The infographic above concludes the simplified version of the machinery and equipment valuation process. 🙁 We are now going to delve a bit deeper into the infographic as it relates to the finer points of the Uniform Standards of Professional Appraisal Practice (USPAP) publication:

We will quote heavily from the Appraisal Foundation (and refer to them interchangeably as “Appraisal Standards Board” [ASB] and “USPAP”) throughout, as they are recognized by Congress as the source of appraisal standards.

Step 1: Identify the Problem to be Solved

No appraisal “problem” is a simple one.

Like most problems people face, there are many questions that must be answered to fully identify the appraisal problem. Fortunately, we’ve compiled a checklist that needs to be answered to ultimately identify the problem to be solved:

✔ Identify the Client and All Other Intended Users

This is one of the more straight forward identifications, once the “client” and “intended user” definitions are understood.

USPAP defines the client as “the party or parties who engage, by employment or contract, an appraiser in a specific assignment.” USPAP further clarifies that “The client may be an individual, group, or entity, and may engage and communicate with the appraiser directly or through an agent.”

In addition to the client, who engages the appraisal assignment, we must also identify all other intended users.

According to USPAP, an intended user is defined as “the client and any other party as identified, by name or type, as users of the appraisal or appraisal review report by the appraiser on the basis of communication with the client at the time of the assignment.”.

The client and all intended users should be clearly identified in the appraisal report.

EA says… It seems like we serve a new business sector every day, but the most common are: Bankers & other Lenders

Brokers

Business Consultants

Business Owners (e.g., Construction, Farming)

Certified Public Accountants (CPA, for Taxes)

Corporations (Mining, Oil Field) Financial Institutions

Government Officials

Individuals (e.g., inheriting a machine)

Law Firms & Attorneys

Merger & Acquisition Professionals

Turnaround Management Specialists

✔ Identify the Intended Use of the Equipment Appraiser’s Opinions & Conclusions

Why did the client engage an appraiser?

That is the next question we need to answer. We know what an intended user is, but what about the intended use of an appraisal?

The Appraisal Standards Board defines Intended Use as “the use or uses of an appraiser’s reported appraisal or appraisal review assignment opinions and conclusions, as identified by the appraiser based on communication with the client at the time of the assignment.”.

Examples include funding due diligence, taxes, etc.

✔ Identify the Type and Definition of Value

Value is defined by the ASB as:

The monetary relationship between properties and those who buy, sell, or use those properties.

The ASB further states that value must always be qualified with a specific definition of value, such as Fair Market Value, Liquidation Value, or Investment Value.

✔ Identify the Effective Date of the Appraiser’s Opinions and Conclusions

The appraisal effective date sets the (time) frame of reference for which the appraiser arrived at his or her valuation conclusions.

EA says… Appraisal effective date is a very important identification because machinery and equipment markets vary with the times, as does most any market. For example, a 2006 effective date of a home appraisal would (most likely) be appraised much higher than that same home with a 2009 effective date, due to the housing market collapse. Though valuing Real Estate is a different practice than the valuation of equipment (and other personal property), it makes sense here to borrow an example from the housing market to illustrate the importance of effective date.

✔ Identify the Characteristics of the Equipment Property

We feel this is one of the most important steps in delivering a credible appraisal report, so we gave it its own step. We cover this in detail in Step #2: Collect.

✔ Identify any Extraordinary Assumptions or Hypothetical Conditions

Extraordinary assumptions are things that are believed to be true. It is important to identify these prior to starting an appraisal assignment because if one of those assumptions is subsequently found to be false, it could affect the equipment appraiser’s conclusions or opinions of fair market.

Hypothetical conditions are things that are currently known to be false, but we create a hypothetical condition of expected, future outcome. Note these, because your appraisal findings are based on these conditions, and your opinions could change if the expected outcome doesn’t come to fruition.

EA says… Extraordinary assumptions and hypothetical conditions help to protect the equipment appraiser. Let’s look at a few examples: Extraordinary Assumptions Desktop appraisasl are a great example of extraordinary assumptions: We don’t physically inspect the equipment in a desktop appraisal, so we base our opinions on things we believe to be true, based on information provided by the client, the equipment owner, phone calls to mechanics, photos, etc. Hypothetical Conditions A hypothetical condition example as it relates to certified machinery valuation might be a front loader that is in the process of an engine rebuild. Most any machine without an engine is worth less on the open market than a fully functional one. As such, we base our fair market value conclusion on the expectation that the engine is rebuilt or replaced with a new one.

Determine Scope of Work

Once the above are identified, the equipment appraiser has completed the first step in the process:

Identify the problem to be solved.

With the problem detailed, the appraiser has sufficient information to determine the scope of work necessary to produce credible assignment results. USPAP defines scope of work at a high level as

The type and extent of research and analyses in an appraisal assignment.

And at a more specific level:

The extent to which the property is identified

This will be discussed more in Step #2: Collect, but the basic scope of work question is:

Does the appraiser plan to identify only the major components of a process (an aggregate plant, for example)? Or does the appraiser plan to identify the individual characteristics of the equipment (make, model, year, etc.)?

The extent to which tangible property is inspected

This is an important scope of work question to answer, as it is not always possible to physically inspect each and every equipment item.

For example, when performing an on-site appraisal for an excavation contractor, it might not be feasible to travel to see one excavator that is located at a job site 2 states away.

The type and extent of data researched

Will the appraiser search for comparable sales at a local level? National? Global?

Will the appraiser seek out reproduction or replacement values for the equipment property?

The type and extent of analyses applied to arrive at opinions or conclusions

As per The Appraisal Standards Board, the appraiser must consider all 3 valuation approaches (covered in Step #3: Consider below).

The last two scope of work considerations take aim at answering the question of how much digging is necessary to provide credible appraisal results.

Enough with identifications, let’s get our eyeballs (and hopefully hands) on the equipment property.

Step 2: Collect, Identify, Classify, and Describe

Now it’s time to roll up our sleeves, put our hard hat on, and dig in.

We already determined what level of detail we plan to identify the equipment in the scope of work section above. This determination depends largely on the property being valuated.

For example, let’s say the assignment is an aggregate plant. Our certified machinery and equipment appraisers will take the following 3 step systematic (macro) approach to identifying the plant’s characteristics:

#1 Collect facts and data relating to the full life cycle of the plant

First identify the product and byproducts that the plant produces. In our example, the final product is concrete.

#2 Determine how the finished product is produced

Identify the major components in the aggregate plant.

In our example, we might have a quarry, a crushing plant, a washing plant, and a batching plant that all play an integral role in producing the final product. Often, a plant diagram or flowchart is the most efficient way to answer this question.

#3 Identify the output capacity of the plant

This is an important identification, especially if we choose to value the plant using the income valuation approach (more on the income approach in Step #3: Consider below).

If the assignment isn’t a plant, but equipment valuation for a fleet of rolling stock (trucks, construction equipment, trailers, etc.), we take a different approach to identifying characteristics. In this scenario, we are more interested in capturing and recording equipment characteristics on a micro level, such as year, make (Caterpillar, John Deere, etc.), model, serial number or VIN, and hours/miles.

EA says… The method(s) by which you collect, identify, classify, and describe the equipment characteristics depends on the scope of work decision “the extent to which tangible property is inspected” we made above.

Regardless of the method by which we identify the equipment’s characteristics, the equipment owner should be able to quickly provide the certified machinery and equipment appraiser with the most complete, up-to-date facts and data on the equipment property.

After all, the business owner purchased the equipment, oversees the servicing, and thus, should know it better than anyone, right?

If the business owner isn’t able to furnish this information, the machinery appraiser should identify that, realize that it will take extra time to collect this information, and account for this in the scope of work.

Step 3: Equipment Valuation Approaches (Consider 3, Apply 1)

With the complete equipment list at our fingertips, we need to carefully consider all 3 equipment valuation approaches:

Sales Comparison Cost Income

After careful consideration, the appraiser chooses one* approach that he/she feels is necessary to produce the best credible assignment results.

* Note that an appraisal report can utilize more than 1 valuation approach. For example, an assignment might include 1 very common machine and 1 very uncommon machine. The heavy equipment appraiser might find many sales comps for the common machine, but find few for the uncommon machine. In that scenario, we might value the common machine using the sales comparison approach and one of the other two for the uncommon machine.

1. Sales Comparison Equipment Valuation Approach

The sales comparison approach is very common in equipment valuation.

If you’ve ever heard your Realtor talk about “comps” when buying or selling a home, then you are familiar with sales comparison approach.

The logic here is that an educated buyer would expect to pay a similar price for similarly sold items. This is true in any market, whether it be a bulldozer or a house.

The tricky part for an equipment appraiser, however, is that heavy equipment sales aren’t a matter of public record, like home sales are (in most states).

This means that comparable sales for equipment aren’t as easy to come by as home sale prices. So the next time you are evaluating machinery and equipment appraisers for an assignment, ask each about their sales comparison methodology.

The sales comparison equipment valuation approach is best applied when there exist many sales of the same, or very similar machines.

EA says… One thing that sets Heavy Equipment Appraisal services apart from the competition is our background in equipment and the strategic alliances we maintain with independent equipment dealers. This means that we have strong network connections to those who buy and sell equipment locally and globally every day, giving us the inside track to those hard-to-come-by equipment sales comps!

Cost Equipment Valuation Approach

This approach to equipment valuation is a deep topic, but can most efficiently be explained by this calculation:

Cost Approach = Current Cost – Depreciation

Let’s break this equation:

Current Cost

Specifically, we’re looking at fair market value of the machine, as if it were new. Clearly, a machine is never new after leaving the factory and we often appraise equipment that isn’t new in this decade. So how do we arrive at the current price of that?! To do so, we first consider the Replacement New approach, then move onto the Reproduction New approach, if necessary.

Replacement Cost New

How much to replace the subject machine with the current-day-equivalent? That is replacement cost.

Reproduction Cost New

If it is more economical (cheaper) to reproduce the same exact item (or the same exact item is still being manufactured), we will use the reproduction cost approach.

Depreciation

Appraisal depreciation is different than the accountancy term “depreciation” and consists of functional and economic obsolescence and physical deterioration.

Now that you know a bit about current cost and depreciation, as they relate to appraisals, we could really rewrite the equation above to be:

Cost Approach = (Replacement or Reproduction Cost) – (Physical Deterioration + Functional Obsolescence + Economic Obsolescence)

This approach is best applied when dealing with unique property and there don’t exist many sales of the same subject property (thus, unable to apply the sales comparison approach).

Income Equipment Valuation Approach

The income approach is another accepted machinery and equipment valuation technique. This approach attempts to forecast future earnings generated by the equipment being appraised.

The income technique to equipment valuation includes many steps and variables, requires making assumptions, and necessitates complex mathematical calculations. Even with the amount of work required for the income approach, the end result is still only speculative, and thus, isn’t utilized as often as the preceding approaches to machinery valuation.

Still, there are scenarios where the income approach fits perfectly. A good time to use the income technique might be for a plant and machinery valuation assignment – like the aggregate plant example discussed in step 2 above.

Step 4: Equipment Valuation

Now that we’ve identified all items necessary to produce credible results, collected all equipment characteristics, and chosen a valuation approach, it’s time to apply our value opinions and conclusion to the equipment or machinery.

Truthfully, we’ve already accomplished most of this step by way of the previous 3 steps. So now we can take what we have accumulated and start tying those pieces together for inclusion into the appraisal report.

This will help the certified machinery and equipment appraiser to compile all of the results in one place, in an organized manner. This helps to provide big picture clarity on the assignment by identifying areas that are complete, sections that need attention, and things that have been overlooked.

With a rough draft of the appraisal report in front of our eyes, we inspect every detail, looking for deficient areas. Once those areas are identified, the appraiser should go into Sherlock Holmes investigation mode.

This might mean the appraiser gets on the phone with the foremost expert of a piece of machinery, or meets up with an appraiser peer to inquire about a similar experience, or does an equipment auction results search, or…

The depth of this step will vary from appraiser to appraiser, based on their experience (and/or imagination), so this might be a good series of questions to ask when considering appraisers.

EA says… It is important to note that appraisers aren’t experts on each and every piece of equipment out there. Shy away from machinery and equipment appraisers who tell you otherwise…because it’s just not possible! We’re not the foremost experts on every type of equipment. And we’re proud to say that. Posing as an expert on everything is a stubborn mindset that minimizes effectiveness by producing less-credible appraisal results. (in our humble opinion) 🙂 We are professional researchers with 30+ year background in equipment, cultivate a strategic alliance with one of the best independent equipment dealers in the United States, maintain a database of equipment sales, and a possess an ever-expanding network of contacts in the equipment industry at our fingertips.

Step 5: Deliver

Finish preparing the appraisal report in accordance with Standard 8 of the USPAP. Make any reconciliations necessary.

Deliver the appraisal report to the intended users identified in Step 1.

Appraisal assignments should be a collaborative effort throughout the appraisal life cycle, and appraisal results delivery should be no different. The equipment owner and/or client should have a chance to see the appraisal before the final delivery.

The point of this isn’t to allow for biased opinions to persuade values, or any other reason but to help identify omissions or miscommunications – and ultimately, make any necessary reconciliations.

Once all sides are confident that no blatant errors or omissions exist, put the final touches on the certified machinery appraisal report, and deliver it to the client and intended users.

Simple, right?!

Now we can dust our hands from this appraisal project, burn all of our research behind us, and move on to the next appraisal assignment.

Not so fast!

According to the USPAP Record Keeping Rule:

An appraiser must retain the workfile for a period of at least five years after preparation or at least two years after final disposition of any judicial proceeding in which the appraiser provided testimony related to the assignment, whichever period expires last.

In other words, keep everything.

F-O-R-E-V-E-R!