What is the obsolescence factor in the process of valuating machinery and equipment?

What is the obsolescence factor in the process of valuating machinery and equipment?

Webster’s Third New International Dictionary defines obsolescence as a factor included in depreciation that covers the decline in the value of assets resulting from the presence of new and better processes or machines, changes in demand, design, or craftsmanship, etc. From technical or legal changes, but material depreciation is not covered in the valuation of machinery and equipment.

Obsolescence can be divided into three types:

1- Technical obsolescence:

It occurs due to a change in the design and building materials of the factory and the machines under valuation. The machines and equipment are considered modern, advanced equipment with a low occupancy rate improved efficiency, and technical obsolescence may result from the advancement of new technologies that cause changes in the production rate or reduce operational costs.

2- Job obsolescence:

It is the loss in value of machinery and equipment due to failure to meet the requirements of more efficient and less expensive alternatives in functional obsolescence.

Equipment valuators usually consider functional obsolescence when there is a technical development in assets. Functional obsolescence occurs when a machine loses its maximum capacity during its operation due to the low level of its parts or due to a defect in the design.  Or an error in the location of the industrial facility, and this is a comparison to its most recent alternatives.

3- Economic obsolescence:

Economic obsolescence may include the loss of the value of an asset due to external factors such as changes in laws or regulations, an increase in the cost of raw materials, manpower, facilities, financing capacity, or changes in the industry. These factors of economic obsolescence may affect the value of a machine or piece of equipment.

This is due to external factors specific to the factory and its equipment. It may be due to a change in demand for the manufactured product, or lack of supply of raw materials and labor, or legislation affecting taxes, customs duties, environmental controls, or zoning controls. (Valuation of machines and equipment)

Factors on which economic obsolescence is based:

• Lack of demand for the company’s product
• Overcapacity in industry
• Raw material supply disruption
• High cost of raw materials, labor, facilities, or transportation
• While the selling price of the product remains constant or may decrease at a low rate
• Government regulations

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