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When is Equipment Impaired?

Date: Feb 22, 2016 @ 07:00 AM
Filed Under: Asset Management

As accredited machinery appraisers, we know value changes over time by factors inherent with the equipment and outside factors that cannot be controlled. We may look at equipment value at the current date with no expectations. Nevertheless, the expected future residual is impacted by what is occurring in the market. The highest and best use of the machines may remain the same during the term of the lease, but the machine’s value usually continues to depreciate due to wear and tear and/or changes in technology. In a worst case scenario, when applicable, does equipment impairment become pertinent at the beginning of the lease term analysis or toward the end of a lease?

As an example, in the South Texas Eagle Ford shale oil patch region where a barrel of oil has dropped from $100 a barrel to less than $30 a barrel over the past year, was this expected in the time frame when the lease was prepared? If not, leased equipment used to facilitate the delivery and processing of oil may be affected drastically in a short period of time based on supply and demand versus over the long term of the lease. Right now, we have layoffs and idle equipment occurring with the forecast that the market will remain stagnant for up to two more years. For those who are drilling and servicing the oil patch, there are two groups of thoughts: wait it out or liquidate these assets. Those working in the oil patch will more likely hunker down until the price of oil goes back up.

What Constitutes a Fair Value?

Finance lease theory may be based on a net orderly value or the expected prospective value after commissions and fees are deducted and all related storage and maintenance fees are absorbed by the lessee; but as appraisers, should the present value during a periodic review engage the appraiser to consider fair value under duress or some other form of orderly liquidation for this industry? Does the lessor believe the impairment is pertinent and sustaining or only temporary? I leave that to the auditor to decide. But the reality is, appraisers need to interpret what is the proper level of trade where the subject equipment is being used at the time of the review to justify what is considered to be an arm's length transaction considering the following definitions:

  • Fair Market Value: An opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.
  • Orderly Liquidation Value: An opinion of the gross amount, expressed in terms of money, that typically could be realized from a liquidation sale, given a reasonable period of time to find a purchaser (or purchasers), with the seller being compelled to sell on an as-is, where-is basis, as of a specific date.
  • Forced Liquidation Value: An opinion of the gross amount, expressed in terms of money, that typically could be realized from a properly advertised and conducted public auction, with the seller being compelled to sell with a sense of immediacy on an as-is, where-is basis, as of a specific date.
  • FAS 157 “Fair Value”: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
  • Exposure Time: The estimated length of time that the property interest being appraised would have been offered on the market prior to the hypothetical consummation of a sale at market value on the effective date of the appraisal.
  • Remaining Useful Life: The estimated period during which a property of a certain effective age is expected to actually be used before it is retired from service.
  • Economic Obsolescence: A form of depreciation where the loss in value or usefulness of a property is caused by factors external to the property. These may include such things as the economics of the industry; availability of financing; loss of material and/or labor sources; passage of new legislation; changes in ordinances; increased cost of raw materials, labor or utilities price; reduced demand for the product; increased competition; inflation or high interest rates; or similar factors.

Every definition of value represents a transaction based on whether equipment can be easily moved or would be sold in place. What is the proper exposure time of marketing versus selling the asset? We have auction vendors using terms in the oil patch, “the sooner you sell the more you will get, the longer you wait the less.” Does this make the exposure time to market the equipment a distress sale? Conversely, is the market period to sell at the appropriate definition the same? Consider the choices the seller may have. There are private and public auctions that specialize in selling oil rigs, transfer pumps, testing rigs, and rolling stock to these markets. Does the seller have the ability to wait and sell later, or is there an immediacy to sell. Is the exposure time of the asset to sell from six months to a year, or six months or less? Does the seller have the ability to wait should the asking price not reach the amount of equity needed to fulfill a proper rate of return?

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