Taking benefit of Insurance Valuation for Asset Management

Fixed assets represent the largest item on Company's insurance budget– especially in capital-intensive industries like manufacturing, power generation, oil & gas.

While completing a property insurance appraisal, the findings can also be useful for fixed asset management as both require a physical inspection of the fixed assets inventory.

When it comes to insurable values, accuracy is vital to avoid excess insurance premiums on ghost assets.

An insurance appraisal will consider a total replacement cost of all the fixed assets and buildings. This would also include expensed assets below the capitalization threshold.

The purpose of an asset management system, or asset system, is to keep track of the equipment and inventory vital to the day-to-day operation of the business.

The only reliable way to verify and validate the fixed asset information is to conduct a physical inventory. Eliminate assets those have been lost, stolen, or unusable but are still listed as an active fixed asset in the system and also inclusion of new assets upon purchase

From insurance point of view, this means their balance sheets match up with their records, and assets that have been loaned, lost or stolen are timely identified and excluded from insurance premium. Companies not effectively managing their assets typically lose considerable amounts of time and money.

Without an accurate, real-time, organized system for tracking assets, it will be difficult to plan timely preventive maintenance of the important machines.

The benefits of an asset management system include :

·        To track and manage an asset’s entire lifecycle, from initial acquisition to periodic maintenance to phase-out from inventory

• To monitor asset use and make improvements.
• to implement preventive maintenance and routine inspections, thereby preventing expensive repairs and downtime.
• To maximize equipment lifecycles and staving off early replacements
• Reduced waste and increased profitability
• In obtaining better residual value while selling off machines due to functional or economical obsolescence

An asset management record may contain details like purchase date, serial number, manufacturer, model, lifecycle cost including maintenance and repair, present value, number of each type of fixed asset, locations, and estimated lifespans.

Such record provides a picture of the present conditions of the machineries and also help companies prepare for the future. Based on facts, they can make decisions about the assets they will need in the coming year. Subsequently, they can avoid under or over-stocking assets and manage their resources responsibly. Asset management optimizes an asset's operational performance during its lifespan and aims to keep these assets running profitably for as long as possible.

The decision to repair or replace an asset depends upon various factors, including the type of asset, age, wear and tear, and role in the production line. To decide between repairing and replacing an asset, a management company must compare its current value and the repair costs. If repair costs are less than the value of equipment, it is best to get it repaired. However, when the repair costs exceed the value of equipment, it is better to replace it.

 The above interpretations are absolutely personal in nature and are not binding on any individual/ organization in particular.

 

CONCEPT OF DEPRECIATION IN INSURANCE VALUATION

The following paragraphs are being reproduced from the Book: CONCEPT OF DEPRECIATION IN INSURANCE VALUATION, which may be valuable for fixing residual life of the insured fixed assets.

Although I tried my best to recover the source/origin of this publication, I could not trace this so far. However I find the concept very useful while assessing old but satisfactorily usable machines, 

"The depreciation being provided by the Insured in his books of account in line with what is permissible under Income Tax regulations, need not necessarily be considered as an appropriate basis for computing the insurable value of capital assets.

Insurance is concerned with actual intrinsic loss of useful working life deducted due to real wear and tear, and not the notional amounts deducted from the reducing balances, for the purpose of Income Tax and Balance Sheets.

Maximum Depreciation: (Residual Value concept)

Suppose a machine is 18 years old and is still giving satisfactory performance and almost the rated output. Assuming that we ascribe a life of 20 years to this machine, the total depreciation will touch 90%, at 5% per year. This is not fair if the machine is still giving satisfactory production, because of good maintenance. In such case, where it can be established that the standard of maintenance is good, it is enough if the maximum depreciation is levelled off at 75%. Thereafter, the ‘Residual Value Concept’ will take over.

Surely, after 15 years, when we reach a total depreciation of 75%, the machine is not a mere scrap. If it is still working well, it will at-least have a ‘Residual Value’ of 25% applied on its present replacement cost.

In some industries including all Petro-Chemical complex, where very high standard of renewals and maintenance is a must for safe operation of the plant; where there is a full fledged maintenance department, staffed with qualified engineers; where regular periodical maintenance shutdowns are taken to completely overhaul and check the entire Plant and Machinery; where the industry concerned maintains adequate spares to replace worn out items as and when needed – in such cases, it has to be conceded that the Plant is in excellent condition at all times; depreciation could be at a lower level provided there is satisfactory evidence of such a high standard of maintenance.

However, where it is evident that the Plant and Machinery have been ‘worked to death’ they are in a highly worn out condition with no renewals/replacements having been carried out as per maintenance norms then the maximum depreciation can be taken even upto 95%; the balance 5% representing practically the ‘Scrap Value’ of the machinery.

In the case of nonworking obsolete old machines lying in the factory, their value should be worked out only on the basis of their weight as metal scrap.

It will be seen from the above that, unless the valuation and depreciation exercises are carried out appropriately, serious distortions will result. The escalation and depreciation formulae shown in the above two tables should not be followed blindly for all cases.

Wherever they are found unsuitable necessary modifications should be made suitably.

In the case of capital assets other than plant and machinery, such as furniture, fixtures, office equipment, the same consideration as explained above would normally apply.

The depreciation being provided by the Insured in his books of account in line with what is permissible under Income Tax regulations, need out necessarily be considered as an appropriate basis for computing the insurable value of capital assets.

Insurance is concerned with actual intrinsic loss of useful working life of a deducted due to real wear and tear, and not the notional amounts deducted from the reducing balances, for the purpose of Income Tax and Balance Sheets.

Maximum Depreciation : (Residual Value concept)

Suppose a machine is 18 years old and is still giving satisfactory performance and almost the rated output. Assuming that we ascribe a life of 20 years to this machine, the total depreciation will touch 90%, at 5% per year. This is not fair if the machine is still giving satisfactory production, because of good maintenance. In such case, where it can be established that the standard of maintenance is good, it is enough if the maximum depreciation is levelled off at 75%. Thereafter, the ‘Residual Value Concept’ will take over.

Surely, after 15 years, when we reach a total depreciation of 75%, the machine is not a mere scrap. If it is still working well, it will at-least have a ‘Residual Value’ of 25% applied on its present replacement cost.

In some industries including all Petro-Chemical complex, where very high standard of renewals and maintenance is a must for safe operation of the plant; where there is a full fledged maintenance department, staffed with qualified engineers; where regular periodical maintenance shutdowns are taken to completely overhaul and check the entire Plant and Machinery; where the industry concerned maintains adequate spares to replace worn out items as and when needed – in such cases, it has to be conceded that the Plant is in excellent condition at all times; depreciation could be at a lower level provided there is satisfactory evidence of such a high standard of maintenance.

However, where it is evident that the Plant and Machinery have been ‘worked to death’ they are in a highly worn out condition with no renewals/replacements having been carried out as per maintenance norms then the maximum depreciation can be taken even upto 95%; the balance 5% representing practically the ‘Scrap Value’ of the machinery.

In the case of nonworking obsolete old machines lying in the factory, their value should be worked out only on the basis of their weight as metal scrap.

It will be seen from the above that, unless the valuation and depreciation exercises are carried out appropriately, serious distortions will result. The escalation and depreciation formulae shown in the above two tables should not be followed blindly for all cases.

Wherever they are found unsuitable necessary modifications should be made suitably.

In the case of capital assets other than plant and machinery, such as furniture, fixtures, office equipment, the same consideration as explained above would normally apply".

The publication has not been originated by me. I have come across this publication while undergoing self-study sessions for IBBI Valuation Examination.

Above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular.