Equipment Appraisal 101 - 5 Steps to Machinery and Equipment Valuation

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Equipment Appraisal 101: 5 Steps to

Machinery and Equipment Valuation

Do you understand the value of an equipment appraisal?

Do you have a solid understanding of the steps required to

produce a credible machinery and equipment appraisal?

The who, what, when, where, and why?

If not, this heavy equipment appraisal infographic is the

perfect place to start!

The Appraisal Standards Board describes personal property (personal property =

most everything NOT Real Estate) appraisal development in Standard 7: Personal

Property Appraisal Development of the USPAP publication as:

In developing a personal property appraisal, an appraiser must identify the problem to

be solved, determine the scope of work necessary to solve the problem, and correctly

complete research and analyses necessary to produce a credible appraisal. - retrieved

from http://uspap.org/#/65/

Unfortunately, the rest of USPAP Standard 7 isn't as easy to follow, so we cut

through the legalese and came up with this simple infographic flowchart that will

give you an idea of the machinery and equipment valuation steps we follow:


The infographic above concludes the simplified version of the machinery and

equipment valuation process. We are now going to delve a bit deeper into the

infographic as it relates to the finer points of the USPAP publication. We will quote

heavily from the Appraisal Foundation (and refer to them interchangeably as

"Appraisal Standards Board" [ASB] and "USPAP") throughout, as they are

recognized by Congress as the source of appraisal standards.

For those of you that didn't vacate the premises after learning that the simple part

was over, heres my take on the valuing machinery and equipment insights from

the infographic:

Step #1: Identify the Problem to be Solved

No equipment appraisal "problem" is a simple one. Like most real-world problems

we face, there are many questions that must be answered to fully identify the

appraisal problem. Fortunately, we've compiled a checklist of questions that need

to be answered to ultimately identify the problem to be solved:

Identify the Client and All Other Intended Users

This is one of the more straight forward identifications, once the "client" and

"intended user" definitions are understood. USPAP defines the client as "the party

or parties who engage, by employment or contract, an appraiser in a specific

assignment." USPAP further clarifies that "The client may be an individual, group,

or entity, and may engage and communicate with the appraiser directly or through

an agent."

In addition to the client, who engages the appraisal assignment, we must also

identify all other intended users. According to USPAP, an intended user is defined

as "the client and any other party as identified, by name or type, as users of the

appraisal or appraisal review report by the appraiser on the basis of

communication with the client at the time of the assignment.".


eavy Equipment Appraisal says...

It seems like we provide machinery and equipment appraisals for a new business

sector every day, but the most common are:

Bankers & other Lenders

Brokers

Business Consultants

Business Owners (e.g., Construction,

Farming)

Certified Public Accountants (CPA)

Corporations (Mining, Oil Field)

Financial Institutions

Government Officials

Individuals (e.g., inheriting a

machine)

Law Firms & Attorneys

Merger & Acquisition Professionals

Turnaround Management Specialists

The client and all intended users should be clearly identified in the appraisal report.

Identify the Intended Use of the Equipment Appraiser's

Opinions & Conclusions

Why did the client engage an equipment appraiser to provide a machinery and

equipment appraisal? That is the next question we need to answer. We know what

an intended user is, but what about the intended use of an appraisal?

The Appraisal Standards Board defines Intended Use as "the use or uses of an

appraisers reported appraisal or appraisal review assignment opinions and

conclusions, as identified by the appraiser based on communication with the client

at the time of the assignment.".

Identify the Type and Definition of Value

Value is defined by the ASB as "the monetary relationship between properties and

those who buy, sell, or use those properties.". The ASB further states that value

must always be qualified with a specific definition of value, such as Market Value,

Liquidation Value, or Investment Value.


Identify the Effective Date of the Appraiser's Opinions and

Conclusions

The appraisal effective date sets the (time) frame of reference for which the

appraiser arrived at his or her valuation conclusions.


Appraisal effective date is a very important identification because machinery and

equipment markets vary with the times, as does most any market. For example, a

2006 effective date of a home appraisal (Real Estate or Real Property) would (most

likely) be appraised much higher than that same home with a 2009 effective date,

due to the housing market collapse.

Though valuing Real Estate is a different practice than the valuation of

equipment (and other personal property), it makes sense here to borrow an

example from the recent Real Estate market to illustrate the importance of effective

date.

Identify the Characteristics of the Equipment Property

We feel this is one of the most important steps in delivering a credible equipment

appraisal, so we gave it its own step. We cover this in detail in Step #2: Collect.

Identify any Extraordinary Assumptions or

Hypothetical Conditions

Extraordinary assumptions are things that are believed to be true. It is important to

identify these prior to starting a machinery and equipment appraisal assignment

because if one of those assumptions is subsequently found to be false, it could

affect the equipment appraiser's conclusions or opinions of value.

Hypothetical conditions are things that are currently known to be false, but we

create a hypothetical condition of expected, future outcome. Note these, because


your appraisal findings are based on these conditions, and your opinions could

change if the expected outcome doesn't come to fruition.


Extraordinary assumptions and hypothetical conditions help to protect the

equipment appraiser. Let's look at a few examples:

Extraordinary Assumptions

Our Desktop Equipment Appraisals are a great example of extraordinary

assumptions. We don't physically inspect the equipment in a desktop appraisal, so

we base our opinions on things we believe to be true, based on information

provided by the equipment owner, phone calls to mechanics, photos, etc.

Hypothetical Condition

A hypothetical condition example as it relates to machinery valuation might be a

front loader that is in the process of an engine rebuild. Most any machine without

an engine is worth less on the open market than a fully functional one. As such, we

base our value conclusion on the expectation that the engine is rebuilt or replaced

with a new one.

Determine Scope of Work

Once the above are identified, the equipment appraiser has completed the first

step in the process: identify the problem to be solved. With the problem detailed,

the appraiser has sufficient information to determine the scope of work necessary

to produce credible assignment results. USPAP defines scope of work at a high

level as "the type and extent of research and analyses in an appraisal assignment".

And at a more specific level:

The extent to which the property is identified

This will be discussed more in Step #2: Collect, but the basic scope of work

question is: Does the appraiser plan to identify only the major components of a


process (an aggregate plant, for example)? Or does the appraiser plan to identify

the individual characteristics of the equipment (make, model, year, etc.)?

The extent to which tangible property is inspected

This is an important scope of work question to answer, as it is not always

possible to physically inspect each and every equipment item. For example, when

performing a Field Equipment Appraisal for an excavation contractor, it isn't

feasible to travel to see one excavator that is located at a job site 2 states away.


We offer Desktop Equipment Appraisals, whereby we don't physically inspect any of

the machinery. This is a popular choice made by the client or intended users. The

client might opt for a desktop appraisal for a variety of reasons, including: the

appraisal assignment has a tight deadline or because they are usually more cost

effective than a field appraisal.

The type and extent of data researched

Will the machinery and equipment appraiser research comparable sales at a local

level? National? Global? Will the appraiser seek out reproduction or replacement

costs for the equipment property?

The type and extent of analyses applied to arrive at opinions or

conclusions

As per The Appraisal Standards Board, the appraiser must consider all 3 valuation

approaches (covered in Step #3: Consider below).

The last two scope of work considerations take aim at answering the question

of how much digging is necessary to provide credible appraisal results.

Enough with identifications, let's get our eyeballs (and hopefully hands) on the

equipment property.


Step #2: Collect, Identify, Classify, and

Describe

Now it's time to roll up our sleeves, put our dirt digging (hard) hat on, and dig in.

We already determined what level of detail we plan to identify the equipment in

the scope of work section above. This determination depends largely on the

property being valuated.

For example, let's say our assignment is an aggregate plant. Our machinery and

equipment appraisers will take the following 3 step systematic approach to

identifying the plant's characteristics:

#1 Collect facts and data relating

to the full life cycle of the plant

We will first identify the product and

byproducts that the plant produces. In

our example, the final product is concrete.

#2 Determine how the finished

product is produced

Identify the major components in the

aggregate plant. In our example, we might

have a quarry, a crushing plant, a washing

plant, and a batching plant that all play an

integral role in producing the final product. Often, a plant diagram or flowchart is

the most efficient way to answer this question.

#3 Identify the output capacity of the plant

This is an important identification, especially if we choose to value the plant using

the income valuation approach (more on the income approach in Step #3:

Consider below).


If the assignment isn't a plant, but equipment valuation for a fleet of rolling stock

(trucks, construction equipment, trailers, etc.), we take a different approach

to identifying characteristics. In this scenario, we are more interested in capturing

and recording equipment characteristics such as year, make (Caterpillar, John

Deere, etc.), model, serial number or VIN, and hours/miles.


The method(s) by which you collect, identify, classify, and describe the equipment

characteristics depends on the scope of work decision "the extent to which tangible

property is inspected" we made above. As mentioned, we provide both physical

inspections (field appraisals) and desktop appraisals.

Regardless of the method by which we identify the equipment's characteristics,

the equipment owner should be able to quickly provide the machinery and

equipment appraiser with the most complete, up-to-date facts and data on the

equipment property. After all, the owner purchased the equipment, oversees the

servicing, and thus, should know it better than anyone, right?

If the owner isn't able to furnish this information, the machinery appraiser should

identify that, realize that it will take extra time to collect this information,

and account for this in the scope of work.

Step #3: Consider 3, Apply 1 Equipment

Valuation Approach

With the complete equipment list at our fingertips, we need to carefully consider

all 3 equipment valuation approaches: 1) Sales Comparison approach 2) Cost

approach 3) Income approach. After careful consideration, the appraiser chooses

one approach that he/she feels is necessary to produce the best credible

assignment results.

Sales Comparison Equipment Valuation Approach


The sales comparison approach is very common in equipment valuation. If you've

ever heard your Realtor talk about "comps" when buying or selling a home, then

you are familiar with sales comparison approach. The logic here is that an

educated buyer would expect to pay a similar price for similarly sold items. This is

true in any market, whether it be a bulldozer or a house.

The tricky part for an equipment appraiser, however, is that heavy equipment sales

aren't a matter of public record, like home sales are (in most states). This means

that comparable sales for equipment aren't as easy to come by as home sale

prices. So the next time you are evaluating machinery and equipment appraisers

for an assignment, ask each about their sales comparison methodology.


One thing that sets Heavy Equipment Appraisal apart from the competition is our

background in equipment and the strategic alliances we maintain with independent

equipment dealers.

This means that we have strong network connections to those who buy and sell

equipment locally and globally every day, giving us the inside track to those hard-to-

come-by equipment sales comps!

The sales comparison equipment valuation approach is best applied when there

exist many sales of the same, or very similar machines.

Cost Equipment Valuation Approach

The cost approach to equipment valuation is a deep topic, but can most

efficiently be explained by this calculation:

Cost Approach = Current Cost - Depreciation

Let's break this equation down by talking a bit more about current cost and

depreciation:

Current Cost


Specifically, we're looking at current cost of the machine, as if it were new. Clearly, a

machine is never new after leaving the factory and we often appraise equipment

that isn't new in this decade. So how do we arrive at the current cost of that?! To

do so, we first consider the Replacement Cost New approach, then move onto the

Reproduction Cost New approach, if necessary.

Replacement Cost New

What is the cost of replacing the the subject machine with the current-day-

equivalent? That is replacement cost.

Reproduction Cost New

If it is more economical (cheaper) to reproduce the same exact item (or the same

exact item is still being manufactured), we will use the reproduction cost approach.

Depreciation

Appraisal depreciation is different than the accountancy term "depreciation" and

consists of functional and economic obsolescence and physical deterioration.

Now that you know a bit about current cost and depreciation, as they relate to

appraisals, we could really de-simplify the equation above to be:

Cost Approach = (Replacement Cost or Reproduction Cost) - (Physical

Deterioration + Functional Obsolescence + Economic Obsolescence)

The cost equipment valuation approach is best applied when dealing with unique

property and there don't exist many sales of the same subject property (thus,

unable to apply the sales comparison approach).

Income Equipment Valuation Approach

The income approach is another accepted machinery and equipment valuation

technique. This approach attempts to forecast future earnings generated by the

equipment being appraised.


The income technique to equipment valuation includes many steps and variables,

requires making assumptions, and necessitates complex mathematical calculations.

Even with the amount of work required for the income approach, the end result is

still only speculative, and thus, isn't utilized as often as the preceding approaches to

machinery valuation.

Still, there are scenarios where the income approach fits perfectly. A good time to

use the income technique might be for a plant and machinery valuation assignment

- like the aggregate plant example discussed in step 2 above.

Step #4: Equipment Valuation

Now that we've identified all items necessary to produce credible results, collected

all equipment characteristics, and chosen a valuation approach, it's time to

apply our value opinions and conclusion to the equipment or machinery.

Truthfully, we've already accomplished most of this step by way of the previous 3

steps. So now we can take what we have accumulated and start tying those pieces

together for inclusion into the appraisal report.

This will help the machinery and equipment appraiser to compile all of the results

in one place, in an organized manner. This helps to provide big picture clarity on

the assignment by identifying areas that are complete, sections that need attention,

and things that have been overlooked.

With a rough draft of the appraisal report in front of

our eyes, we inspect every detail, looking for

deficient areas. Once those areas are identified, the

appraiser should go into Sherlock Holmes

investigation mode.

This might mean the appraiser gets on the phone

with the foremost expert of a piece of machinery, or

meets up with an appraiser peer to inquire about a

similar experience, or researches auction results,

or...


The depth of this step will vary from appraiser to appraiser, based on

their experience (and/or imagination), so this might be a good series of questions

to ask when considering appraisers.


It is important to note that appraisers aren't experts on each and every piece of

equipment out there. Shy away from machinery and equipment appraisers

who tell you otherwise, because it's just not possible!

We at Heavy Equipment Appraisal aren't afraid to admit that we're not the foremost

experts on every type of equipment. In fact, we're proud to say it! We think that

trying to be an expert on everything is a stubborn mindset that slows us down, and

minimizes our effectiveness by producing less-credible appraisal results.

While we're not experts on every machine, we are professional researchers who

just so happen to have a background in equipment, cultivate a strategic alliance

with one of the best independent equipment dealers in the United States, maintain

a vast database of equipment sales results, and a possess an ever-expanding

network of contacts in the equipment industry at their fingertips!

Step #5: Deliver

Finish preparing the appraisal report* in accordance with Standard 8 of the of

the USPAP. Make any reconciliations necessary. Deliver the appraisal report to the

intended users identified in Step 1.

*Though we touched on the subject of appraisal report writing throughout, we deemed it

outside the scope of this article, so won't offer any more detail. But don't worry, we will

cover the nuts and bolts of equipment appraisal report writing in another write-up, so

check back soon!

Though delivery seems assumed, we felt it was significant enough to have its own

step to wrap things up. Appraisal assignments should be a collaborative effort

throughout the appraisal life cycle, and appraisal results delivery should be no

different. The equipment owner and/or client should have a chance to see the


appraisal before the final delivery. The point of this isn't to allow for biased

opinions to persuade values, or any other reason but to help identify omissions or

miscommunications - and ultimately, make any necessary reconciliations.

Once all sides are confident that no blatant errors exist, put the final touches on the

machinery and equipment appraisal report, and deliver it to the client and intended

users.

Simple, right?!

Now we can dust our hands from this appraisal project, burn all of our

research behind us, and move on to the next appraisal assignment, right? Not so

fast! According to the USPAP Record Keeping Rule:

An appraiser must retain the workfile for a period of at least five years after preparation

or at least two years after final disposition of any judicial proceeding in which the

appraiser provided testimony related to the assignment, whichever period expires last. -

retrieved from http://uspap.org/#/26/

In other words, keep everything. FOREVER! Put

it on lockdown! It's safer that way.

You're proud of your work and want your

appraisal business to thrive, so you want to

show it off to anyone that comes knocking.

Oh, and you probably don't want to be in hot

water by violating the ASB's Ethics Rule!

Documents

Equipment Appraisal 101 - 5 Steps to Machinery and Equipment Valuation