Can Fire in Cotton Bales be treated as Spontaneous Combustion:

Cotton bales covered under the Standard Fire and Special Perils (SFSP) policy are stored in covered warehouses without any electrical cabling inside.

"Often, in the event of a fire, representatives of the insured often attempt—out of both ignorance and sincerity—to prove that the cause was spontaneous combustion."

Standard fire and special perils policy does not cover spontaneous combustion, which is an ‘add on’ in fire insurance.

Cotton is assigned to Class 4.1 of the IMDG Code (Flammable solids) and not a spontaneously combustible material.

 Cotton fires often begin as smoldering fires, which can burn internally for extended periods before erupting into flames. This can make it difficult to detect the fire until it's well-established. The considerable compression prevents the fire from spreading as quickly as it would spread through uncompressed bales.

However Specific characteristics and negative external influences may cause cotton bales to behave like a substance from Class 4.2 (Substances liable to spontaneous combustion) of the IMDG Code.

Self-heating / Spontaneous combustion

Cotton bales can spontaneously combust due to various factors, including dampness, oil contamination, and improper storage, leading to smoldering and eventual fire. The tight packing of cotton within bales allows for internal heat buildup, particularly when damp or oily, which can lead to ignition. 

• Dampness:

When cotton is pressed or baled in a damp state, it can generate heat internally, especially if the moisture content is high and the heat cannot dissipate. This heat buildup can eventually reach the ignition temperature, leading to spontaneous combustion. 

• Oil Contamination:

The presence of oils, even in small amounts, can significantly increase the flammability of cotton and lower the temperature at which it can spontaneously ignite. 

• Improper Storage:

Stacking bales too high, inadequate ventilation, or improper spacing can contribute to heat buildup and the risk of spontaneous combustion. 

• Microbial Activity:

Microbes can grow and reproduce in damp cotton, generating heat as a byproduct of their activity, which can further contribute to the risk of spontaneous combustion. 

Spontaneous Combustible Materials

The following materials should preferably be notified to insurer and covered as ‘add on’ in fire insurance policy.

The following materials can be subdivided based on their propensity to spontaneously:

(Reference: sovereigninsurance.ca)

Strong Propensity: Charcoal • Cod liver oil • Fish oil • Fishmeal • Fish waste • Linseed oil • Clothing, silk, fabrics and rags soaked with oil • Tung nut flour (or tung, or Chinese wood) • Peanut seed coat (skin covering the peanut, under the shell) • Pigments in Oil • Cornmeal based pet food

Average Propensity: •Food for animals • Foam rubber • Certain metallic powders • Bituminous coal • Fertilizers • Hay • Coconut bark • Manure Distillery or brewery beans • Whale oil • Cottonseed oil • Corn oil • Menhaden oil • Perilla oil • Pine oil • Soybean oil • Tung oil (or tung oil, or Chinese wood) • Red oil (unrefined palm oil) • Roofing papers and felts • Paint containing drying oils • Pyrite • Rubber residue • Wool residue • Paper waste

Low Propensity: •Cotton seeds • Mustard oil • Palm oil • Peanut oil • Turpentine

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

 

EFFECTIVE LIFE & REMAINING USEFUL LIFE OF PLANT & MACHINERY

To determine the effective life and remaining useful life of plant and machinery, one needs to consider the asset's physical condition, operational performance, and the applicable depreciation methods. The effective life is the period during which the asset is expected to be used productively, while the remaining useful life is the estimated period from the current date until the asset is no longer expected to be used. 

1. Understanding Effective Life:

Effective life refers to the period an asset is expected to be used productively, considering factors like physical condition, technological advancements, and operational performance. It's a more practical estimate than the legal or statutory useful life, which may be specified in accounting standards or tax regulations.

2. Factors Affecting Effective Life:

• Physical Condition: Regular maintenance, wear and tear, and potential damage can impact an asset's physical condition and, consequently, its effective life.

• Technological Advancements: New technologies and innovations may render older equipment obsolete, shortening its effective life.

• Operational Performance: How an asset is used, the frequency of use, and the intensity of operations can affect its effective life.

3. Determining Effective Life:

• Historical Data: Analyze past maintenance costs, repair records, and production data to assess the asset's historical performance and predict its future performance.

• Manufacturer's Specifications: Consult the manufacturer's recommendations for maintenance schedules and expected lifespan.

• Expert Opinion: Seek professional advice from engineers, valuers, or other experts familiar with the specific type of plant and machinery.

4. Remaining Useful Life:

The remaining useful life is the estimated period from the current date to when the asset is expected to be retired or no longer used. It's calculated by subtracting the asset's age from its effective life.

5. Importance of Accurate Determination:

• Depreciation: The remaining useful life is crucial for calculating depreciation, which affects a company's financial statements and tax obligations.

• Maintenance and Replacement Planning: Accurate estimates of effective and remaining useful life help in planning maintenance schedules and replacement cycles, optimizing asset utilization and minimizing costs.

• Asset Management: Knowing the remaining useful life of assets enables businesses to make informed decisions about their asset management strategy, such as whether to upgrade, refurbish, or retire an asset.

6.       Documentation:

It's important to document the methods and calculations used to determine effective life and remaining useful life for transparency and also for insurance claim purposes.

7.            Regular Review:

The effective life and remaining useful life should be reviewed regularly to ensure they remain accurate and up-to-date, especially in light of changes in technology, operating conditions, and maintenance practices. 

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

 

Depreciation due to Deterioration of Plants & Machines

Depreciation It is the usual wear and tear caused by the normal working of any asset, its use is liable to a certain amount of deterioration despite the care and attention bestowed on its maintenance and preservation.

Physical depreciation is broken down into curable and incurable

Curable Depreciation

The following input for machinery under consideration by technical personnel of clients helps in estimating curable depreciation.

(i) Did the equipment undergo major repair or reconditioning?

(ii) Did the equipment undergo capability test?

(iii) What is the present condition in terms of production rate and accuracy vis-à-vis the original at the time of purchase?

Curable depreciation is fixable by refurbishing, rebuilding of the equipment

Physical Incurable Depreciation

Physical depreciation is caused from age, wear and tear, fatigue, exposure to the elements or lack of maintenance. Overall physical depreciation is caused more by use rather than age.

A visual inspection can help to assess present condition of the machine

General Upkeep:

If an equipment is well-maintained during its service life and is expected to operate longer with lower costs, its value may be higher than expected for a machine of its age.

Dirt, dust, and other contaminants can interfere with lubrication and cause abrasive wear on the surfaces of the rotating equipment. This can also lead to increased friction, leading to increased heat, and damage to seals, bearings, and other components. Contamination can also lead to corrosion and oxidation, which can cause parts to degrade and fail prematurely. Additionally, contaminants can interfere with the flow of fluids, cause bearing failure, cause pressure spikes, block lubricant pathways, and reduce equipment efficiency.

Observed deterioration (also known as the 0 – 100% method)

 Lump sum figure of depreciation can be adopted as given below:

 Condition                                                        Depreciation %

New (N)                                                            0 - 5

Excellent (E)                                                    6 - 10

Very Good (VG)                                              11 - 20

Good (G)                                                         21 - 50

Fair (F)                                                            51 - 70

Poor (P)                                                           71 - 90

Scrap (S)                                                          91 - 100

If upkeep and maintenance are high, then the effective age will be lower than the actual age and conversely if upkeep and maintenance have been low then the effective age will be greater than the actual age.

As one of the important obsolescence factors considered by the cost approach, physical deterioration influences the conclusion of value.

Reference Document: STANDARDS ON VALUATION OF PLANT, MACHINERY AND EQUIPMENT; Publisher: Centre for Valuation Studies, Research & Training Association, India

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

 

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. 

 

Why Plant & Machinery Valuation Matters:

Followings are the reasons why plants and machineries are needed to be appraised periodically:

1. Financial Reporting:

Accurate valuation ensures that assets are reported correctly on the balance sheet, impacting depreciation, taxation, and overall financial health. 

2.               2    Insurance and Risk Management:

Accurate machinery and equipment appraisal assists in reducing any financial losses. It eliminates the impact of loss or theft by enabling to secure sufficient insurance coverage for plant & equipment.

Furthermore, knowing the depreciation rate of assets enables to anticipate their declining value and plan accordingly, reducing the financial burden of future replacements.

3. Investment Decisions:

Valuations are essential for making informed decisions about investments, acquisitions, and disposals of machinery. Accurate valuations enable to make informed choices when buying or selling equipment. Knowing their true market value will help negotiate the best price. 

4. Fundraising:

Accurate valuations are crucial for securing loans or attracting investors, as lenders and investors rely on the value of assets as collateral. 

5. Mergers and Acquisitions:

Valuations are vital in determining the fair market value of machinery during mergers and acquisitions. 

6. Asset Management:

By understanding the value of machinery, companies can optimize its utilization, maintenance, and replacement, maximizing return on investment. By tracking the value of assets over time, one can monitor their performance and make informed decisions about their economic lifespan and replacement. 

This allows to maximize the return on investment of machinery and equipment while ensuring their continued functionality and productivity.

Note: Point 1, 4 &5 are better to be left on Company’s Chartered Accountants.

 

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

 

INSURANCE OF CNC MACHINES UNDER ELECTRONIC EQUIPMENTS INSURANCE

CNC machines & machining centers are widely used for precision machining of automotive and other engineering components. These machines are generally covered under Machinery Insurance policies for sudden unforeseen breakdowns.

Option to insure under either MB or EEI Policy

CNC Machines preferably should be insured under EEI Policy as EEI provides much wider coverage in comparison with MB Policy

Note – Where it is not feasible to give a breakup of values for minor electronic equipment (non-metallic items) which were integral to various machines, eg CNC Machines, wherever such CNC Machines are insured, the Insured can have option to cover the same either under MB or EEI policy.

In India, a CNC machine, due to its significant electronic components, is typically covered under an Electronic Equipment Insurance (EEI) policy rather than a standard Machinery Breakdown (MB) policy, meaning it should be included in your EEI coverage to ensure protection against damages or breakdowns related to its electronic parts and systems. 

All Electronic equipment like Computers, Medical, Biomedical, Micro- processors; Audio/Visual equipment including the value of Systems Software may be covered under Electronic Equipment Policy. The term equipment shall also include the entire computer system consisting of CPU, Keyboards, Monitors, Printers, Stabilizers, UPS, System Software etc.

Cover granted under E.E.I policy are virtually against all insurable perils namely fire, RSMD, Terrorism, Flood, Storm, subsidence, Earthquake, accidental breakdown while at work or rest, electrical damage, faulty manipulation, dropping, falling impact etc.

OTHER FEATURES: If the insured want to opt out fire and allied perils cover, a premium reduction in rate is offered based on the coverage.

SUM INSURED: Sum Insured shall be equal to the cost of replacement of the insured property by new property of the same kind and same capacity, which shall mean its replacement cost including freight dues and customs duties, if any and erection costs. The sum insured of the equipment insured under this section shall include the value of ‘System Software’.

PROHIBITION TO ISSUE MB POLICY ON ELECTRONIC EQUIPMENT- Unless otherwise specifically provided for in MB Guide Rate, no machinery breakdown policy should be issued on Electronic Equipment like Computers, Medical, Bio-medical, Micro processors, Audio-visual equipment which must be covered under EEI Policy only.

Loss or damage sustained during transit and any loss/damage attributable to transit shall be excluded under both Machinery Breakdown and Electronic Equipment Policy

An Electronic Equipment Insurance (EEI) policy in India would cover an industrial CNC machine against a wide range of damages, including electrical breakdowns, mechanical failures, fire, theft, accidental damage, and even damage caused by faulty operation, essentially providing comprehensive protection for the machine's functionality due to unforeseen events; the key is to ensure the CNC machine is specifically listed as covered under the EEI policy. 

Key points about CNC machine coverage under EEI:

• Specific coverage:

EEI policies generally cover damages caused by electrical surges, short circuits, faulty operations, accidental impacts, fire, theft, and natural calamities to the electronic components of a CNC machine. 

• Separate policy needed:

While some minor electronic parts integrated into a standard machine might be covered under an MB policy, for comprehensive protection of a CNC machine, a dedicated EEI policy is recommended. 

• Consult with insurer:

Always check with insurance provider to clarify the exact coverage details for specific CNC machine to ensure it is appropriately included within the EEI policy. 

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