Below is some information relating primarily to tangible asset appraisal and valuation matters that may be useful. In this material is actionable value related strategies and techniques that may well save or gain quite material cash flow benefits. In preparing this information a number of points were considered as follows: 1. Generally accounting and finance folks have an overview idea of appraisals but are not aware of the intricacies of such strategies / procedures / reports for varied applications. 2. Conversely, many appraisers are not aware of the procedures and requirements of fixed asset accounting for financial and/or tax reporting, managerial accounting, or finance. 3. The above two points reflect the generalized lack of knowledge and understanding across these two professions that is unfortunate, particularly for the users of the services since direct and/or opportunity costs are therefore incurred. 4. To complicate the matter further public vs. private companies may have differing objectives depending on their respective cash flow vs. reported earnings objectives. The requirement to engage an appraiser may be a bother, particularly when it involves an expense without a direct return. Perhaps an insurance valuation is the best example of costs without return. Until a loss occurs all is very “pleasant”, but then a loss occurs and one must deal with the claim adjuster of the insurance company. The second costly event not offering a direct benefit may be an appraisal of tangible and/or intangible assets for financing purposes. Additionally, we have fair value accounting, which does not generate a direct return but certainly effects earnings through depreciation and/or amortization charges. Yet in many other appraisal / valuation instances, a significant return on dollars expended may be realized. A financial advantage may be realized by knowing more about a specific matter, or being smarter about the matter. Examples of such situations are property tax reporting, accelerated depreciation studies, federal income tax reporting, fixed asset accounting and information system techniques, and so forth. If one puts together the financial advantages / returns of each valuation process, with benefits of other processes, the return on investment results may be compounded. In this article there are specifics relating to the following: • Fixed Asset Accounting • Accelerated Depreciation, aka Cost Segregation Analysis • Federal (IRS) or State (DOR) Income Tax Reporting • Fair Value Accounting • Property Tax Appraisals / Appeals • Tagging of Assets • Insurance Valuations and Loss Preparedness Fixed Asset Accounting The wise knowledge and use of fixed asset accounting procedures and systems, with astute appraisal / valuation strategies, is the linkage to realizing direct and opportunity financial benefits. The below spreadsheet is a simplified example of how the elements of an asset booking may vary depending upon the reporting application. Be aware it is inappropriate to report a different component of value for different applications. However, it is acceptable to consider in the overall value differing specific components. In the spreadsheet below the most obvious example is not to report or exclude the environmental permitting for property tax purposes. Another obvious example is not to include a legal dispute in the insurance reporting cost. The spreadsheet is not meant to represent the exact way to book assets for differing applications. Rather it is presented to give the reader the idea of what can possibly be done. Firms should have an overall detailed procedural manual in this regard, as well as certainly have the fixed asset accounting software that can handle the varied entry and informational requirements for each reporting application. Unfortunately many fixed asset reporting software systems are weak in their capability to isolate differing booking cost elements. This costs the user many dollars. Further, the fixed asset accounting staffs of many firms often are not aware / trained in the financial benefits of differing appraisal / valuation and fixed asset reporting strategies. Perhaps the accountants handling the fixed asset accounting policies / procedures are doing an acceptable job from their compliance and auditing perspective. However, a view and discussion of the processes from the perspective of appraisers / valuers also knowledgeable of accounting may enhance the processes. The idea is to get the practitioners in these two professions working together to look for beneficial financial opportunities. It may be as simple as assigning values to coded fields and/or setting up multiple books for differing applications. General Note: In appraisal language historical cost is the cost to the first user / owner. Original cost is the cost to each of the subsequent users / owners. In a purchase price allocation the entries therefore would be original cost, and there may be a “step up” in value to what for financial reporting is called Fair Value, or for federal income tax purposes is called Market Value (appraisers consider these value concepts to be synonymous to Fair Market Value in Continued Use with an Earnings Analysis or with Assumed Earnings). A poor fixed asset record lists the assets as just below with the cost shown: Dust Collector $20,000 Boom Lift $15,000 Mixer $40,000 A good fixed asset system description of the assets, also including location, tag number, flow diagram number, locational data, date of acquisition and cost information is as follows: Accelerated Depreciation, aka Cost Segregation Analysis Accelerated depreciation allows companies to deduct the costs of assets faster than their value actually declines. The thought “faster than their value actually declines” is debatable. Regardless of this possible debate, accelerated depreciation does allow faster depreciation than straight line, and perhaps over a shorter life. Further, depreciation for federal income tax purposes usually will be faster than the “matching principle” of usual accounting practices. But rather than just an isolated machine or a computer, there are cost components of new and/or previously owned facilities that may be eligible for accelerated depreciation. This important subset of the concept of accelerated depreciation by appraisers and income tax practitioners is referred to as Cost Segregation Analysis. Under United States tax laws and accounting rules, cost segregation is the process of identifying personal property assets that are grouped with real property assets, and separating out personal property assets for tax reporting purposes. A cost segregation study identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations. Personal property assets include a building’s non-structural elements, exterior land improvements and allocated indirect construction costs. The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life (typically 3, 5, 7 and 15 years) rather than the building (39 years for non-residential real property). Think cash flow here based upon more depreciation for federal income tax purposes. Yet the eligible assets (debatably) may be classified differently for financial reporting purposes, thereby realizing the financial benefits of both strategies. If so, the fixed asset accounting system must be capable and structured to accommodate these procedures. Personal property assets found in a cost segregation study generally include items that are affixed to the building but do not relate to the overall operation and maintenance of the building. Land / Site Improvements generally include items located outside a building that are affixed to the land and are not inherent to the overall operation and maintenance of a building. Reducing tax lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow. For an office building cost examples of non-structural elements eligible for accelerated depreciation are “strippable / reusable” wall covering, tacked down carpeting, millwork, accent lighting, allocated portions of the electrical system, and so forth. Relating to site improvements eligible property is site improvements such as sidewalks and landscaping, etc. Again, such eligible assets may be depreciated over 3, 5, 7 or 15 years, rather than over 39 years. For a manufacturing or processing facility the components of the facility that generally relate to the production processes are eligible. Examples would be special exhaust systems and drainage systems, equipment foundations, machinery enclosures and platforms, allocated utilities, and so forth. A very large enclosed equipment platform is not a 39 year lived building. Whether the facility is new or previously owned does not matter. The “engineering” analyses of the costs eligible for accelerated depreciation are similar. Further, it is not just the direct costs that are eligible but also an allocation of the indirect costs to each asset is includable in the calculation. This latter consideration in the cost segregation analysis of new facilities is often captured by service provider professionals. For previously owned structures elements of indirect costs sometimes may be overlooked, unless an experience appraiser knowledgeable in cost segregation techniques handles the allocation matter.  Accountants usually cannot do this well. Federal (IRS) / State (DOR) Income Tax Reporting Financially it seems prudent to appropriately and legally pay the least amount in taxes. Therefore, when completing an valuation there is an innate orientation to optimize fixed asset accounting booking strategies considering asset classification and value element inclusion / treatment. Private entity clients appreciate this orientation, particularly when they understand that the appraisal / valuation fee may be greatly exceeded by the present value of the cash flow enhancements through accelerated depreciation / amortization. Some, however, due to their particular tax / earnings orientation may not be able to enjoy such financial benefits and unfortunately extend the depreciation / amortization (the IRS / DOR is more pleased with this). The public clients, who have an orientation towards earnings enhancement, may be willing to pay an increased income tax payment price by extending depreciation / amortization (again, the IRS / DOR is pleased). There may be a conflict of objectives between not only the private vs. the public taxpayer, but also the profitable taxpayer vs. the less / not profitable taxpayer. So what to do? Discuss with the CEO / CFO or the other appropriate party(s) the issues addressed, and others, within this document. Communication and understanding is critical. Be direct. Ask the simple question “are you tax or earnings oriented”. Likely the private client will say “tax”. Then go deeper by asking “can you stand as much accelerated depreciation / amortization as may be appropriately developed”. A caution, the maximum tax benefits may affect loan covenants that are in place. Based upon the answers to these questions discuss the available appraisal / valuation and fixed asset accounting techniques that may be considered / utilized. The same questions should be asked of the public client, whereas the private client may lean either way, more likely the public client may lean towards earnings enhancement (but not always). The public client may want to “balance” taxation matters with the earnings objectives of the business operation. This may well be a sensitive issue to discuss. Note that the value information may not change but the classification of the valuation data may be coded to fit the situation / objectives. Fair Value Accounting Books and official guidelines have been written on this subject. Some salient thoughts are offered herein for consideration. A key thought is that U.S. Fair Value Accounting is slightly different from International Fair Value Accounting, particularly as it relates to including varying levels of synergy and transaction costs. The guidelines have changed over time and continue to be in exposure draft form and/or under review. A review of the most current drafts and guidelines is always appropriate. The appraiser is assisting the reporting entity in developing the Fair Value Accounting document / report. That is, the Chief Financial Officer is the ultimate signer and provider of the document, assisted by the appraiser / valuer. The CFO is in charge. The wise appraiser / valuer will have thorough discussions with the CFO or the appropriate party concerning the quality of the selling entities fixed asset accounting record. They will also discuss tax or financial reporting drivers, as well as the cost / benefits of valuation needs that may be cost effectively fulfilled during a fair value accounting study (i.e. a new fixed asset accounting record, insurance placement values, insurance proof of loss preparedness, accelerated depreciation, property tax minimization). So how is such a “fair value accounting” study completed? Tangible Assets (Real Property and Tangible Personal Property, aka Machinery and Equipment) As noted above, discussions are held with the CFO, and perhaps the external auditor. The quality of the existing fixed asset record is reviewed. Generally such records are poor to fair. The choice has to be made whether to use (migrate) religiously the prior record, use some information to degrees, or discard the old record and create a new record. As an aside, there is not a direct cost to discarding the old record, in any regard.  Yet, the old record likely will need to be retained and maintained for property tax reporting (rendition) requirements. The fair value accounting report service options to varying degrees may be: • The appraiser using the old record models (”trends and bends”) the values into Fair Value, or • The appraiser using the old record models the values into Fair Value, tests the accuracy of information provided, and goes to the marketplace for value information, or • The appraiser develops a new detailed inventory of the assets, and goes to the marketplace for value information. In either of the three above generalized procedures, usually a digital file (EXCEL) is given to the CFO to facilitate uploading the data into the company’s fixed asset accounting system. Intangible Assets, Business Enterprise Value, Economic Support, Bargain Purchase Again, books have been written on this subject. Intangible assets are valued essentially using discounted cash flow techniques and/or market comparisons, if available. The business enterprise should be valued to ascertain the overall value and to see if there is a bargain purchase. The concept of a bargain purchase most directly may be developed through this procedure (other written procedures are fundamentally flawed). If the business value (being invested capital defined as the sum of the non-current liabilities with the valued equity) is materially equal to the effective purchase price there is not a bargain purchase. If there is not a bargain purchase yet the initially appraised value of the tangible assets is greater than the indicated level of economic support (the purchase price), then the tangible assets are reduced for this relative difference, called economic obsolescence. Note that the tangible asset appraisal should consider physical deterioration, functional / technological obsolescence, and utilization. Lastly, accounting protocol indicates that the impairment of the assets for economic obsolescence may not go beyond net orderly liquidation value. Some interesting issues / thoughts: • An example of economic support / obsolescence is a company that makes VHS tapes / cartridges. The level of economic support is inadequate due to external obsolescence. • Can the same asset have differing Fair Market Value in Continued Use values within the same plant? Yes, depending upon the asset utilization and product made. For example, a plant that makes left hand and right hand golf clubs with the left hand specific assets on a production line having less value. Why, because there are fewer left handed golfers and therefore less demand. • Can the same asset have differing Fair Market Value in Continued Use values within differing plants?  Yes, as just above noted, depending on the capital contribution level. How May Others Complete a Fair Value Accounting Valuation? It depends upon who is completing the requisite tangible and intangible assets valuation. A general thought is that if one single entity is not controlling / coordinating the analysis and/or aware of the nuances of the valuation techniques relating to business valuation, intangible assets valuation, real property appraisals, tangible personal property appraisals, and of course applicable valuation guidelines – watch out! Conversely if a given entity is completing only one discipline element (say the real property analysis) of the valuation they should understand how their work properly inter-relates with elements of the analysis completed by the other discipline (as intangibles and machinery). Unfortunately too often a specific discipline service provider either does not understand the valuation concepts of the other disciplines, does not want to know, or is not given the opportunity to intelligently and thoroughly discuss the matter. Some service providers emphasize ‘trending and bending” aka “modeling”. This means the practitioner takes the current fixed asset record and “indexes” the values upward for inflation considerations and depreciates the assets down for age / life considerations. The prior sentence is “appraisal speak”. In English, based upon varying levels of expertise and the quality / usability of the fixed asset record the resulting Fair Value information is properly developed. The issues the practitioner at least may consider are as follows: • prior allocations on the record; • current and changing capitalization policy; • what value elements are included in the cost data; • how are repairs, trade-ins, asset movement, etc. treated; • has a full physical or testing physical inventory of assets been completed; • what assets are on the record but not in place or partially in use; • is there functional obsolescence; • is there technological obsolescence; • are certain assets not being fully used; • is there economic obsolescence and how is it being developed; and • how to properly handle Construction in Process / Progress (”CIP”). The Fair Value accounting practitioner should address at least all these issues. Property Tax Appraisals / Appeals In order to properly address property tax (Ad Valorem Taxation) a separation of real property vs. tangible personal property is appropriate. Real Property In general, the local assessor essentially values the buildings and site improvements using the Cost Approach methodologies. The land is typically valued using the Sales (Market) Comparison Approach.  The improvements are usually trended up for inflation each year until perhaps a mass revaluation is completed or the assessment is appealed. It is wise to separate out of the real property assets that can be identified as tangible personal property, which instead of forever increasing in value actually decrease in value, or may be exempt from taxation due to environmental use (as effluent collection ponds / dams). More later on this issue in Tangible Personal Property below. Tangible Personal Property (machinery / equipment) In the U.S. tangible personal property (aka personalty) may be considered as anything other than the basic building structure and land improvements. Yet certain assets like silos or large holding tanks may be considered by the tax assessor as real property. Why? Personal property may not be taxed in the local jurisdiction and/or if the asset is called real property the taxable value increases forever. Such is the tax assessor’s perspective and strategy. Other than the above thought personalty when booked new (the historical cost) is the basis of value. With the renditions submitted (requisite periodic tax reporting information) by the taxpayer this basic data is “indexed” up for inflation, and then “depreciated” for property tax assessment calculations down to likely a 10% or 20% minimum. The struggle with the tax assessor is that the indexing does not consider technology advancements or outside market forces. Further, the depreciation factors are arbitrary and do not reflect market considerations. These two basic problems with indexing and depreciation application skew the values most often higher than the assessment definition of Fair Market Value. Such is the constant property tax value struggle. All too often the fixed asset record of the taxpayer overstates the historic information provided. Here are some points / strategies to receive a fair assessment for property taxation. 1. Book the assets properly in the first place. Do not include any direct or indirect intangible assets such as engineering, permitting, legal fees, in house oversight, etc. The value should only be the f.o.b. cost of the asset, freight, perhaps sales taxes, rigging, millwright, local utility hookup, etc. The intangible assets relating to the asset may be entered into a separate linked field in the fixed asset record. Note that in some states engineering is included as being taxable. 2. Properly identify assets that may be listed as tangible personal property (such as equipment enclosures, platforms, or silos) by the taxpayer but that the assessor may include in their real property value assessment. If not done these asset entries and their values could result in their being doubly taxed, i.e. as both real property and tangible personal property. 3. Properly identify assets that are excluded from taxation for environmental reasons. Assure that you have the proper paperwork (permitting) authorizing such treatment of these assets.  4. Describe the assets properly looking forward to how to identify such assets say 5-20 years hence when they are disposed. This is critical. 5. Annually have the appropriate personnel at each facility peruse the fixed asset record for assets that have been disposed, scraped, not in service, partially used, etc. Again, the assets need to be properly described in the first place. Assets on the fixed asset record that are not in place and in use are referred to as “ghost assets”. 6. Do not render (report for property taxation) non-value adding assets such as short term repairs / maintenance, moving an asset from one place to another, demolition, training, etc. Such assets perhaps should be expensed, or if booked for reasons of accounting amortization / depreciation, can be coded for such thoughtful treatment. 7. Upgrades to assets may be rendered (debatable). However, possibly only a portion of the cost should be considered as actually adding value. 8. One way to calculate the historic cost of disposed assets scheduled but not identifiable on a “weak” fixed asset record is to apply reverse inflationary factors to the current costs of such assets. An estimate but better than doing nothing and being taxed forever on assets that are gone (ghost assets). 9. Asset transfers are often at net book value. It perhaps would be wiser to transfer at used market value adding depreciated reinstallation costs. The transferor may take a loss, but the transferee books the asset “properly”. 10. Costs related to the disposal of an asset should be expensed. Yet many times when an asset is replaced not only is the disposal of the initial asset not properly handled, but the disposal cost of the asset is rolled into the costs of installing the replacement asset. This is not good. 11. Determine if taxes are included in the historic cost rendered. If so this may be considered taxation on a tax. 12. When booking an asset the thought “what value is added” should be the basic principle. Note that the phrase is “what value” not “what costs”. 13. Along this line as 12 above, rework, repairs, other excessive costs are not “value added”. 14. Make assumptions, as possible and appropriate, that if an asset is beyond its normal useful life then the asset has been disposed. Obvious example is a 10 year old computer on the fixed asset record. When in doubt consider the asset disposed. Assuming that the fixed asset record is appropriately “cleaned” of entries that could not be reported or have been reported in error there is still more to do. It may be appropriate and reasonable to consider additional depreciation factors, such as functional obsolescence, technological obsolescence, and economic / external obsolescence. Remember, the tax assessor would like all the assets to be categorized as forever increasing real property vs. decreasing in value (to 10% or 20% of historic cost) tangible personal property. In summary, addressing property taxation overpayments may well be a significant cash flow enhancer. When blended with a Fair Value appraisal, an insurance appraisal, or even a financing / refinancing appraisal, there may be significant fee savings. Insurance Valuations and Loss Preparedness An insurance appraisal fulfills three needs: these are independence, placement value data, and proof of loss preparedness. Differing levels and types of insurance appraisals fulfill each of these needs to differing degrees. Addressing each need in turn below: Independence: the insurance company would like to see an appraisal from an outside firm. This is somewhat obvious so that there is not fraud perpetrated by the assured. Some insurance companies have their own appraisers but unpleasant loss settlement situations may still occur. Placement: an independent valuation will inform the assured about the amount of insurance to carry. Such an analysis may be completed in great detail with say a +/-10% possible variance or in an overview manner with a +/-20% or greater variance. Be wary, just because the insurance carrier does an insurance placement value analysis, as stated before an unpleasant loss situation may occur, with the insurance company denying that the proper amount of insurance was carried. Proof of Loss: along with having the appropriate amount of insurance, this is the most important element of an insurance appraisal. Directly stated, if one is not prepared to prove one’s loss instantly 10% of a fair settlement is gone. If not well prepared this loss settlement amount may be 25% or even more. The strategy is to get a balanced fair and equitable settlement in a timely manner. These thoughts are directly linked. One can get a fair settlement say 5 years hence, but it is not timely. Or one can get a timely less fair settlement if one accepts 75 cents on the dollar. Again, not good. One wants the fair settlement at full value in say 6-12 months or whatever time is appropriate for the loss situation, balancing the wishes of “fair” and “timely” is the critcal concept. What is adequate Proof of Loss? The fixed asset accounting record most often is greatly inadequate for a loss situation. Without going into a long explanation, many fixed asset accounting systems contain data that includes intangibles in the values, non-value entries, allocated values from acquisitions, “ghost” assets, and on and on. The appropriate proof of loss document may be an independently developed appraisal and listing of assets, with this document being annually updated by facility staff or outside consultants. Flow diagrams help. Photographs and movies of specific assets and systems help. Files that have original purchase costs and descriptive detail are wonderful (but rarely are available). Engineering records may help. However, for most facilities / operations the assured is not prepared. Oversight in this regard is strongly suggested. Why, because ultimately it is the assured’s responsibility to reasonably prove one’s loss. For those facilities where a detailed valuation for Fair Value accounting is prepared the information is very good, at that instant. Yet the information must be kept up to date.  It must be kept up to date either within the fixed asset accounting system or as a separate aside record. Critical property and casualty insurance thoughts: • One may rather deal with the IRS than fight an insurance battle. • Understand the insurance policy (contract) coinsurance clause wherein the assured shares in the settlement to the extent of the insurance that should have been carried, say 80%. • The fixed asset accounting record is not adequate proof of loss. • Understand the difference between a Replacement Price policy and an Actual Cash Value policy. • Replacement Price policies are “repair or replace” often up to Actual Cash Value (a litigious issue considering the issues of Market Value, depreciation or betterment). Usually the insurance policy states that Acutal Cash Value will be paid until or if the covered assets are replaced (the language varies per differing insurance contract forms). If under a Replacement Price policy the carrier depreciaes labor, the carrier could be acting in “bad faith”. • Actual Cash Value policies generally consider the current cost new for the same functional utility of the covered assets less physical depreciation / deterioration.  However, in some instances, Actual Cash Value is considered to mean the cost of replacing the asset at Fair Market Value - Removed, or Used Market (another litigious issue). • Being unprepared to prove one’s loss may be extremely costly. • The insurance company will not pay for betterments, meaning if you have an old Model A asset and now a Model B is only available you will not receive the settlement for a Model B loss. Check insurance contracts in this regard concerning betterments. • The insurance company may well not pay for engineering or intangible assets relating to specific tangible assets. Check the policy and/or discuss this matter with the broker. • Understand what the insurance policy says. One can underinsure as well as over insure. A personal note. Are you prepared for a loss at your home? Do you have the proof of value and listing of the assets, or at least photos or a movie of the residence and the contents? Is this information somewhere else other than in your residence?  All are encouraged to get prepared for an unfortunate insured event. But imagine in a loss situation how much less of a fair settlement you would receive if such data is not available. Then project this thought into your business situation.