuation of floating assets. Paper presented at Nigerian Institution of Estate Surveyors and Valuers at Eko Hotel, Lagos. International Valuation Standards Committee (2005) Guidance Notes 3: valuation of plant and equipment. International Valuation Standards Committee (2010) Exposure Draft: valuation of plant and equipment. Mendenhall, J & Roedel, J.F. (n.d). definition of values. MVS machinery valuation services Inc. Retrieved March 23, 2011 from www.machinetoolappraisal.com Olusegun, K. (2009).practical approach to plant and machinery valuation. Lagos: Climax Communications Ltd Royal Institution of Chartered Surveyors (RICS) (2008). Valuation Standards Guidance Note 2 (6th Edition) Royal Institution of Chartered Surveyors (RICS) (1979). Valuation Standards Guidance Note Sushil, J. (n.d). Valuation of plant and machines. Retrieved March 23, 2011 from www.valuerplus.com/links/emag8.html