Tangible Assets Lose Their Value
Thomas M. Brown
service for the valuation of machinery and equipment is a
rare exception in today’s market. Standard service begins
with planning the study and includes a site visit, an inventory
of assets to the level of item control necessary for planning,
and a valuation of the controllable units and property groupings.
market demands lower-priced alternatives to arrive at the
value of tangible personal property. Two practices in use
within the appraisal profession that have responded to this
demand are 1) net book value (NBV) equals fair market value
(FMV) and 2) trend and depreciate historical property records.
The question is whether these lower-cost practices can still
provide a reasonable grasp of the asset values in question.
Book Value Equals Fair Market Value
provisions of both SFAS 141, Business Combinations,
and 142, Goodwill and Other Intangible Assets,
have led to an acceptance of the reported NBV as evidence
of the FMV of the tangible assets.
is the net result of a variety of accounting decisions related
to whether expenditures are capitalized or expensed. NBV
is a function of the property classification of the asset,
the application of a depreciable life and method, the recognition
of a salvage value, and the application of a depreciation
convention. NBV is further influenced by the accounting
system’s ability to keep up with asset transfers and
partial or complete retirement of the asset itself. In addition,
there is the impact of fully reserved assets that have zero
NBV or that may even be removed from the record when they
become fully reserved.
presence of reported goodwill is the result of a company’s
having applied purchase accounting to an acquisition sometime
in its past. Thus,
the NBV of tangible assets is further subject to SFAS 141
purchase price allocation treatment and the application
of depreciable lives and methods to what is essentially
a collection of used assets.
is dependent upon the cost of new assets, the market prices
of similar assets being bought and sold in the used market,
and the impact of age, wear, technology, and market conditions
as they may be quantified in physical, functional, and economic
is the likelihood that NBV will equal FMV? Mathematically,
it can and does happen. But those incidents are far fewer
than proponents suggest. The following are some of the events
that drive FMV to be different than NBV.
existence of fully depreciated assets on the books and in
use with NBV equal to zero. For example, consider
the valuation of a large developer of computer software
for an SFAS 141 allocation. The company used an 18-month
life for depreciation of its computer equipment. Thus, all
computer equipment more than 18 months old had zero NBV.
The company, however, had tens of millions of dollars of
computer equipment more than 18 months old that was still
in use. The equipment represented millions of dollars to
the buyer of the business that would not be recognized if
it were assumed that NBV equals FMV.
capital-versus-expense policy may influence the magnitude
of the difference between NBV and FMV. Many
companies have high dollar cutoffs, meaning some longer-lived
assets below the dollar cutoff may not be reported on the
books at all. Other companies capitalize large expenditures
because of the magnitude of the expenditure, but the result
may not be a long-lived asset with value. Such costs include
relocating equipment, repairs, cleaning, and painting. The
effects of the capital-versus-expense policy can be compounded
over time. The company may be more aggressive in expense
treatment in good years, while capitalizing costs more in
is based on the historical property record.
Most companies’ historical property records lack the
communication and policies to capture and reflect all asset
retirements. Many companies’ property records have
one or more “group” entries, such as “1997
equipment, $2,749,635” or “1998 improvements,
$44,898,000,” that do not describe any specific assets.
Rarely are partial retirements made to group entries as
components of these asset records are retired. Over time,
the cost (and NBV) remain on the books, but assets are gone
and thus have zero FMV.
the trend-and-depreciate approach, price adjustment factors
are developed to trend the original costs reported in the
property record to estimates of cost of reproduction-new
(CRN) as of the purchase date. Then, depreciation factors
are applied to the CRN to arrive at an estimate of FMV.
The accuracy of the resulting value opinion is often dubious
due to a variety of factors, some of which are explored
factors must be developed for the specific type and age
of the equipment. The type of equipment makes
a difference, since the price changes of equipment vary
over time. For example, prices of computer equipment may
decrease while general machine tool prices increase over
the same period. Thus, the property record must reflect
sufficient detail to develop trend factors to reflect a
company’s unique mix of asset types. Examples of records
that would not be specific enough to be trended might include
plant addition, machinery and equipment, warehouse equipment,
and addition to the printing line. Such records lack the
specific nature of the asset to properly develop a trend
application of trend-and-depreciation factors depends upon
the asset records reflecting the acquisition date and cost
when purchased new. Property records that
reflect prior purchase accounting have the acquisition dates
reset to the date of the business purchase, and cost is
allocated. An allocated record is not a proper base for
trending and depreciation. Trend factors are developed based
on price changes of the asset type over time. The base is
always the cost of the asset when new in its year of manufacture.
When either piece of information is lost through purchase
accounting, trend-and-depreciate methodology cannot be applied.
NBV will equal FMV only by accident.
trend-and-depreciate exercise largely depends upon the quality
of the historical property record. If asset
retirements have not been properly removed from the record
over the years, costs will be overstated and the resulting
value will be too high. If the record is missing costs due
to capitalization issues or write-offs of fully reserved
assets, the value indicated by trending will understate
the true asset value.
Means for Efficient Valuation
standard service outlined earlier is the best means of determining
what assets are present, their location, age, condition,
and FMV. The standard service is costlier than some other
services, but is the best approach when documented and fully
supportable values are needed for the IRS, an accounting
review, or the courtroom.
the name of cost savings there are many abuses in the application
of the NBV-equals-FMV theory and the trend-and-depreciate
routine. Consumers of valuation services should be aware
of other cost-effective means to determine FMV when records
are suspect. Through the use of trained and experienced
machinery and equipment valuation experts, valuation consultants
are able to opine on supportable values in a cost-effective
manner. Some of these alternatives include the following:
If there are multiple properties that are similar in nature,
such as retail stores, the appraiser can inspect and model
typical facilities. Value indications of base models can
then be applied to the universe of properties.
If the requirements are simply to have values without
much documentation, the experienced machinery and equipment
appraiser can do a walk-through on a facility. Equipped
with years of experience and knowledge of machinery and
equipment values, the appraiser can create a short-form,
line-item listing of what physically exists in the facility
and its respective value.
The trend-and-depreciate method can be combined with on-site
verification. During the on-site verification, the appraiser
can accomplish a number of things to enhance the reliability
of the value conclusion. First, the appraiser can verify
the existence of major assets and remove recorded assets
which are no longer in existence. The appraiser can also
spot major assets that may not be on the existing record,
value them, and include them in the conclusion. By being
on site, the appraiser can also note the use of assets
and maintenance policies to develop depreciation factors
representative of the actual property.
Sometimes the sheer size of a project intimidates the
parties. An acquisition may include tens or even hundreds
of domestic locations and a similar number of international
properties. The fear of large appraisal fees may influence
the appraisal decision, resulting in minimal valuation
work and unreliable value conclusions. One alternative
is to stratify the project into modules; a valuation plan
can be developed for each module depending on the size,
relative value, and location of owned property. Depending
upon the company’s needs, major facilities may have
walk-throughs and other locations may be trended, while
some minor locations default to NBV. The result will be
more supportable than a valuation based solely on trending
or NBV equals FMV.
Costs of Inaccurate Appraisals
are the implications of asset valuations that are completed
hastily and result in poor and perhaps unsupportable values?
First, overstating asset values will overstate property
tax bills for years to come. When records are used for insurance
placement, overstating values means paying excessive insurance
premiums. Understating values exposes the company to inadequate
coverage in the event of disaster. In addition, there is
the excessive cost of labor to try and track and report
the investment in fixed assets while using an asset record
that is inaccurate and unreliable.
most important reason, however, is that management and boards
of directors have an ethical, legal, and fiduciary responsibility
to properly maintain records that accurately report a company’s
financial position. Management and directors have an obligation
to shareholders, the SEC, the IRS, taxing authorities, and
others relying on their financial statements to supply records
that fairly reflect reported assets.
M. Brown is a senior vice president and national
director for the Industrial Valuation Group of American Appraisal