In one engagement, we valued a number of paper mills. The value of the older equipment has suffered a loss in value due to FO from excess capital cost.įunctional obsolescence from excess operating cost: As a result of new technology or superior design, it may not only be cheaper to acquire a modern asset, it may also be cheaper to operate it. Today one can find laser-based equipment offering the same (or better) utility in a big box hardware store for several hundred dollars. For example, not too long ago, surveying equipment cost thousands of dollars.
When the replacement cost for an asset is less than the reproduction cost, the difference is an indication of FO.
This is the easiest form of FO to quantify if the cost of the necessary upgrade can be identified.įunctional obsolescence from excess capital cost: Equipment appraisers differentiate between reproduction cost (the cost to reproduce the exact same asset) and replacement cost (the cost to replace an asset with an asset providing the same utility). By upgrading the CNC, the machine’s capacity is increased. For example, a milling machine may have its capacity limited by out-of-date computer numeric controls, or CNC. Symptoms suggesting the presence of functional obsolescence are excess operating cost, excess capital cost, over-capacity, inadequacy, and lack of utility.”Ī few examples will help illustrate the elements of this definition.Ĭurable functional obsolescence: This form of FO is present in an asset when, with the expense of replacing necessary components, the asset can be brought up to current operating standards.
“a form of depreciation in which the loss in value or usefulness of a property is caused by inefficiencies or inadequacies inherent in the property itself, when compared to a more efficient or less costly replacement property that new technology and changes in design, materials, or process that result in inadequacy, overcapacity, excess construction, lack of functional utility, or excess operating costs in the property. The ebook “Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets,” from the American Society of Appraisers, defines functional obsolescence as: Let’s consider in more detail the third form of depreciation, functional obsolescence. Economic depreciation (or obsolescence) is the loss in value resulting from factors external to the asset (or group of assets) such as changes in supply of raw materials or demand for products. Physical depreciation is the normal wear and tear that diminishes the value of assets over time. The determination of fair value of machinery and equipment assets for financial reporting purposes should include the consideration of three forms of depreciation: physical, economic and functional.