Anna MSC PM 1st VALUATION PDF

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Pl ant a nd Ma chinery Valuation\106-Valuation of Pla nt & Ma chi nery-I\106- Va l ua ti on of Pl a nt a nd

Ma chi nery-I.docx – Final– Pri nt on 24-1-17
886E160
1–9
ANNAMALAI UNIVERSITY
DIRECTORATE OF DISTANCE EDUCATION
M.Sc. PLANT AND MACHINERY VALUATION

First Year
VALUATION OF PLANT AND MACHINERY - I

LESSONS: 1 – 9
Copyright Reserved
(For Private Circulation Only)
FIRST YEAR
EDITORIAL BOARD
Members
Dr. C. Antony Jeyashekar
Dean
Faculty of Engineering and Technology
Annamalai University
Annamalai nagar.
Dr. G. Ganesan Dr. A. Prabaghar

HOD of Manufacturing Engineering Associate Professor and Wing Head
Faculty of Engineering & Technology Engineering Wing - DDE
Annamalai University Annamalai University
Annamalainagar. Annamalainagar.
Internals
Dr. M . Arulselvan Dr. K. Srinivasan

Assistant Professor Assistant Professor
Manufacturing Engineering Manufacturing Engineering
Engineering Wing – DDE Engineering Wing – DDE
Annamalai University Annamalai University
Annamalainagar. Annamalainagar.
Lesson W riter
Dr. R.K. Patel
Valuer & Insurance Surveyor
No:79, Nirman Park, Manjalpur
Vadodara – 390011.
i
FIRST YEAR
SYLLABUS
Overview of industrial structure in India. Historical perspective on industrial
policy and features of the policy currently in vogue.
P & M Valuation using: Asset based (cost) approach, Market approach,
Income approach
Definitions & assessment - functional, technological and economic
obsolescence, Valuation in-situ and ex-situ - Trans location (shifting) of Plant &
Machinery , Proximity impact – raw material / demand center / fuel / other,
Financial Incentives by State & Central Govt - impact on Value.
Valuation of assets in leasing & hire purchase, Difference between leasing and
hire purchasing
Role of a Valuer in lease and hire purchase transactions, Salient features of a
valuation report in sale & lease-back transaction
Valuation for Banks. Sources of funding:
Equity, term loans, working capital loans, venture capital. Role of Banks in
secured lending, Valuation requirements for financial institutions and banks.
Valuation of assets – in working condition, Utilization of funds certification &
verification of assets.
Valuation standards – Guidance Notes – Generally accepted valuation practices.
Emerging trends in Industrial scenario – Outsourcing / vendor ratings /
Global influence / quality assurance / ISO Standards- Industrial visits.
References:
1. Valuation of Plant and Machinery (Theory & Practice) by Kirit Budhbhatti
2. Guidance Notes published by Internatioal Valuation Standard Committee (IVSC)
on Valuation
3. Valuation of Plant and Machinery by C.J.C. Derry
4. Property Valuation Hand Book B5, Published by Centre for Advanced Land Use
Studies, College of Estate Management
5. Inflation Accounting by W.T. Baxter
6. Industrial Valuation by Karslake and Nichols, Published by Estate Gazettes U.K.
7. Appraising of Machinery and Equipment, Edited by John Alico, Published by
American Society of Appraisers, ISBN - 07-001475-2, Mc Graw Hill, New Delhi
ii
FIRST YEAR
CONTENT
Lesson Page
Title
No. No.
1 Overview of industrial structure in India 1
2 Fundamentals of Valuation of Plant & Machinery 38
3 Procedure of Plant & Machinery Valuation 46
4 Depreciation of Plant and Machinery in Valuation 67
5 Age, Life and Remaining Life of Plant and Machinery in Valuation 81
6 Valuation for Banks 88
7 Valuation for Insurance 112
8 Relevant Valuation Standards for Valuation on Plant & Machinery 122
9 Case Studies of Plant and Machinery Valuations 130

LESSON-1
OVERVIEW OF INDUSTRIAL STRUCTURE IN INDIA

1.1 INTRODUCTION
1.1.1 Department of Industrial Policy and Promotion
The role of the Department of Industrial Policy and Promotion (DIPP) is to
promote the industrial sector in India and facilitate balanced development of
industries.
Under the seventh edule of the Constitution, those industries which are
declared by Parliament, by law, in the public interest, to be under control of Union,
are administered by DIPP. In addition to this Constitutionally delineated role,
matters relating to development of industries by the Union, explosives, UNIDO,
patents, inventions and designs, trademarks and merchandise marks,
manufacture, supply and distribution of salt by Union agencies and regulation and
control of manufacture, supply and distribution of salt by other agencies, are
specifically administered by the Department of Industrial Policy and Promotion on
behalf of the Union of India. Further, the Department is also responsible for the
administration of the Boilers Act, 1923, for the subject “Boiler” which is in the
Concurrent List.
1.1.2 Objectives, Functions, and Laws Administered
The broad objectives of the Department, in line with its defined role, are as
follows:
a) Accelerating industrial growth by providing financial, infrastructural and other
support. Facilitating foreign investment in industries and coordinating with
different agencies for fastracking of investment approvals.
b) Facilitating development of industries in North East and other special category
states.
c) Improving intellectual property rights regime consistent with the country’s
international commitments.
d) Maintaining a sound information base of macroeconomic indicators of
industrial production and prices.
e) Initiating measures towards procedural changes to make functioning of the
department more transparent and responsive.
Over the years, the role of DIPP has evolve d from being a regulator and
administrator of the industrial sector to that of a facilitator of new technology, and
Foreign Direct Investment inflows into the country.
1.1.3 The key functions of DIPP are:
a) Formulation and implementation of industrial policy and administration of
Industries (Development & Regulation) Act, 1951.
b) Monitoring and stimulation of industrial growth in general as also the industries
specifically assigned to DIPP as per Allocation of Business Rules, 1961.
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c) Promotion of industrial development in North East and special category states of
J&K, Himachal Pradesh and Uttarakhand through appropriate incentives
framework.
d) Formulation of Foreign Direct Investment Policy and promotion and facilitation
of direct foreign and nonresident investments.
e) Nodal department for investment related issues in Bilateral/Regional Economic
Cooperation Agreements.
f) Formulation of policies relating to Intellectual Property Rights in the field of
Patents, Trade Marks, Industrial Design and Geographic Indication of Goods
and administration of regulations and rules under IPR.
g) Compilation of Wholesale Price Index and monthly industrial production
statistics for use in construction of the Index of Industrial Production.
The Department of Industrial Policy and Promotion administers the following
Central Legislations through its attached/subordinate offices and statutory
organizations:
1. The Patents Act, 1970, the Trade Marks Act , 1999 , the Geographical
Indications of Goods (Registration and Protection) Act, 1999 and the Designs
Act, 2000. The associated Rules are administered through the Office of the
Controller General of Patents, Designs and Trade Marks (CGPDTM). The
Intellectual Property Appellate Board provided under the Trade Marks Act,
1999, has been set up in Chennai.
2. The Explosives Act, 1884, and the Rules made thereunder i.e. the Explosives
Rules 2008, the Gas Cylinder Rules,2004, Static & Mobile Pressure Vessels
(Unfired) Rules, 1981, and Ammonium Nitrate Rules 2012, which are
administered through the Petroleum & Explosives safety organization Nagpur.
3. The Salt Cess Act, 1953, is administered through the Office of the Salt
Commissioner, Jaipur.
4. The Boilers Act, 1923, is administered through the Indian Boiler
Regulations,1950, framed by the Central Boilers Board, which is a statutory
body under the said Act. Enforcement of this Act is the responsibility of both
the State and Union governments since the subject “Boiler” is listed in the
concurrent list of the Constitution of India.
1.2 OBJECTIVES
The main objective of this lesson is to abreast the students about the
industrial mechanism, industrial policy and administrative machinery for
promotion and development of industries in India.
1.3 CONTENTS
1.3.1 Industrial Policy
1.3.2 National Manufacturing Policy
1.3.3 Foreign Direct Investment (FDI) Policy
1.3.4 Specific Industries Administered by DIPP
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1.3.5 Investment Promotion and International Cooperation
1.3.6 Make in India
1.3.7 Invest India
1.3.8 Startup India
1.3.9 Intellectual Property Rights
1.3.10 Productivity and Quality
1.3.11 UNIDO Activities
1.3.12 Programmes for Industrial Infrastructure Development-Modified Industrial
Infrastructure Upgradation Scheme (IIUS)
1.3.13 Delhi Mumbai Industrial Corridor Project
1.3.14 Chennai Bengaluru Industrial Corridor (CBIC)
1.3.15 Bengaluru-Mumbai Economic Corridor (BMEC)
1.3.16 Vizag Chennai Industrial Corridor (VCIC)
1.3.17 Amritsar Kolkata Industrial Corridor (AKIC)
1.3.18 North East connectivity
1.3.19 National Industrial Corridor Development Authority (NICDA)
1.3.20 Package for Special Category States
1.3.21 Monitoring of Industrial Activity, Production and Prices
1.3.22 Industries and Industrial & Technical Development in India
1.3.23 Light Industrial Machinery Sector
1.3.24 Salt Industry
1.3.25 Labour Welfare Activities and Development Works
1.3.26 Internal Policy Guidelines of DIPP to consider requests for transfer of land
at places other than Mumbai and its suburbs, for public purposes.
1.3.1 Industrial Policy
The Department is responsible for formulation and implementation of
promotional and developmental measures for growth of the industrial sector,
keeping in view the national priorities and socioeconomic objectives. While
individual administrative ministries look after the production, distri bution,
development and planning aspects of specific industries allocated to them, this
department is responsible for the overall Industrial Policy. The Statement of
Industrial Policy 1991, tabled in Parliament as a Resolution, forms the basis of the
subsequent steps taken by the Government under the Policy to liberalize and
promote industries over the years, including the Foreign Direct Investment (FDI)
Policy and the specific National Manufacturing Policy (NMP) announced in 2011 .
1.3.2 National Manufacturing Policy
In order to bring about a quantitative and qualitative change and to give
necessary impetus to the manufacturing sector, the Department has notified the
National Manufacturing Policy (NMP) with the objective of enhancing the share of
manufacturing in GDP to 25% and creating 100 million jobs over a decade or so.
The policy is based on the principle of industrial growth in partnership with the
States. The Central Government will create the enabling policy frame work, provide
incentives for infrastructure development on a Public Private Partnership (PPP)
basis through appropriate financing instruments, and State Governments will be
encouraged to adopt the instrumentalities provided in the policy. The Department
has taken up the implementation of the policy in consultation with concerned
Central Government agencies as well as the States.
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National Investment and Manufacturing Zones (NIMZs) are an important
instrumentality of the Policy. These zones have been conceived as large integ rated
industrial townships with state-of-the-art infrastructure; land use on the basis of
zoning; clean and energy efficient technology; necessary social infrastructure; skill
development facilities, etc. to provide a conducive environment for manufacturing
industries. So far twelve NIMZs have been granted in -principle approval outside the
DMIC region. Out of which one NIMZ at Prakasam has been granted final approval.
Government has also launched the Technology Acquisition and Development
Fund (TADF) as envisaged in the National Manufacturing Policy on 18 th November,
2015 to provide the funding specific to acquisition and development of clean and
green technologies. The fund will support, via subsidies, manufacturing of
equipment/ machines/devices for controlling pollution, reducing energy
consumption and water conservation.
1.3.3 Foreign Direct Investment (FDI) Policy
The Department of Industrial Policy & Promotion is the nodal Department for
formulation of the policy of the Government on Foreign Direct Investment (FDI). It is
also responsible for maintenance and management of data on inward FDI into
India, based upon the remittances reported by the Reserve Bank of India.
The FDI policy is reviewed on an ongoing basis, with a view to making it more
investor-friendly. To attract higher levels of FDI, Government has put in place a
liberal policy on FDI, under which FDI, up to 100% , is permitted, under the
automatic route, in most sectors/ activities. Significant changes have been made in
the FDI policy regime in recent times, to ensure that India remains an increasingly
attractive investment destination. The Department plays an active role in the
liberalization and rationalization of the FDI policy. Towards this end, it has been
constructively engaged in extensive stakeholder consultations on various aspects of
the FDI policy.
1.3.4 Specific Industries Administered by DIPP
The Department monitors industrial growth and production in general and in
select industrial sectors such as leather, cement, paper and pulp, tyre and rubber,
light electrical industries, consumer goods, consumer durables, light machine tools,
light industrial machinery, light engineering industries, etc. as indicated in the
allocation of Business Rules, 1961. Appropriate policy interventions are made, as
required based on emerging concerns from time to time.
For overall development of Leather Sector, the Department administers the
Indian Leather Development Programme (ILDP). The scheme aims at augmenting
raw material base through modernization and technology upgradation of leather
units, address environmental concerns, human resource development, support to
traditional leather artisans, address infrastructure constraints and establish
institutional facilities.
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1.3.5 Investment Promotion and International Cooperation
The Department plays an active role in investment promotion and facilitation
through dissemination of information on the investment climate and opportunities
in India and by advising prospective investors about investment policies and
procedures and opportunities. International Co-operation for industrial
partnerships is solicited through both bilateral and multilateral arrangements. It
also coordinates with apex industry associations like Federation of Indian
Chambers of Commerce and Industry (FICCI). Confederation of Indian Industry(CII),
the Associated Chambers of Commerce and Industry (ASSOCHAM), etc; in their
activities relating to promotion of industrial cooperation, both through bilateral and
multilateral initiatives intended to stimulate and inflow of foreign direct investment
into India.
1.3.6 Make in India
The Department has launched “Make in India” initiative, a global promotional
campaign to project India as an investment destination and potential
manufacturing hub. The campaign was launched by the Prime Minister on 25 th
September 2014.
1.3.7 Invest India
In order to assist and handhold foreign investors, Invest India has been set up
as a Joint Venture Company (Not for Profit Company) between Department of
Industrial Policy & Promotion (DIPP), Ministry of Commerce and Industry,
Government of India, Federation of Indian Chambers of Commerce and Industry
(FICCI) and various State Governments. Invest India is responsible for promoting
and facilitating investments to India. The shareholding is 51% of FICCI, 45% of
DIPP and 4% with the states.
An Investor Facilitation Cell has been created at Invest India to assist, guide,
support, handhold and facilitate investors during various states of their project.
The cell has already responded to more than 16000 queries on ‘Make in India portal
(www.makeinindia. com), as of 31.12.2015.
1.3.8 Startup India
Economic Survey (2014-15) estimates that 300 million youth will enter the
labour force by 2025, and there is a need to accommodate the growing proportion of
economically active population. India need to create at least 10 million jobs every
year for the next 10 years to gainfully employ India youth and meet their
aspirations. It identifies the (small) share of manufacturing in total employment as
a major impediment to the pace of quality employment generation in India.
Government of India recognizes growth of entrepreneurship and manufacturing as
an immediate requirement towards gainfully utilizing India’s workforce.
The concept of a startup has recently caught the imagination of masses. What
actually constitutes a startup may be widely debated as ranging from any MSME to
technology driven software companies or entrepreneurs undertaking disruptive
business models. A report by NASSCOM estimates that there are about 4200
startups in India. Interestingly, the overall entrepreneurship activity can be assessed
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through various figures. According to Annual Report 2014-15 of Ministry of MSME
3,62,991 MSMEs (2,96,526 micro, 5912 small and 7,338 medium) filed EM-I in
2013-14. This number has steadily grown from 1,72,703 in 2007-08 to 3,62,991 in
2013-14. It is estimated that the number of enterprises in unregistered sector is
much larger. According to monthly data published by Ministry of Corporate Affairs
14,682 LLPs were registered during 2014-15. The number of LLPs registered in 2015-
16 till November, 2015 is 13,813. During 2014-15, 64,395 companies were registered
of which 62,897 were private limited companies. The ‘Startup India’ initiati ve
specifically targets those enterprises which are engaged in innovative business which
is defined as development and commercialization of:-
a) A new product or service or process; or
b) A significantly improved existing product or service or process that will
create or add value for customers or workflow.
The process of recognition of an entity as startup has been assigned to various
private players which include –
i. Incubators established in a post-graduate college in India;
ii. Incubators funded by Government of India under any scheme for promotion of
innovation
iii. Incubation, recognized by Government of India
iv. Incubation funds/ Angel funds/Private Equity funds/ Accelerator/ Angel
Network duly registered with SEBI.
In addition, an entity which is funded by Government of India under any
scheme for promotion of innovation or granted a patent by the Indian Patent and
Trademark Offices are also recognized as Start-ups.
An action plan to create a conducive ecosystem for startups in India was
released by the Prime Minister of India on 16 th January, 2016. The action plan aims
at giving the right nudges to the development of various components of the
ecosystem. The Action Plan provides for the following:-
A) Simplification and Handholding
• Compliance Regime based on Self-certification
• Mobile app and Portal
• Startup India Hub
• Legal Support and Fast-tracking Patent Examination at Lower Costs
• Relaxed Norms of Public Procurement for Startups
• Faster Exit for Startups
B) Funding support and Incentives
• Providing Funding Support through a Fund of Funds with a Corpus of INR 10,000 crore
• Credit guarantee Fund for Startups
• Tax Exemption on capital gains
• Tax Exemption to startups for 3 years
• Tax exemption on Investments above Fair Market Value
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C) Industry-Academia Partnership and Incubation
• Organizing Startup Fests to showcase innovations and providing Collaboration
Platforms
• Launch of Atal Innovation Mission (AIM) with Self –Employment and Talent
Utilization (SETU) Program
• Harnessing Private Sector Expertise for Incubator Setup
• Building Innovation centres at National Institutes
• Setting up of 7 New Research Parks modeled on the Research Park at IIT Madras
• Promoting Startups in the Biotechnology sector
• Launching of Innovation Focused Programs for students.
• Annual Incubator Grand Challenge
1.3.9 Intellectual Property Rights
DIPP is entrusted with the responsibility of formulation of policy in respect of
Intellectual Property Rights (IPRs) i.e. Patents, Designs, Trade Marks and
Geographical Indications of Goods. The department administers Intellectual
Property Rights (IPRs) Legislations, namely, the Patents Act, 1970, the De signs Act,
2000, the Trade Marks Act, 1999, and Geographical indications of Goods
(Registration & Protection) Act, 1999, through the Office of Controller General of
Patents, Designs & Trade Marks (CGPDTM), a su bordinate office of this
Department. It also administers establishment matters in respect of the Intellectual
Property Appellate Board (IPAB).
DIPP undertakes bilateral and multilateral cooperation activities in respect of
Intellectual Property Right matters on behalf of the government. It is the nod al
department for all matters relating to the World Intellectual Property Organization
(WIPO).
1.3.10 Productivity and Quality
DIPP is the nodal department for the promotion of productivity and quality in
the industrial sector. National Productivity Coun cil, New Delhi, an autonomous
body under this Department, undertakes programmes of technical cooperation with
the Asian Productivity Organization(APO), Tokyo by sourcing experts to advise on
productivity related projects and by deputing officials from the private and public
sector to programmes conducted by the APO in industry, agriculture and service
related sectors, in addition to its own training and awareness programmes on
productivity.
The Quality Council of India, another autonomous body under this
Department, promotes adoption of quality standards relating to Quality
Management Systems (ISO 9001 Series), Environment Management Systems (ISO
14001 Series), Food Safety Management Systems (ISO 22000 Series), Product
certification and inspection bodies through the accreditation services provided by
National Accreditation Board for Certification Bodies (NABCB). Besides NABCB,
there are three other boards viz National Accreditation Board for Education &
8
Training (NABET); National Accreditation Board for Hospitals and Healthcare
Providers (NABH); and National Board for Quality Promotion(NBQP) which provide
accreditation certification on education, health and quality promotion respectively.
1.3.11 UNIDO Activities
DIPP is the nodal Department for all matters related to UNIDO operations in
India. UNIDO is a specialized agency of the United Nations for industrial activities
within the United Nations system.
India has been an active member of the organization since its inception.
UNIDO has established its presence in India by means of following centers/offices
with different mandates viz. (i) UNIDO Regional Office (URO) which is headed by
UNIDO Representative (UR) to India and Asian region. (ii) UNIDO Centre for South-
South Industrial Cooperation (UCSSIC), New Delhi (iii) International Centre for
advancement of Manufacturing Technology (ICAMT), Bengaluru (iv) International
Center for Inclusive and Sustainable Industrial Development (IC-ISID), New Delhi.
The UNIDO Regional Office for South Asia, set u p in New De lhi on 1st
January, 2000, covers seven countries – India, Bangladesh, Sri Lanka, Nepal,
Bhutan, Maldives and Afghanistan – and acts as a focal point to mobilize
knowledge, information and technology for the region.
The Country Program of Cooperation betwe en the Republic of India and
UNIDO (CP 2013-17) signed in Vienna in September, 2013, by then Secretary, DIPP
and DG, UNIDO, is presently guiding the activities of UNIDO in India. CP (2013 -17)
serves as the framework for interventions by UNIDO in India, as aligned with the
Government’s 12th Five Year Plan and the United Nations Development Action
Framework (UNDF) (2013-2017).
DIPP has established a new center, IC-ISID (International Center for Inclusive
and Sustainable Industrial Development) in collaborati on with UNIDO after
successfully completion of UCSSIC and ICAMT. The center started its operation
from 1st May 2015. The IC-ISID echoes the theme of UNIDO’s post- 2015
development agenda .i.e. Inclusive and Sustainable Industrial Development aims to
bring best practices and new improved manufacturing technology to Indian
Industry and share India’s experience in cluster based development within the
framework of South- South Cooperation. The DIPP has undertaken 5 core projects
under IC-ISID related to Leather, Pulp & Paper, Cement, Bicycle and Cluster
Development.
1.3.12 Programmes for Industrial Infrastructure Development-Modified Industrial
Infrastructure Upgradation Scheme (IIUS)
Industrial Infrastructure Upgradation Scheme (IIUS) was launched in 2003
with the objective of enhancing competitiveness of domestic industry by providing
quality infrastructure through public private partnership in selected functional
clusters/locations. On the basis of evaluation of the Scheme in December 2011, a
modified version of IIUS viz ‘Modified Industrial Infrastructure Upgradation Scheme
(MIIUS)’ was notified in July 2013. Under MIIUS, projects can be undertaken to
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upgrade infrastructure in existing Industrial Parks/ Estates/ Areas. Greenfield
Projects in backward areas and North Eastern Region (NER) can also be sanctioned
under the scheme. Projects are to be implemented by the State Implementing
Agency (SIA) of the State Government. Central Grant upto 50% of the project cost
with a ceiling of ` 50.00 crore can be considered under MIIUS with minimum State
Implementing Agency’s contribution of 25% case of North Eastern States, the
central grant and the minimum contribution of the SIA will be 80% and 10%
respectively.
26 projects have been granted ‘in-principle’ approval under MIIUS. Final
approval has been accorded to 17 Projects with central grant amounting to `
426.90 crore and the remaining 09 projects with central grant of ` 255.54 crore are
at ‘in-principle’ approval stage. Central assistance of ` 81.35 crore has been released
to 11 projects as on 03.12.2015 under MIIUS.
1.3.13 Delhi Mumbai Industrial Corridor Project:
The DMIC project was launched in pursuance of an MOU signed between the
Government of India and the Government of Japan in December 2006. DMIC
Development Corporation (DMICDC) incorporated in 2008, is the implementing
agency for the project. DMICDC has been registered as a company with 49% equity
of Government of India, 26% equity of the JBIC and the remaining held by
government financial institutions. The Japanese Government had also announced
financial support for DMIC project to an extent of US$ 4.5 billion in the first phase
for the projects with Japanese participation involving cutting edge technology.
The project spans the States of Uttar Pradesh, Haryana, Rajasthan, Madhya
Pradesh, Gujarat and Maharashtra along the Western Dedicated Freight Corridor
(DFC) of the railways. Initially, 8 nodes/cities in the six DMIC states have been
taken up for development.
Four DMIC Projects i.e. (i) Dholera Special Investment Region(DSIR) in Gujarat
(ii) Shendra Bidkin Industrial Park (Maharashtra) (iii) Integrated Industrial
Township Project, Greater Noida in Uttar Pradesh and (iv) Integrated Industrial
Township Vikram Udyogpuri near Ujjain in Madhya Pradesh are under
implementation. Master Planning, Environment Clearance and legal framework
authorizing power to SPVs have been completed. Special Purpose Vehicles (SPVs),
which is the implementing agency, have been formed. Land has been made
available by the concerned State Governments. The Central Government equity
have also been released to the concerned SPVs. Funds of ` 5100 crore for creation
of trunk infrastructure packages which includes Common Effluent Treatment Plant
(CETP), Administrative Business Centre (ABC), Water Treatment Plant (WTP),
Sewage Treatment Plant (STP) and Roads and Services has already been put in
place by Government of India. These trunk infrastructures will be created within
next 3 to 4 years. These four projects will offer/create many opportunities for
investors.
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1.3.14 Chennai Bengaluru Industrial Corridor (CBIC):
During the visit of the Prime Minister of Japan to India in December, 2011, the
two Prime Ministers stressed the importance of infrastructure development in the
areas between Chennai and Bengaluru and directed to operationalize the modalities
for preparation of the Comprehensive In tegrated Master Plan for development of
Chennai Bengaluru Industrial Corridor (CBIC). The corridor between Chennai-
Bengaluru- Chitradurga (around 560 Km) would have an influence area spread
across the States of Karnataka, Andhra Pradesh and Tamil Nadu. Japan
International Cooperation Agency (JICA) Study Team undertook the Preliminary
Study for Comprehensive Integrated Master Plan for Chennai - Bengaluru Industrial
Corridor (CBIC) and a total 25 priority projects across various sectors aimed at
removing infrastructural bottlenecks were identified in their report. The progress on
these projects is being regularly monitored in DIPP.
JICA submitted its Final Draft Report on the Master Planning of 3 identified
Industrial Nodes namely Ponneri (Tamil Nadu), Tumkur (Karnataka) and
Krishnapatnam (Andhra Pradesh) in June, 2015. In a meeting held on CBIC under
the Chairmanship of Secretary, DIPP and co-chaired by Charged d’ Affairs,
Embassy of Japan with all stakeholders, line Ministries, and the Study Team
engaged by JICA, the report of master planning of above 3 industrial nodes has
been accepted as final and State Governments have been requested to initiate the
process of notification of master plan of these nodes. It was also decided that the
present list of identified 25 priority projects has been revised by adding some more
projects on the request of the State Governments concerned.
State Support Agreement (SSA) and Share Holder Agreement (SHA) has been
shared with the concerned State Governments in order to further customize it for
the CBIC States and finalise it with concerned State Governments at the earliest
and also to proceed ahead with the drafting of SSA and SHA .
1.3.15 Bengaluru-Mumbai Economic Corridor (BMEC):
During the Summit meeting held between India and United Kingdom in
February, 2013, the Prime Ministers of both the countries welcomed the
development in cooperation on infrastructure since the last summit. They noted
UK’s interest in cooperating with India for the development of a new Bengaluru-
Mumbai Economic Corridor (BMEC). The leaders agreed to examine and evolve the
modalities and content of a feasibility study of this project concept through mutual
discussions and to work out a roadmap for a possible partnership in this area.
Delhi Mumbai Industrial Corridor Development Corporation Ltd. (DMICDC)
and UK Trade and Investment (UKTI) has been identified the nodal agencies on
Indian and UK side for this project. DMICDC has appointed M/s Egis India
Consulting Engineers Pvt. Ltd. in JV with IAU ile -de-France & CRISIL Risk &
Infrastructure Solutions Limited as consultant for feasibility study of BMEC.
The consultant has submitted the Draft Perspective Plan Report of BMEC
region. Government of Karnataka identified ‘Dharwad’ as the first industrial node in
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Karnataka under the BMEC and DMICDC has initiated the work of master planning
of ‘Dharwad’ Node in Karnataka. Government of Maharashtra is yet to identify a
node in the State.
1.3.16 Vizag Chennai Industrial Corridor (VCIC):
A Concept note prepared by Asian Development Bank on East Cost Economic
Corridor (ECEC) linking Kolkata – Chennai - Tuticorin was considered and it was
decided to get a feasibility study done with the help of Asian Development Bank in
respect of the corridor. In compliance of the commitment made by the Central
Government in the Andhra Pradesh Reorganization Act, 2014, it was decided that
in the first phase of the study, Asian Development Bank would focus on the Vizag-
Chennai Section so that a final view on Vizag- Chennai Industrial Corridor may be
taken within the timeline prescribed in the Act and further action would be taken
accordingly.
As part of feasibility study of VCIC and also in terms of AP Reorganization Act,
2015, ADB team has since submitted the final report on Conceptual Development
Plan (CDP) of VCIC within prescribed time period. Thus the action in terms of AP
Reorganisation Act, 2014 has been completed.
Out of four nodes namely Vishakhapatnam, Kakinada, Gannavaram and
Kankipadu and Srikalahasti-Yerpedu of Andhra Pradesh identified by ADB in their
CDP-VCIC region, ADB prioritized two nodes namely Vishakhapatnam and
Srikalahasti-Yerpedu for which master planning has been initiated by third quarter
of 2015. Regional Perspective Planning of VCIC is in progress. Department of
Economic Affairs has accorded approval of project loan of USD 500 million and
programme loan of USD 125 million from ADB to the proposal of Government of
Andhra Pradesh for VCIC-DP.
1.3.17 Amritsar Kolkata Industrial Corridor (AKIC):
In order to give a boost to industrial development in the densely populated
states of Northern and Eastern India, the Government has approved to commence
preparatory work on creating an Amritsar Kolkata Industrial Corridor (AKIC). This
will be structured around the Eastern Dedicated Freight Corridor (EDFC) as the
backbone and also the highway system that exists in this route. The AKIC will also
leverage the Inland Water System being developed along National Waterway-1 which
extends from Allahabad to Haldia. The AKIC will cover the seven states namely
Punjab, Haryana, Uttar Pradesh, Uttarkhand, Bihar, Jharkhand and West Bengal.
Delhi-Mumbai Industrial Corridor Development Corpn. Ltd. (DMICDC) has
been entrusted with the work of undertaking the feasibility study of AKIC as the
nodal agency. DMICDC has since identified and appointed M/s LEA Associates
South Asia Pvt. Ltd. & M/s E&Y as Consultants for preparation of Perspective Plan
for AKIC Project. The consultants have already submitted the Inception Report i.e.
first deliverable and the same has been forwarded to the respective State
Governments for their comments/ suggestions. Timeline on the Perspective
Planning/ Feasibility Study of AKIC have since been received from DMICDC, the
nodal Agency.
12
1.3.18 North East connectivity
During the last visit of the Prime Minister to Japan, it was decided to connect
the North East to these corridors and extend this connectivity to Myanmar on the
other side. A review meeting under the chairmanship of Secretary, DIPP was held
on 1 st December, 2015 on the proposal for connectivity and socio-economic
development of North- Eastern Region. JICA has been asked to initiate the work and
feasibility study has been initiated by JICA.
1.3.19 National Industrial Corridor Development Authority (NICDA):
The formation of the NICDA was announced by the Union Finance Minister in
Budget Speech, 2014 for development of new industrial/economic Corridors
identified by the Government of India. NICDA is under process of constitution.
1.3.20 Package for Special Category States
For promoting industrialization in the remote, hilly and inaccessible areas,
Central Government has formulated and notified North East Industrial and
Investment Promotion Policy (NEIIPP), 2007, for the eight states of North East
Region and Transport Subsidy Scheme, 1971, which in addition to the eight states
of North East region also covers Himachal Pradesh, Uttarakhand, Jammu &
Kashmir, Darjeeling district of West Bengal, Andaman & Nicobar Administration
and Lakshadweep Administration. Benefits/ incentives available under different
schemes of North East Industrial and Investment Promotion Policy (NEIIPP), 2007,
include Capital Investment Subsidy, Interest Subsidy, Reimbursement of
Insurance, 100% Income Tax Exemption and Excise Duty Exemption based on
value addition norms specified by the Department of Revenue, Ministry of Finance.
Transport subsidy, ranging from 50% to 90% is provided on the transport cost
for transportation of raw material and finished goods to and from the location of the
unit and the designated rail-head or port as the case may be. Transport su bsidy
also covers movement of raw materials/finished goods from one state to another
within the North Eastern Region. The Transport Subsidy Scheme, 1971, has been
modified and replaced by Freight Subsidy Scheme, 2013, which has been no tified
on 23rd January, 2013.
New Industrial Policy and other concessions for the State of J&K were
introduced by DIPP on 14 th June, 2002 for a period of ten years. The
incentives/concessions provided for industrial development in the State included (i)
Central Capital Investment Subsidy Scheme, 2002; (ii) Central Interest Subsidy
Scheme, 2002; (iii) the Central Comprehensive Insurance Scheme, 2002. The
package of incentives for the State of J&K has been extended for a further period of
five year upto 14.06.2017.
New Industrial policy and other concessions for the States of Himachal
Pradesh and Uttarakhand were introduced by the Department of Industrial Policy &
Promotion on 7 th January, 2003 with a aim to provide the required incentives as
well as an enabling environment for industrial development, improve availability of
capital and increase market access to provide a fillip to the private investment in
13
the state. The scheme which was originally valid till 6 th Jan., 2013, has been
extended upto 31 st March, 2017.
1.3.21 Monitoring of Industrial Activity, Production and Prices
DIPP monitors the performance in the industrial sector through collating
information on Industrial Entrepreneurs’’ Memorandum (IEM), Industrial License,
Letter of Intent (LOI), Foreign Investment data and industrial production returns.
The Department also compiles and prepares index of production of 8 core
infrastructure industries on a monthly basis. Besides, the Department publishes
the monthly Wholesale Price Index (WPI) which forms the basis for official
information on inflation.
1.3.22 Industries and Industrial & Technical Development in India
1.3.22.1 Cement Industry
India is the second largest manufacturer of cement in the world. The industry
plays a crucial role in the development of the housing and infrastructure sector of
the economy. The price and distribution control of cement was removed in 1989
and the cement industry has been de-licensed in 1991 under the Industrial
(Development & Regulation) Act, 1951. Since then the Cement Industry has
progressed well both in capacity/production and as well as in process technology.
India is producing, different varieties of cement like Ordinary Portland Cement
(OPC), Portland Pozzolana Cement (PPC), Portland Blast Furnace Slag Cement
(PBFS), Oil Well Cement, White Cement, etc. These varieties of cement are produced
as per the Bureau of Indian Standard (BIS) specifications and its quality is
comparable with the best in the world.
1.3.22.2 Capacity, Production and Dispatch of Cement
Cement is one of the most technologically advanced industries in the country.
The modern Indian Cement plants are state-of-the-art plants and are comparable to
the best in the world.
The Indian Cement Industry has managed to keep pace with the global
technological advancement. Induction of advanced technology has helped the
industry to improve its efficiency by conserving energy, fu el and addressing
environmental concerns.
The cement industry comprises of 210 large cement plants with an installed
capacity of 350.00 million tonnes and more than 350 mini cement plants with an
estimated capacity of 11.10 million tonnes per annum. There are a few large cement
plants owned by the Central and the State Governments.
The Production and Dispatch figures for the year 2014-15 are (up to March
2015) 270.93 Million Tonnes (MT) and 258.46 Million Tonnes (MT) respectively. The
Department collects Cess on Cement @ Rs. 0.75 per metric tonne of cement
manufactured/ produced from medium and large industries. The Cess collected for
the years 2014-15 and 2015-16 is Rs. 19.86 Cr and Rs. 9.38 Cr (up to September
2015) respectively.
14
Cement Information System (CIS) Portal was launched to compile data about
the cement industry regarding Capacity, Production, Dispatch, Export and Import
of Cement , mode of dispatch of cement across the country, Cess paid on cement,
etc.
National Council for Cement and Building Materials (NCCBM) is an
autonomous apex R&D organization under the Administrative Control of this
Department.
The Budget provisions for the current financial year 2015-16 is Rs. 5.00 Cr for
‘Plan’ and Rs. 14.55 Cr for ‘Non-Plan’ activities. Outlay for the 12th Five Year Plan
for NCCBM is Rs. 35 Cr.
1.3.22.3 Cigarette Industry (HS Code:24)
The Cigarette Industry is an agro-based labour intensive industry. Cigarette is
included in the First Schedule to the Industries (Development & Regulations) Act,
1951 and requires Industrial License.
The production of cigarettes during 2014-15 was 8,17,690.63 lakh (in
numbers). During the current financial year (April, 2015 to November, 2015), the
production has been 5,74,771.57 lakh (in numbers) .
The export and import of Cigars, Cheroots, Cigarillos and Cigarettes of Tobacco
or Tobacco Substitutes in the year 2014-15 and for current financial year (April,
2015 to November, 2015) (HS Code: 2402) are as follows:
(Value in Rs. Lacs)
HS Code Export Import
2015-16 (April to 2015-16 (April
2402 2014-15 2014-15
Nov., 2015) to Nov., 2015)
75,459.60 52,727.63 14,422.97 9,822.22
1.3.22.4 Explosives Industry
There are 118 Explosives Plants and 137 Site Mixed Explosives Plants in the
medium and Small Scale Sector, engaged in the production of Explosives. The
installed and production capacity are as under:
The number of licences issued under the Explosives Act 1884 and Petroleum
Act 1934 and the production of Explosives during the last 5 years are as under:
15
Production of Explosives for the last 5 years
Annual
Instal l ed 2015-16 (upto
Description 2011-12 2012-13 2013-14 2014-15
Licensed 31/12/2015)
capacity
Class 1 Gun Powder (Metric Tonnes) 1565.55 710.6 577 549 535.327 376.565
Class 2 604651 238193 267275 269999 344147 265401
(a) Cartridges (b) Site Mixed (Metric 1463721 483828 499249 519878 604234 546193
Tonnes)
Class 3 Div 1 (NG) ** Nil Nil Nil Nil Nil
Class 3 Div-2 19954.67 5063.1 5656.5 6186 7015 5767
Booster and PETN* (Metric Tonnes)
Class 6 Div 1 Safety Fuse (Million 261.6 81.1 77 74 68 46
meters)
Class 6 Div 2 Detonating fuse (Million 711.2 370.6 367.5 427 458 347
mtrs)
Class 6 Div 3 Detonators (Million no.) 1116.05 970.7 992.2 1031 907 702
PETN- Penta Erythritol Tetra Nitrate
** Possession, sale and transport of Class 3 Division 1 (Nitro-Glycerine based
explosives has been prohibited since 01/04/2004). However, manufacturing
units in private sector authorized to manufacture N.G. and N.G. based explosives
for use by Armed Forces of the Union, Ordnance factories or other
establishments of Defence forces have been exempted w.e.f.13/02/2015.
1.3.22.5 Glass Industry (HS Code:70)
Glass Industry comes under the category of delicensed industry. Glass
Industry covers seven items such as sheet and flat glass (including sheet, float,
figured, wired, safety, mirror glass)(NIC-26101), Glass Fiber and Glass Wool (NIC-
26102), Hollow Glassware (NIC-26103), Laboratory Glassware (NIC- 26104), Table
& Kitchen Glassware (NIC- 26105) and Glass Bangles (NIC-26106) and other
Glassware (NIC-26109). There has been a growing acceptability of the Indian flat
glass products in the global market. There is considerable scope for glass fibre
products, particularly, due to growth in petrochemical sector and al lied products.
The production of Glass Sheet, Toughened Glass, Fibre Glass, Glass Bottles
during 2014- 15 were 92,820.32 thousand square metres, 34,37,690.80 square
metres, 40,687.53 tonnes, 9,53,923 tonnes respectively and during the current
financial year (April, 2015 to December, 2015) have been 65,725.25 thousand
square metres, 24,35,414.15 square metres, 37,313.00 tonnes and 6,68,533.00
tonnes respectively.
The export & import of glass & glassware in the year 2014-15 and current
financial year (April, 2015 to November, 2015) (HS Code: 7005, 7007, 7008, 7009
and 7010 ) are as follows:
16
(Value in Rs. Lacs)
HS Export Import
Code
2014-15 2015-16 (April to Nov., 2014-15 2015-16 (April to Nov,
2015) 2015)
7005 29,091.77 13,879.47 80,377.49 51,753.93
7007 14,211.27 10,974.61 32,144.59 26,293.05
7008 1,973.51 1,532.37 3,343.25 1,268.31
7009 16,335.34 12,080.72 41,693.72 30,388.59
7010 1,19,345.45 92,285.29 30,823.37 23,601,65
Total 1,80,957.34 1,30,752.46 1,88,382.42 1,33,305.53
1.3.22.6 Wood Based Industry (HS Code:44)
Plywood, Veneers of all types and other wood based products such as particle
board, medium density fiber board etc. form the major segment of the Wood based
Industry in India. The Industry comes under the delicensed category. However, in
terms of Press Note No. 9 (1998 Series) dated 27.8.98, issued by the Department of
Industrial Policy & Promotion, entrepreneurs who wish to obtain approval from the
Government to set up a wood based proje ct should obtain prior clearance from the
Ministry of Environment & Forests before submitting the applications to the
Administrative Ministry / SIA and enclose a copy of “in principle” approval given by
the Ministry of Environment & Forests.
The total production of Plywood, Wood Veneer and Particle Boards during
2014- 15 was 52,550.00 thousand square metres, 1,07,784.00 thousand square
metres and 7,733.34 thousand square metres respectively and the production of
these products during the current financial year ( April, 2015 to December, 2015),
has been 39,108.82 thousand square metres, 62,748.97 thousand square metres
and 6,733.91 thousand square metres respectively
The export and import of wood and articles of wood in the year 2014 -15 and
for the current financial year (April, 2015 to November, 2015) (HS Code: 4408,
4409, 4410, 4411, 4412, 4415 and 4416 ) are as follows:
(Value in Rs. Lacs)
HS
Export Import
Code
2015-16 (April to 2015-16 (April to
2014-15 2014-15
Nov., 2015) Nov., 2015)
4408 9,445.35 5,689.10 71,467.05 72,301.18
4409 3,266.17 842.21 9,600.11 7,047.84
4410 1,432.53 931.74 19,205.16 16,863.36
4411 7,727.54 4,616.90 52,053.11 39,211.87
4412 17,899.83 10,663.51 55,225.83 34,902.91
4415 8,128.47 4,908.94 6,965.00 4,838.34
4416 17.94 53.80 770.43 923.12
Total 47,917.83 27,706.20 2,15,286.69 1,76,088.62
17
1.3.22.7 Paints & Allied Products Industry (HS Code: 32)
The Paints & Allied Industry which has been exempted from compulsory
licensing, mainly consists of paints, enamels, varnishes, pigments, printing inks,
etc. These play a vital role in the economy by way of protecting national assets from
corrosion. These items are manufactured both in the organized sector and small
scale sector.
The production of paints of all kinds and printing ink during 2014 -15 was
7,77,281.04 tonnes and 2,12,137.94 tonnes respectively. During the current
financial year ( April, 2015 to December, 2015), the production of these products
has been 598,142.22 tonnes and 1,71,687.33 tonnes respectively.
The export and import of Paints & Allied Products in the year 2014 -15 and for
the current financial year (April, 2015 to November, 2015) (HS Code: 3208, 3209,
3210 and 3215 ) are as follows:
(Value in Rs. Lacs)
HS Code Export Import
2015-16 (April 2015-16 (April
2014-15 2014-15
to Nov., 2015) to Nov., 2015)
3208 18,610.93 13,229.65 98,624.81 76,538.49
3209 4,783.61 2,663.40 28,890.16 18.685.70
3210 1,233.15 1,646.91 13,082.82 7,572.37
3215 1,04,382.92 63,437.46 1,33,705.14 1,13,317.47
Total 1,29,010.61 80,977.42 2,74,302.93 2,16,114.03
1.3.22.8 Watch Industry (HS Code:91)
The Watch Industry in India comprises of units both in the organized as well
as the small scale sector. The organized sector contributes 40% of the total demand
while the rest is met by the unorganized sector. Most of the watches are being
manufactured under the electronic system.
The production of Clock/Watch/Timepiece Movement and Watches (Wrist)
during 2014-15 was 10025,934 (in numbers) and 11,46.83 (thousand numbers).
During the current financial year (April, 2015 to December, 2015), the production
has been 80,99,582 (in numbers) and 7,896.99 (thousand numbers) respectively.
The export & import of Clocks and Watches in the year 2014-15 and for the
current financial year (April, 2015 to November, 2015) (HS Code: 91) are as follows:
(Value in Rs. Lacs)
Export Import HS Code Export
HS
2015-16 (April to Nov.,
Code 2014-15 2015-16 (April to Nov., 2015) 2014-15
2015)
91 56582.59 43072.45 1,90,126.94 1,35,335.35
1.3.22.9 Metal Container Industry (HS Code:7310)
The principal types of metal (tin) containers are food containers generally
known as OTS (Open Top Sanitary) cans and General Line Containers for packaging
non-food commodities such as paints, lubricants, pesticides, etc. The Metal
Container Industry is delicensed.
18
The production of Tin containers during 2014-15 was worth Rs,455.52 crores
and during the current financial year (April, 2015 to December, 2015) has been
Rs.324.21 crores.
The export & import of containers in the year 2014-15 and for the current
financial year (April, 2015 to November, 2015) (HS Code: 7310 ) are as follows:
(Value in Rs. Lacs)
Export Import HS Code Export
HS Code
2014-15 2015-16 (April to Nov., 2015) 2014-15 2015-16 (April to Nov., 2015)
7310 30,414.80 20,657.14 34,472.02 27,698.38
1.3.22.10 Soaps & Detergents Industry (HS Code:34)
Soaps and Detergents are not licensable and are manufactured both in the
small-scale and organized sector. It includes Laundry soaps, synthetic detergents,
toilet soaps, bathing bars, etc. Multinational Companies lead the manufacture of
toilet soap in India. The success of manufacturing companies in this sector
depends on many factors viz. quality, marketing, technology and distribution
strategy.
The production of Synthetic Detergents, Toilet Soaps and Washing Soaps
during the year 2014-15 was 13,08,727.24 tonnes, 7,05,904.37 tonnes and
1,07,642.94 tonnes respectively. During the current financial year (April, 2015 to
December, 2015), the production has been 9,57,263.36 tonnes, 5,44,287.56 tonnes
and 96,206.40 tonnes respectively.
The export and import of Soap, Organic Surface Active Agents, Washing
Preparations etc. in the year 2014-15 and for the current financial year (April, 2015
to November, 2015) (HS Code: 3401 and 3402 ) are as follows:
(Value in Rs. Lacs)
HS Code Export Import HS Code Export
2014-15 2015-16 (April to Nov., 2015) 2014-15 2015-16 (April to Nov., 2015)
3401 63,106.46 41,798.26 30,702.65 22,361.30
3402 2,01,370.60 1,20,776.23 1,57,436.88 1,04,290.44
2,64,477.06 1,62,574.49 1,88,138.53 1,26,651.74
1.3.22.11 Leather Industry
Leather Industry plays an important role in the Indian economy in view of its
substantial overall output, export earnings and employment potential. The Leather
Industry is the tenth largest amongst the manufacturing sector of India and i s one
of the top ten export earners for the country. The leather sector provides
employment to about 2.5 million people, mainly from the weaker
sections/minorities, of which about 30% are women. The sector has very strong
linkage to job creation in rural economy and on social equity. The sector is
dominated by small and medium enterprises.
The export of leather and leather products from India has undergone a
structural change during the last two decades. India was traditionally the exporter
of raw hides and skin and semi-processed leather. However, in the last two decades
19
the share of leather footwear, leather garments, leather goods, footwear components
and several articles of leather in the total exports has increased substantially as a
result of the Government’s policy to encourage export of value added leather
products.
India’s Export performance of the Leather Sector during the last five years is
presented below:-
(Value in Million US$)
2010-11 2011-12 2012-13 2013-14 2014-15
Finished leather 841.13 1024.69 1093.73 1284.71 1329.05
Footwear& Footwear-Components 1758.67 2079.14 2066.91 2345.60 2638.73
Leather Garments 425.04 572.54 563.54 596.15 604.25
Leather Goods 855.78 1089.71 1180.82 1353.91 1453.26
Saddlery & Harness 87.92 107.54 110.41 145.54 162.70
Non-Leather Footwear - - - 202.06 306.42
Total 3968.54 4873.62 5015.41 5937.97 6494.41
Source - Council for Leather Exports (CLE), India.
Items of manufacture in the Leather Sector do not attract Licensing Provisions
under The Industries Development and Regulation Act 1951 .
It was proposed to Constitute a Council to promote scale and competitiveness
of domestic leather industry. In this regard, the Department has approved
constitution of ‘Council for Footwear, Leather & Accessories (CFLA)’.
In respect of increasing skilled manpower in the country, 77735 unemployed
persons have been provided placement linked skill development training and out of
these 62092 trainees (79.64% ) have been provi ded employment in the leather sector
against the total target of 1.44 lakh persons for 2015- 16 (Till 31.12.2015) under
Indian Leather Development Programme (ILDP).
Further in respect of setting up new FDDIs to cater to enhanced demand for
specialists in leather the Department has approved establishment of two new
branches of Footwear Design and Development Institute (FDDI) in Banur (Punjab)
and Ankleshwar (Gujarat) with Government of India assistance of Rs. 100 crore for
each branch. Construction works for these branches have started.
1.3.22.12 Light Electrical Industry Sector
The Light Electrical Industry is a diverse sector having a number of distinct
products and sub-products. It includes goods like electrical wires and cables,
transmission tower, cranes, lifts & escalators, refrigerators, washing machine, air
conditioners, storage batteries, dry cell batteries, electrical lamps & tu bes etc. A
brief on some of these industries is given below:-
1.3.22.13 Electrical wires and cables
Electrical wires and cable industry is one of the oldest industries established
in the country in the field of electrical products. A wide range of wires and cables
are manufactured in the country which includes communication cables such as
jelly filled telephone cables, optic fibre cables, local area network cables,
switchboard cables, co–axial cables, VSAT cables, electrical cables such as
20
electrical wires, winding wires, automotive/battery cables, UPS cables, flexible
wires, low voltage power cables and EHT power cables. The power cable industry
may be mainly divided into four segments viz: house wiring (up to 440V), LT (1.1 to
3.3kV), HT (11 to 66kV), EHV (66kV and above). Well -established R & D facilities
are key factors for development of this industry. In India, renowne d laboratories
like Central Power Research Institute (CPRI), and Electrical Research and
Development Association (ERDA) are well equipped with the most advanced product
testing facilities meeting international standards.
The production of insulated cable & wires of all kinds in 2014-15 was 64.55
lakhs core km. and in 2015-16 (April-December) was 49.32 lakhs core km. The
export and import of wires and cables (HS code. 7413 & 8544) in 2014 - 15 was Rs.
4306.74 Crore and Rs. 3133.45 crore respectively whereas in 2015-16 (April-
November) the same was Rs. 3133.45 crore and Rs. 3597.69 crore respectively.
1.3.22.14 Transmission Towers
Transmission towers support high voltage transmission lines which carry
electricity over long distance. These lines typically feed into the sub-station so that
the electrical voltage can be reduced to a level that can subsequently be used by
consumers. There is an increasing trend in India to have larger power stations,
particularly mega and ultra-mega power projects. Consequently while there would
be fewer but larger power generating stations, the demand for transmission of
energy would grow substantially. The move to integrate India’s transmission
networks through a national grid of inter-regional transmission lines will facilitate
transfer of power from surplus regions to deficit regions. The industry has facilities
for testing transmission towers up to 1000 KV with the objective of catering to
future growth of transmission systems in the country as well as to export demand.
The export and import of transmission towers (HS Code 730820) in 2014-15
was Rs. 1929.97 crore and Rs. 31.12 crore respectively whereas in 2015 -16 (April-
1.3.22.15 Cranes
Cranes and hoists are an important category of material handling equipment
required by almost all sectors across the industry. Wide range of cranes are
manufactured in the country and these include Electric Overhead Traveling (EOT)
cranes, mobile cranes, ladle cranes, hydraulic decks, crab cranes, floating cranes,
controller cranes, etc. There is a good potential for growth of this sector in view of
increased industrial activities in various fields as well as construction industry.
The production of cranes in 2014-15 was 17063.63 tonnes and in 2015-16
(April- December) is 9829.85 tonnes. The export and import of cranes (HS Code
No.8426) in 2014-15 was Rs. 689.23 crore and Rs. 1852.07 crore respectively
whereas in 2015-16 (April-November) the same was Rs. 658.67 crore and Rs.
1464.30 crore respectively.
21
1.3.22.16 Lifts and Escalators
The use of lifts and escalators is increasing rapidly due to substantial
investments in construction of multi-storied housing complexes, large malls and
supermarkets of international standards, modernization of airports and railway
stations apart from industrial sectors. A wide range of lifts and escalators are
manufactured in India. These include single speed, double speed, gearless,
hydraulic, servo and Variable Voltage Variable Frequ ency (VVVF) elevators.
The production of Lifts in 2014-15 was Rs. 1323.98 crore and in 2015-16
(April- December) was 850.76 crore. The export and import of Lifts, Escalators,
Conveyers etc. (HS Code No. 8428) in 2014-15 was Rs. 520.15 crore and Rs.
2329.53 crore respectively whereas in 2015-16 (April-November) the same was Rs.
349.54 crore and Rs. 1492.14 crore respectively.
1.3.22.17 Refrigerators
In India, refrigerators have the highest aspiration value of all consumer
durables with the exception of television. The refrigerator Industry has become
highly competitive. A number of brands have entered the market and the
consumers have wide choices. There are two basic designs adopted in refrigerators
presently being manufactured in the country. These are c ommonly referred to as
Direct Cool (DC) and Frost Free (FF) Refrigerators. There has been a gradual shift in
consumer preference towards frost free segment. Due to an increase in the number
of dual income households there is a shifting trend in the demand from
conventional 180L refrigerators to the larger 220L and higher capacity refrigerators
with double doors.
The production of refrigerators in 2014- 15 was 92.34 lakh and in 2015-16
(April – December) was 61.59 lakhs. The export and import of refrigerators (HS
Code 8418) in 2014-15 was Rs. 1689.67 Crore and Rs. 2379.37 Crore respectively
whereas in 2015-16 (April-November) the same was Rs. 1048.77 Crore and
Rs.1634..84 Crore respectively.
1.3.22.18 Washing Machines
The washing machine market in India can be divided into two semi–automatic
and fully– automatic. With rising disposable incomes and higher aspirations, there
is a gradual shift towards higher capacity washing machines and also towards
fully–automatic washing machines. Controls are changing from purely mechanical
to fully electronic as microcontrollers are incorporated into the designs. While
providing intelligence, microcontrollers boost reliability, drive down costs and
improve energy efficiency.
The production of washing machines by units in the organized sector in 2014-
15 was 39.91 lakh and in 2015-16 (April-December) was 33.50 lakh. The export
and import of washing machines (HS Code 8450) in 2014-15 was Rs. 266..91 crore
and Rs. 924.53 crore respectively whereas in 2015-16 (April-November) the same
was Rs. 224.20 crore and Rs. 655.15 crore respectively.
22
1.3.22.19 Air Conditioners
Air Conditioners are gradually being treated as a necessity in the socio -
economic environment with changing life style. The air–conditioners’ market can be
classified into three segments: window AC, split AC and central AC. The split ACs
are gaining popularity due to limitation of space and increase in number of people
living in flats in multi-storied complexes and also due to less noise. Bureau of
Energy Efficiency (BEE), a statutory body under the Ministry of Power has
introduced energy efficiency based star rating for air conditioners to help
consumers buy the best energy efficient products.
The production of air conditioners by units in the organized sector in 2014-15
was 26.50 lakh and in 2015-16 (April-December) was 16.66 lakh. The export and
import of air conditioners (HS Code 8415) in 2014-15 was Rs. 799.79 crore and Rs.
5372.07 crore respectively whereas in 2015-16 (April- November) the same was Rs.
606.85 crore and Rs. 3206.65 crore respectively.
1.3.22.20 Lead Acid Storage Batteries
Lead Acid Batteries are accumulators of current and power which is
discharged over a period of time. They are used in vehicles and also for various
industrial uses such as for back up power for UPS application, control rooms,
power stations, telecommunications, etc. In addition, it is also used for emergency
lights for houses, telephone systems and as power source for mining etc. A new
application of Lead Acid Batteries has emerged today in electric vehicles. The
average life of the battery is approximately 2 years, hence these batteries will be
needed as replacement throughout the life of the vehicle or the machinery in use.
Although there are few large scale manufacturers of the product in India, there are
large numbers of very small scale units manufacturing the product in a most
unorganized manner. The product manufactured by them normally does not meet
the required standards as specified by BIS. In order to ensure safe disposal of lead
acid batteries, Ministry of Environment and Forests notified the Batteries
(Management and Handling) Rules, 2001 under Environment (Protection) Act 1986.
The production of lead acid batteries by the units in the organized sector in
2014-15 was 860.45 lakh and in 2015-16 (April-December) was 627.50 lakh. The
export and import of lead acid batteries (HS code 8507) in 2014- 15 was Rs.
1231.97 crore and Rs. 3365.44 crore respec tively whereas in 2015-16 (April-
1.3.22.21 Dry Cell Batteries
Dry cell batteries are one of the most commonly used items. These are the
oldest type of batteries which are still being used. Performance of dry cell batteries
has undergone progressive improvements through technological developments. New
types of dry cell batteries with longer shelf life and greater dependability and also
rechargeable cells have come up. Nickel cadmi um batteries and other rechargeable
batteries are manufactured in the country to meet the requirement of defence,
telecommunications and electronics. The growing popularity of cellular phones,
23
laptops and imported toys could open the market for a new range of batteries that
are not produced at present.
The production of dry cells in 2014-15 was 21036.22 lakh and in 2015-16
(April- December) was 15240.99 lakh. The export and import of dry cell batteries
(HS Code 8506) in 2014-15 was Rs. 93.59 crore and Rs. 672.41 crore respectively
whereas in 2015- 16 (April-November) the same was Rs. 44.94 crore and Rs. 394.57
crore respectively.
1.3.22.22 Electrical Lamps and Tubes
Wide range of lamps and tubes are being manufactured in the country which
include general lighting service lamps such as incandescent bulbs, halogen lamps,
gas discharge lamps such as fluorescent tube light, compact fluorescent lamp, high
pressure mercury vapour lamps, metal halide lamps, low pressure and high
pressure sodium vapour lamps and variety of special lamps. The higher energy cost
have led to the development of energy efficient lamps consuming less power and
giving output as close to daylight. Compact Fluorescent Lamps (CFL) which
consume about 20% of the electricity for the same light output and last up to 8
times longer than the GLS are getting more popular. LEDs have a great potential to
provide highly efficient lighting with little environmental pollution in comparison to
the incandescent lamps (ICLs) and fluorescent lamps (FTLs, CF Ls). Penetration of
LEDs in India could significantly reduce lighting load as almost 22 -25% of
electricity is consumed for lighting, which is also a major contributing factor of
peak demand. Due to higher costs, LEDs are not very popular even though its
production has started in the country.
The production of General Lighting Services (GLS) Lamps by units in the
organized sector and fluorescent tubes in 2014-15 was 7369.05 lakh and 1954.45
lakh respectively. In 2015-16 (April-December) production of GLS lamps by the
units in the organized sector and fluorescent tubes was 5000.15 lakh and 1494.90
lakh. The export and import of electric lamps and tubes (HS code-9405) in 2014-15
was Rs 902.56 crore and Rs. 2447.20 crore respectively whereas in 2015-16 (April-
1.3.22.23 Light Engineering Industry Sector
The light Engineering Industry is a diverse industry with a number of distinct
sectors. This industry includes mother of all industries like castings and forgings to
the highly sophisticated micro-processor based process control equipment and
diagnostic medical instruments. This sector also includes industries like bearings,
steel pipes and tubes, fasteners, etc. The products covered unde r the engineering
industry are largely used as input to the capital goods industry. Hence the demand
of this sector in general depends on the demand of the capital goods industry.
1.3.22.24 Roller Bearing Industry
Roller bearings are essential components in the rotating parts of virtually all
machines such as automobiles, electric motors, diesel engines, industrial
machinery & machine tools, etc. The indigenous manufacturers are manufacturing
24
bearings of quality and precision at par with world renowned manufacturers.
Bearings which are used for special applications that require high technology are
still being imported. There is considerable scope for development of bearings of
smaller size and lighter weight with improved performance in harsh operating
conditions like high or low temperature. Automobile industry accounts for bulk of
the total demand of this industry with estimated share of 35% , electrical industry’s
share is 12% , after market (replacement) share is 40% and the remaining 13%
consumption is by other industries.
The production of ball & roller bearings in 2014-15 was 8907.25 lakh and in
2015-16 (April-December) is 6735.36 lakh. The export and import of ball & roller
bearings (HS code 8482) in 2014-15 was Rs. 2674.65 crore and Rs. 5544.54 crore
respectively whereas in 2015-16 (April-November) the same was Rs. 1745.25 crore
and Rs. 3683.17 crore respectively.
1.3.22.25 Ferrous Castings
Ferrous castings are pivotal to the growth and development of engineering
industries since these constitute essential intermediates for automobiles, industrial
machinery, power plants, chemical and fertilizer plants etc. Indian foundry industry
is the third largest in the world. This industry is now well established and is spread
across a wide spectrum consisting of large, medium, small and tiny sector. The
salient feature of the foundry industry in India is its geographical clustering.
Typically, each foundry cluster is known for catering to some specific end use
markets. For example, the Coimbatore cluster is famous for pump sets castings,
the Kolhapur and Belgaum cluster for automotive castings, Rajkot cluster for diesel
engine castings and Batala and Jalandhar cluster for machinery parts and
agricultural implements. Advanced countries like USA, Japan, Germany are
unlikely to add much capacity due to stringent pollution control norms there. India
can thus have a dominant presence in this field and can become an important
casting supplier to the world.
The production of steel castings and C.I. castings in 2014-15 was 480129.16
tonnes and in 2015-16 (April-December) is 348180.92 tonnes. The export and
import of casting (HS code 7325) in 2014-15 was Rs. 6825.76 crore and Rs. 458.73
crore respectively whereas in 2015-16 (April-November) the same was Rs. 4238.33
crore and Rs. 379.72 crore respectively.
1.3.22.26 Medical and Surgical Instruments
Medical and surgical equipment industry has been playing a critical role in the
health care delivery system. Indigenous manufacturers are currently in a position
to manufacture wide variety of electro medical equipment such as electro
cardiograph (ECG machine), X-ray scanner, CT scanners, short wave physiotherapy
unit, electro surgical units, blood chemistry analyzer etc. However, sophisticated
instruments such as nuclear magnetic resonance (NMR) scanners, multi channel
monitors etc. are stil not manufactured in the country. Most of the units
manufacturing medical equipment are in MSME sector.
25
The export and import of Medical and surgical equipment (HS code 9018 to
9022) in 2014- 15 was Rs. 5693.36 crore and Rs. 2775.86 crore respectively
whereas in 2015-16 (April- Sept) the same was Rs. 14420.90 crore and Rs. 7822.74
crore respectively.
1.3.22.27 Process Control Instrument Industry
Process control instruments cover wide range of instruments and systems
required for monitoring and measurement of physical, chemical and biological
properties. They are used for measurement and control of process variables like
pressure, temperature, humidity, liquid level, flow, specific gravity, c hemical
composition including pH and many forms of spectrometry and spectrophotometry.
The process control instruments have become an integral part of the modern
industrial activity. This industry is a key industry which provides tools for
automation. Their importance is significant in high cost large and sophisticated
process industries like fertilizer, steel, power plant, refineries, petrochemicals,
cement & other process industries. The present technology is a microprocessor
based centralised control system.
The export and import of process control instruments (HS code 9032) in 2014 -
15 was Rs. 1393.26 crore and Rs. 3933.31 crore respectively whereas in 2015 -16
(April- November) the same was Rs. 995.32 crore and Rs. 3019.74 crore
respectively.
1.3.22.28 Seamless Steel Pipes & Tubes
Seamless steel pipes and tu bes are produced in different sizes. The wide range
in size make them suitable for use in number of areas of application. The process of
manufacture imparts strength and durability to the pipes and t hus can be used for
corrosion – resisting applications. These pipes are also used for aircraft, missile and
anti friction bearing, ordinance, etc. Ultra high strength and corrosion -resistant
properties make these perfect for oil and gas industry, chemical industry and
automobile industry. Oil sector accounts for around 60% of the total requirement of
seamless pipes. Bearings and boiler sector meet around 30% of demand. The
Industry is able to manufacture tubes up to 14” outer diameter.
The export and import of seamless steel pipes and tu bes industry (HS code
7304) in 2014- 15 was Rs. 3274.51 crore and Rs. 5477.59 crore respectively
whereas in 2015-16 (April- November) the same was Rs. 1098.71 crore and Rs.
1.3.22.29 Electrical Resistance Welded (ERW) Steel Pipes & Tubes.
Depending on consumers’ requirement, ERW steel pipes and tubes are
available in various qualities, wall thickness and diameters. High performance ERW
steel pipes and tu bes possess high corrosion resi stance, high deformability, high
strength and high toughness. These pipes are used in fencing, lining pipes, oil
country tubulars, scaffolding, water and gas conveyance etc. There has been
substantial increase in the production of ERW steel pipes due to high demand in oil
and gas industry, infrastructure and automobile uses. There are a large number of
units in the MSME Sector.
26
The export and import of ERW steel pipes and tubes (HS code
73059021,73059029, 73069011 & 73069019) in 2014-15 was Rs. 293.43 crore and
Rs. 16.36 crore respectively whereas in 2015-16 (April-November) the same was Rs.
110.51 crore and Rs 8.51 crore respectively.
1.3.22.30 Submerged-Arc Welded (SAW) pipes
There are two ty pes of SAW pipes namely longitudinal and helical welded.
Longitudinal SAW pipes are preferred where thickness of pipe is more than 25mm
and in high pressure gas pipe lines. Helical welded SAW pipes are used for low
pressure applications. The cost of helical SAW pipes is less than longitudinal pipes.
There is huge demand of SAW pipes in the country due to transportation of oil and
gas and transmission of water.
The export and import of SAW pipes Industry (HS code 7305) in 2014-15 was
Rs. 4481.52 crore and Rs. 473.19 crore respectively whereas in 2015-16 (April-
1.3.22.31 Industrial Fasteners
The fastener industry in India may be classified into two segments: high
tensile and mild steel fasteners. High tensile and mild steel fasteners broadly
include nuts, bolts, studs, rivets and screws. Mild steel fasteners are primarily
manufactured by the unorganized sector while high tensile fasteners requiring
superior technology are dominated by companies in the organized sector.
Automobile industry accounts for bulk of the total demand of this industry.
Consumer durables and railways are the other primary users of high tensile
fasteners. Automobile sector is likely to drive growth in the fastener industry.
The production of nuts & bolts in the organized sector in 2014-15 was
110005.78 tonnes and in 2015-16 (April-December) was 812.94 tonnes. The export
and import of industrial fastener (HS code 7318) in 2014- 15 was Rs. 5788.46 crore
and Rs. 4309.16 crore respectively whereas in 2015-16 (April- November) the same
was Rs. 2201.96 crore and Rs. 3019.29 crore respectively.
1.3.22.32 Steel Forgings
Forgings are intermediate products used widely by original equipment
manufacturers in the production of durable goods. The composition of the Indian
forging industry can be categorized into four sectors - large, medium, small and
tiny. A major portion of this industry is made up of small and medium
units/enterprises (SMEs). The industry used to be labour intensive but with
increasing globalization it is becoming more capital intensive. Among the industries
that depend on forgings are automotive, agricultural machinery and equipment,
valves, fittings, and petrochemical applications, hand tools and hardware, off-
highway and railroad equipment, general industrial equi pment, ordnance, marine
and aerospace. The key driver of demand of forging is the automobile industry.
About 65% of the total forging production is used in this sector. The production of
stamping & forging in the organized sector in 2014-15 was 462766.06 tonnes and
2015-16 (April-December) is 362806.20 tonnes. The export and import of forging
27
industry (HS code 7326) in 2014- 15 was Rs 5279.87 crore and Rs. 3767.45 crore
respectively whereas in 2015-16 (April- November) the same was Rs. 4135.78 crore
1.3.22.33 Bicycle Industry
The bicycle industry of India is one of the most established industries. India is
the second largest bicycle producer of the world, next only to China. Most of the
manufacturing units are located in Punjab and Tamil Nadu with Ludhiana (Punjab)
being a major bicycle production hub. The industry is making endeavor for
enhancing export since there is a significant scope for export of Indian bicycles,
bicycle spare parts and bicycle accessories. Bicycle companies in India are now
focusing on urban markets and are looking to expand their base in the professional
and adventure categories.
The production of all kinds of bicycles in the organized sector in 2014 -15 &
2015-16 (April- December) was 132.46 and 107.20 lakh. The export and import of
bicycle (HS code 8712) in 2014-15 was Rs 360.54 crore and Rs. 194.32 crore
respectively whereas in 2015-16 (April- November) the same was Rs. 176.94 crore
1.3.23 Light Industrial Machinery Sector
1.3.23.1 Food Processing Machinery
The Indian market for food processing machinery has been growing steadily
fuelled by strong domestic demand for processed food and beverage products
spurred by increase in income level, increasing number of women joining the work
force, rapid urbanization, changing life style and mass media promotion. The most
promising areas of growth are fruit and vegetable processing, meat, poultry, dairy &
seafood, packaged/convenience food, soft drinks and grain processing. Food
Processing Sector is expected to grow at a healthy pace considering the rapid
changes in food habits and consumerist culture developing in the country. The
machinery manufacturers have honed their expertise in manufacturing dairy
machinery and other core equipment of food processing machinery.
The production of Food Processing Machinery in the organized sector in 2014 -
15 was Rs. 44.43 crore and 2015-16 (April-December) is Rs. 39.21 crore. The
export and import of food processing machinery (HS code 8438) in 2014-15 was Rs
1049.35 crore and Rs. 1133.76 crore respectively whereas in 2015 -16 (April-
1.3.23.2 Packaging Machinery Industry
Packaging of consumer products or industrial products is emerging as the
most important marketing strategy. Development in packaging technology have not
only contributed to improving the aesthetic appeal of the products but also the
shelf life. In some cases specialized packaging becomes a technical necessity.
Considering the growth prospects in industrial sector and growing consumer
awareness of packaging, it is expected that there would be substantial growth in
this area. There is a wide range of packaging machinery available in the country
covering packaging of vast range of items. Some of the commonly available packing
28
machinery includes machines for coding and on-line printing machines, feeding
and labelling machines, strip packaging, form fill and seal machines, carton filling,
fully automatic bag making machinery and automatic microprocessor controlled
packaging machines.
The export and import of packaging machinery industry (HS code 842220 to
842240) in 2014-15 was Rs 798.21 crore and Rs. 1627.32 crore respectively
whereas in 2015-16 (April- November) the same was Rs. 514.08 crore and Rs.
1.3.22.3 Water Pollution Control Equipment
Due to growing awareness regarding water pollution and stringent
environmental control standards being enforced for various uses including process
industries, the water/ waste water treatment industry is poised for huge growth.
The various categories of water pollution control equipment broadly include waste
water treatment plants, drinking water treatment plants and effluent treatment
plants. Water/waste water treatment is the process of removing contaminants and
it includes physical, chemical and biological processes to remove physical, chemical
and biological contaminants. The primary treatment is the first step in the
treatment process and involves the removal of pollutants that settles or floats. The
common industrial equipments are clarifiers and oil – water separator devises. The
secondary treatment is designed to substantially degrade the biological content of
the sewage. The common equipments are activated sludge, filters, biological
reactors etc. The tertiary treatment is a polishing step to remove contaminants that
missed in the primary and secondary treatment and removal of suspended solids,
refractory organics and toxic components. Tertiary physical processes are filtration
and carbon absorption. Chemical process includes precipitation, oxidation and
neutralization. The biological processes involve biodegrading. Organisms such as
bacteria, fungi, yeasts and algae are commonl y used to break down the organic
matters. The cell tissues are then removed from the treated water by physical method
like clarification. The complete plants are manufactured mostly in the organized
sector and many equipments are manufactured in the MSME Sector as well.
The export and import of Water Pollution Control Equipment (HS code 842121) in
2014-15 was Rs 501.00 crore and Rs. 623.15 crore respectively whereas in 2015-16
(April- November) the same was Rs. 434.29 crore and Rs. 624.75 crore respectively.
1.3.23.4 Air Pollution Control Equipment
Industrialization and urbanization have resulted in a profound deterioration of
India’s air quality. India’s most severe environmental problem, come in several
forms, including vehicular emissions and untreated industrial smoke. Air pollution
in the country especially in metropolitan cities and large towns has assumed great
significance with the adoption of stringent environmental control standards for
various industries. Hence, the pollution control equipment industry has acquired
importance. Further judicial pronouncements have given a definite direction and
urgency for adoption of air pollution control measures. The choice of control
29
method depends on factors such as the nature of pollutant, flow-rate (amount of
pollutant emitted), particle size and desired collection efficiency. The air pollution
control equipments are broadly classified under the categories such as Settling
Chambers, Cyclone and multi –cyclones, Bag Filters, Wet Scrubbers, Spray Tower,
Venturi Scrubber, Ionizing Scrubber and Electrostati c Precipitator. The industry is
in a position to do basic and detailed engineering and supply of plants on turnkey
basis.
The export and import of air pollution control equipment (HS code 842139) in
2014-15 was Rs 703.49 crore and Rs. 1440.68 crore respec tively whereas in 2015-16
(April- November) the same was Rs. 474.98 crore and Rs. 899.81 crore respectively.
1.3.23.5 Industrial Gears
Industrial gears comprise of mainly gears and gear boxes. Gears are used for
two basic purposes: increase or decrease of rotation speed and increase or decrease
of torque. Gears being an important part of a machine have immense usage within
various industries. These industries include automotive industries, coal plants
industry, steel plants industry, paper industry, in mining and many more. In these
industries they behold a wide area of application. They are used in conveyors,
elevators, kilns, separators, cranes and lubrication systems. Gearbox is defined as
a metal casing in which a train of gears is sealed. The manufacture of gears and
gear boxes involve high precision machining and accurate assembly as mechanical
power is to be transmitted noiselessly and with minimum losses. Different types
and sizes of gears such as spur gears, helical gears, worm gears, spiral gears and
many other kinds are manufactured in the country. The demand for gears and gear
boxes predominantly depend on the growth of industrial machinery, machine tools,
and consumer & automobile sector. Considering the industrial growth prospects,
particularly in automobile sector, the demand for gears and gear boxes is expected
to grow at a healthy pace.
The export and import of gears and gearing (HS code 848340) in 2014-15 was
Rs. 1028.21 crore and Rs. 1857.58 crore respectively whereas in 2015 -16 (April-
Note:
Source: 1. Export-Import Data – Export-Import Data Bank, D/o Commerce.
2. Production Data – Industrial Statistics Unit, DIPP
1.3.23.6 Paper, Paper Board & Newsprint Industry*
There are 813 number of paper mills in India producing nearly 14.99 million
ton of Paper, Paper board & Newsprint per ann um. This accounts for about 3.7% of
the world’s production of paper (accounting to 404 million tons per annum). The
estimated turnover of the industry is approximately Rs.50,000 Crore. The industry
provides employment to more than 0.5 million people directly and 1.5 million
people indirectly. The per capita consumption of paper in India is around 13.2 kg
which is far below the global average of 57 kg. Most of the paper mills are in
existence for a long time and hence present technologies fall in a wide spec trum
30
ranging from rather obsolete to the most modern fiber line technologies. Indian
paper industry is highly fragmented with varying sizes ranging from 10 tpd to
1500tpd. There are thirty one large mills based on woody raw materials
(Eucalyptus, Casuarina, Subabul etc.) having capacities ranging from 300 to 1500
tpd contributing to 26% of the total production. The remaining 74% of the
production comes from recycled waste paper and agro residues based mills. In
global context, India is one of the fastest growing markets for paper and paper
consumption in the country is estimated to touch 20 million tons by 2020.
1.3.23.7 Newsprint Industry*
The newsprint sector in the country is governed by the Newsprint Control
Order (NCO), 2004. At present there are 121 mills registered under the Schedule of
the NCO. Out of the 2.56 million tons of newsprint consumed in 2014 -15, 1.24
million tons was met through domestic production and the remaining 1.33 million
tons was met through imports.
1.3.23.8 Rubber Goods Industry
The Rubber Goods Industry excluding tyre and tubes consists of 4550 small
and tiny units generating about 5.50 lakhs direct jobs. The rubber industry
manufacturers a wide range of products like rubber cots and aprons,
contraceptives, footwear, rubber hoses, cables, camelback, battery boxes, latex
products, conveyor belts, surgical gloves, balloons, rubber moulded goods etc. The
main raw materials used by the rubber goods manufacturing industry are Natural
Rubber, various types of Synthetic Rubber, Carbon Black, Rubber Chemicals etc.
The estimated turnover of Rubber Goods Industry in 2015- 16 will be Rs.34880
crore as against Rs.32000 crore in 2014-15. The Industry expect export of rubber
goods worth Rs.6446 crore in 2015- 16 as against Rs.7142 crore in 2014-15. The
expected import of rubber goods is worth Rs.11935 crore in 2015 -16 against
Rs.12577 crore in 2014-15.
The performance of rubber goods industry hardly needs any emphasis. From
healthcare to footwear, high performance tyres to conveyer belts are indispensible
for country’s infrastructure.
1.3.23.9 Tyres & Tubes Industry
Tyres play an integral role to ensure mobility including movement of
passengers and essential goods across the urban and rural landscape of the
country using all types of vehicles ranging from carts, tractors, trucks and buses to
the latest generation passenger cars that ply on the modern expressways. All types
of tyres required to meet the domestic demand are manufactured in India. These
tyres include Moped tyre weighing 1.5 Kg to Off the Road tyres for Earthmovers
which weigh 1.5 tonnes, Bias Ply tyres to rugged all steel radial truck tyres to high
performance passenger car radial and tubeless tyres etc. India is one of the few
countries worldwide which has attained self sufficiency in manufacturing a wide
range of tyres for all applications.
31
1.3.23.10 Salient features of tyre industry:
• Indian Tyre industry consists of 39 Companies with 60 tyre manufacturing plants.
• Tyres & Tubes production during 2015- 16 will be 2545.02 lakh approximately.
Three Indian Companies (MRF Ltd., Apollo Tyres and J&K Tyres) are in the list
of top 25 Global Tyre companies.
• These large tyre companies account for approx. 92% of Industry turnover in
value and tonnage terms.
• All large Indian tyre companies have initiated major capacity expansion
programmes to the tune of Rs.36, 000 crore during 12th Five Year Plan period.
1.3.23.11 Export of Tyres & Tubes
Indian tyres are exported to over 75 countries worldwide. India’s share in
world tyre market is 5% . During 2014-15, export of tyres & tubes was to the tune of
Rs. 10071 crore. The estimated value for export of tyres & tubes for the year 2015-
16 is to the tune of Rs.9027 crore.
1.3.23.12 Import of Tyres & Tubes
Tyres are imported @ Custom Duty of 10% . Tyres are also imported at
concessional custom duty under various agreements such as Asia Pacific Trade
Agreement (8.6% ), ASEANFTA (7% ), Indo-Sri Lanka Agreement, Indo- Singapore
Agreement, SAFTA Agreement (5% ) and India-Malaysia Trade Agreement (7% ).
During 2014-15, import of tyres was to the tune of Rs.2708 crore. The anticipated
import value of Tyres & Tubes during 2015-16 is 3219 crore.
1.3.23.13 Quality (Control) Order for Pneumatic Tyres and Tubes for Automotive
Vehicles
A Quality (Control) Order for Pneumatic Tyres and Tubes for Automotive
vehicles was notified by this Department on 19th November, 2009 in exercise of the
power conferred vide Section 14 of the BIS Act, 1986. The Order prohibits import,
sale or distribution of pneumatic tyres and tubes which do not conform to the
specified Bureau of Indian Standards (BIS) standard and which do not bear the
standard mark. This means the manufactures are required to obtain licences from
BIS for use of standard mark to enable them to sell or distribute pneumatic tyres
and tubes conforming to the specified standard. The Quality Control Order, 2009
has come into force w.e.f. 13th May, 2011.
In terms of the Clause 3(1) (f) of the said Quality Control Order, a Committee
has been constituted under the Chairmanship of Additional Director General of
Foreign Trade to finalize the list of tyres which are not manufactured domestically
and to be imported by Original Equipment Manufacturers (OEMs). The Committee
last reviewed and finalized a list of 675 sizes of tyres (not manufactured
domestically) in January, 2016 which can be imported by OEMs. This list has been
circulated among various stakeholders.
1.3.24 Salt Industry
1.3.24.1Introduction
India is the third largest producer of salt in the world after China and USA with
an average annual production of about 240 lakh ton. It is the second largest producer
32
of iodized salt after China, with an average annual production of 60 lakh ton. At the
time of independence, there used to be a shortfall in production of salt which was met
through imports. Since then, India has made tremendous progress in production of
salt, achieving self-sufficiency in 1953 and exporting salt to other countries.
Salt is one of the essential items of human consumption. The per-capita
consumption of salt in the country is estimated to be 14 Kg, which includes edible
and industrial salt. The current annual requirement of salt in the country is
estimated to be 63 lakh ton for edible use (including requirement of cattle) and 120
lakh ton for industrial use. India exported 56.76 lakh ton of salt valued at
Rs.838.67 crore during 2014-15 & during 2015-16 (up to December) exported
46.37 lakh ton, valued at Rs.566.30 crore.
Salt is manufactured mainly by solar evaporation of seawater, sub-soil brine
and lake brine. Sea salt constitutes about 82% of the total salt production in the
country. Salt manufacturing activities are carried out in the coastal states of
Gujarat, Tamil Nadu, Andhra Pradesh, Maharashtra, Karnataka, Orissa, West
Bengal, Goa and hinterland State of Rajasthan. The 3 major salt producing States
are Gujarat (81% ), Tamil Nadu (8.5% ) and Rajasthan (8% ), which also cater to the
requirement of other States.
Cess is levied on Salt at the rate of Rs.3.50 per ton, under Salt Cess Act 1953.
Salt works having an area up to 10 acres set up by individuals or group of
individuals are exempted from the payment of Cess. Similar salt works setup over
10 acres but up to 100 acres are given 50% concession on the cess payable. Salt
exported to foreign countries is also exempted from payment of cess.
Private sector contributes to more than 93% of the salt production, the public
sector about 1.3% and the co-operative sector, about 5.5% .
1.3.24.2 Production
The targeted and actual production of salt during the last five years are as under:
(Figures in Lakh MT)
Year Target Production
2011-12 240 221.79
2012-13 240 245.47
2013-14 220 230.19
2014-15 270 268.87
2015-16 (upto December) 270 193.12
Salt of high purity is needed for iodization and to meet the needs of industrial
sector. To achieve the required level of purity by upgrading raw salt, Salt
Commissioners Office (SCO) has till date facilitated establishment of 122 salt
washeries /refineries with an annual installed capacity of 132 lakh ton. All the
units are registered with SCO.
1.3.24.3 Salt works and area under Salt Production
There are about 11848 salt works of which only 5.7% i.e. 681 are big salt
works contributing about 67.6% of total salt production of the country and
remaining 32.4% of the total salt production is contributed by the small salt
33
manufacturers. The total area under salt production is about 6.15 lakh acres.(Patta
land, State Govt. land, Port land, Salt Department land). Of this 58569 acres land
belongs to Salt Department for manufacture of Salt. The manufacturing activities
provide direct employment to about 1.04 lakh persons.
1.3.24.4 Distribution of Salt
Railways play an important role in transporting salt from the three major salt
producing States to others. About 65% of edible salt is transported by rail from
production centres and the remaining quantity by road/sea route . Salt is
transported by rail under Preferential Traffic and sponsored programmes on
requirement basis. Railways grant graded concession in freight for transportation of
non-refined iodized salt depending upon distance.
1.3.24.5 Iodized Salt
For human consumption, edible salt needs to be iodized to prevent and control
Iodine Deficiency Disorders (IDD). SCO has been identified as the Nodal Agency for
creation of adequate salt iodization capacity, monitoring production and quality of
iodized salt at production centres and monitoring distribution of iodized salt in the
country, under National Iodine Deficiency Disorders Control Programme (NIDDCP)
being implemented by the Ministry of Health & Family Welfare. SCO has facilitated
establishment of 700 salt iodization units including 122 refineries & washeries
(capacity 132 lakh ton) with an annual installed capacity of 215 lakh ton upto
March 2015. All the salt iodization units are registered with Salt Commissioner.
The production and supplies of iodized salt during the last five years is as under :-
(Figures in Lakh MT)
Year Production Supplies
2011-12 62.00 59.70
2012-13 61.81 58.64
2013-14 58.47 55.08
2014-15 64.54 60.59
2015-16 (upto December) 51.69 46.43
SCO periodically reviews the availability, price and quality of iodized salt, in
association with state governments, iodized salt manufacturers, traders and other
stake holders.
1.3.24.6 Exports
Export of common salt and iodized salt is permitted under Open General
License (O.G.L) India exports salt to Japan, Vietnam, UAE, Qatar, Korea, China,
Malaysia, Nepal, Bangladesh, Indonesia, Bhutan, Hong Cong and Singapore etc.
Export of salt during the last five years.
Year Quantity in Lakh M T Value in Lakh Rs.
2011-12 37.72 49225.34
2012-13 50.04 67943.95
2013-14 58.47 84439.78
2014-15 56.76 83866.58
2015-16 (upto December) 46.37 56630.54
34
1.3.25 Labour Welfare Activities and Development Works
i) SCO pays special attention to the welfare of labourers engaged in salt industry
by extending financial assistance for executing various welfare schemes, viz.
- Medical facilities to salt workers and their families.
- Drinking water facilities in salt works.
- Education facilities and financial assistance to the children of salt labourers.
- Rest sheds and crèches in salt works.
- Recreation facilities to labourers and their wards.
- Cash Rewards to the children of Salt Workers.
In addition, financial assistance is provided for undertaking various schemes
for the benefit of salt industry. The expenditure on development and labour welfare
works during last five years is as under :-
ii) Health-cum-Eye Camp & Sports Meet
As per the Scheme approved by the Ministry of Commerce & Industry for grant
of rewards to 3500 meritorious school children of salt workers Rs.45 lakhs was
sanctioned keeping provision of 50% awards to female children during 2014 -15.
SCO has organized 27 general health cum eye camps & 9 Sports meets for
benefit of salt labourers during the year 2013-14. In the financial year 2014-15, 23
health camps and 9 sports meets have been organized.
It is proposed to organized 30 General Health cum eye c amps and 10 sports
meets for benefit & recreation of salt labourers during the year 2015 - 16.
(Figures in Lakh Rs.)

Year Development Labour W elfare Other Total
W orks W orks W orks Expenditure
2011-12 73.18 75.02 - 148.20
2012-13 5.66 91.44 24.63 121.73
2013-14 33.92 38.13 49.33 121.38
2014-15 1.52 11.63 61.76 74.91
2015-16 (upto 7.09 4.14 12.21 23.44
December)
(iii) Model Salt Farms
SCO is making efforts to educate salt manufacturers in general and small salt
producers in particular for improving the quality of salt to meet the stringent
standards of industrial salt, in order to compete in the international market.
Three Model Salt Farms (MSF) one each at Nawa (Rajasthan), Ganjam (Odisha)
& Markanam (Tamil Nadu) have been established for providing scientific know-how
for the construction of salt works and proper brine management and transfer of
technology to the salt manufacturers. All the Model Salt Farms have been
established to demonstrate the production of good quality salt by proper brine
management. These are used to impart training to the salt manufacturers/workers
for improving the quality of salt by re-modelling and re-alignment of the existing
salt works in association with the scientists of CSMCRI, Bhavnagar.
35
(iv) Training for technology upgradation
With a view to educating salt workers/ artisans for improving the quality of
salt to meet the standards prescribed for industrial and edible salt, the Scheme
“Training for technology upgradation” has been implemented by the Ministry of
Commerce and Industry, Department of Industrial Policy and Promotion,
Government of India during the 12th Plan period. A total of 200 training
programmes costing Rs.3.00 crore were to be conducted during the 12 th Plan Period
ending in 2016-17. Under this scheme, 18 training programmes for technology
upgradation were organized with an estimated cost of Rs.1.5 lakh each during
2014-15. Department of Industrial Policy & Promotion has issued revised
guidelines, as per which two training programmes for master trainers have been
organized by the Central Salt & Marine Chemicals Research Institute (CSMCRI)
Bhavnagar for 40 master trainers in two batches @ cost of Rs.5.00 lakh each. These
master trainers will impart trainings to salt workers for technology upgradation.
Further, 20 training programmes with an estimated cost of Rs.3.00 lakh each will
be organized during the remaining 2 financial years of the current five year plan
period ending in 2016-17.
1.3.26 Internal Policy Guidelines of DIPP to consider requests for transfer of land at
places other than Mumbai and its suburbs, for public purposes.
DIPP has issued Internal Policy Guidelines for dealing with requests received
from Central Government Ministries/Departments, Central Public Sector
Enterprises (CPSEs), State Government and State Public Sector Enterprises (SPSEs)
for transfer of salt pan land owned by the Government of India through SCO, at
places other than Mumbai and its suburbs for public purposes.
Only land declared surplus to the requirement of SCO shall be considered for
transfer for public purposes. Land fit for salt production can be considered for
transfer only in exceptional circumstances. Such identified land shall be offered
first to other Central Government Ministries / Departments, next to Central Public
Sector Enterprises (CPSEs), failing which the Government of the State in which the land is
situated and lastly to the State Public Sector Enterprises. The transfer of land will be on
free hold basis. There shall be no transfer of land to private sector agencies.
A token value of Rs.1 (Rupees One) will be charged for transferring land to
Central Government Ministries/ Departments as per provisions of the General
Financial Rules after obtaining the approval of the Minister in Charge of DIPP. For
cases pertaining to CPSEs, State Governments and their enterprises, market value
will be charged for the land. The market value of the land and its transfer shall be
approved by the Minister in charge of DIPP.
While considering requests for transfer of land, due consideration will be given
to environment related issues and related restric tions.
For lands under active salt cultivation and under consideration for transfer,
the transferee agency shall pay compensation to the lessees, if any, for
36
extinguishing the lease hold rights and also meet the cost of rehabilitation of the
salt workers.
1.4 REVISION POINTS
 Industrial Policy and Promotion
 Make in & Invest India.
 UNIDO Activities.
1.5 INTEXT QUESTIONS
1) What is the role of the Department of Industrial Policy and Promotion (DIPP) is
to promote the industrial sector in India?
2) What are the objectives and functions of the Department of Industrial Policy and
Promotion (DIPP)?
3) What you mean by Startup India? How this concept is likely to help industrial
promotion?
4) Write short note on:
1 National Manufacturing Policy.
2 Foreign Direct investment Policy.
3 Make in & Invest India.
4 Intellectual property Rights.
5 Investment promotion & International co-operation.
6 UNIDO Activities.
7 Startup India.
1.6 SUMMARY
The industrial mechanism is discussed. Since the plant and machinery
valuations will have greater impact of industrial policy and schemes in force and
the same have been elaborated to make the student understand the importance of
these aspects.
1.7 TERMINAL EXERCISE
1) Explain labour welfare activities in India.
2) Discuss how Salt Industry is playing important role in Indian Economy
3) Explain how industrial development has taken place of one of your chosen industry.
1.8 SUPPLEMENTARY MATERIALS
1. (www.commerce.nic.in)
2.(www.dipp.nic.in)
3. https://en.wikipedia.org/wiki/Economy_of_India
4. shodhganga.inflibnet.ac.in/
1.9 ASSIGNMENTS
1. Discuss the industrial policy, industrial mechanism, promotional policies/
scheme in force for an industry you are conversant or experienced or having
expertise.
37
2. Discuss how the industrial policy, industrial mechanism, promotional policies/
scheme in force will impact the valuation of plant and machinery of a particular
industry/ factory/ manufacturing setup.
1.10 SUGGESTED READINGS
1 Department of Industrial Policy and Promotion
2 Ministry of Commerce and Industry
1.11 LEARNING ACTIVITIES
1) To apply in the practical orientation
2) Company activities
3) Group discussion
1.12 KEYWORDS
Department of Industrial Policy and Promotion, FDI, Salt, Manufacturing,
Production, Technology
38
LESSON-2
FUNDAMENTALS OF VALUATION OF PLANT & MACHINERY

2.1 INTRODUCTION
Valuation as an art and science is an exercise falling within the domain of
economics as well as law. An American Judge was posed with the question, “Is
appraising an art or a science?” Prior to his answer the Judge was looking at two
different appraisals with a wide difference in views. Then he answered, “It is neither
an art nor a science, I view it as a mystery!”. Valuation really concerns itself with all
species of legal interests arising out of land and building as well as plant and
machinery which are exchanged for money and therefore entails the phenomena of
exchange, scarcity and choice that characterizes a „market‟ in the economic sense
of the term. Property is purchased both for use and investment; but in both cases
the purchaser measures the expected return or benefits to be received from the
property against cost outlay. The valuer‟s task is to express these benefits in money
terms and to interpret the relationship between cost and benefit as a rate of return,
thus allowing the investor to make a choice between alternatives.
Valuation is a multi-disciplinary subject involving following disciplines over
and above valuation:
1. Economics
2. Law
3. Planning
4. Insurance
5. Accountancy
6. Industrial processes / engineering
7. Environmental issues
2.2 OBJECTIVES
The main objective of this lesson is to make the students thoroughly
understand basic principles of valuation in general and plant & machinery
valuation in particular. At the end of lesson the students will learn basic and
fundamental principles of plant and machinery valuation.
2.3 CONTENTS
2.3.1 Basic Difference Between Cost, Price and Value
2.3.1.1 Cost
2.3.1.2 Price
2.3.1.3 Value
2.3.1.4 Market Value
2.3.2 Valuation Drivers
2.3.3 Property
2.3.4 Definition as per International Valuation Standards
2.3.5 Factors on which the Value of any machinery depends
2.3.6 Basic Approaches to valuation of plant and machinery
39
2.3.1 Basic Difference Between Cost, Price and Value
2.3.1.1 Cost
It is the actual expense incurred by the owner to acquire the Asset. It is a fact.
The cost of producing a thing or object is the sum of the costs of all the components
or elements used in its production like materials, labour (i.e. menpower) and capital
(i.e. money) and considers only the supply side.
2.3.1.2 Price
The Price of a thing or object is decided or fixed by adding, to the cost of
production, commissions, cost of distribution and reasonable profits as well as by
considering demand for that thing in a market.
2.3.1.3 Value
It is not a fact but it is an Estimate. It can be best defined as „ the estimate of
the PRICE of the asset. Value of a thing or object depends on (i) Utility of that thing
or object which may differ from person to person and hence is subjective (ii) the
Scarcity of that thing or object which arises out of demand and supply of that thing
at a particular point of time.
2..3.1.4 Market Value
Market Value is the estimated amount for which an asset ought to exchange
on the date of valuation between a willing buyer and a willing seller in an arm‟s
length transaction after proper marketing wherein the parties had each acted
knowledgeably, prudently and without compulsion.
a) “The estimated amount .....” means a price, normally expressed in terms of
money, payable for the asset in an arm ‟s length market transaction. Market
Value is measured as the best or most probable price reasonably obtainable in
the market at the date of valuation in keeping with the “Market Value”
definition. The estimate specifically excludes an estimated price inflated or
deflated by special terms or circumstances such as typical financing, sale and
leaseback arrangements, special considerations or concessions granted by
anyone associated with the sale, or any element of special value.
b) “ ..... an asset ought to exchange .....” mean s the fact that the value of an asset
is an estimated amount rather than a predetermined or actual sale price. It is
the price at which the market expects a transaction should be completed on the
date of valuation, meeting all other elements of the “Market Value” definition.
c) “ ..... on the date of valuation .....” indicates that the estimated Market Value is
time specific as of a given date. Because markets and market conditions may
change, the estimated value may be incorrect or inappropriate at another time.
The valuation amount will reflect the actual market state and circumstances as
on the valuation date, not as of either a past or future date.
d) “ ..... a willing buyer .....” means one who is motivated, but not compelled to buy.
This buyer is neither overeager nor determined to buy at any price. This buyer is
also one who purchases in accordance with the realities of the current market,
40
and with current market expectations, rather than an imaginary or hypothetical
market that cannot be demonstrated to e xist or to be anticipated by the market.
The assumed buyer would not pay a higher price than the market requires. The
present asset owner is included among those who constitute “the market”. A
valuer must not make unrealistic assumptions about market condi tions nor
assume a level of market value above that obtainable.
e) “ ..... a willing seller .....” means one who is neither an overeager nor a forced
seller prepared to sell at any price, nor one prepared to hold out for a price not
considered reasonable in the current market. The seller is motivated to sell the
asset at market terms for the best price attainable in the open market, and after
proper marketing, whatever that price may be. The factual circumstances of the
actual asset owner are not a part of this consideration because the “ willing
seller ” is a hypothetical owner.
f) “ ..... in an arm‟s length transaction .....” means one between parties who do not
have a particular or special relationship (for example - parent and subsidiary
companies, or landlord and tenant) that may make the price level atypical of the
market. The Market Value transaction is presumed to be between unrelated
parties, each acting independently.
g) “ ..... after proper marketing .....” means that the asset would be marketed in the
most appropriate manner to effect its sale at the best price reasonable in
accordance with the Market Value definition. The length of marketing time may
vary with market conditions, but must be sufficient to allow the asset to be
brought to the attention of an adequate number of potential purchasers. The
marketing period occurs prior to the valuation date.
h) “ ..... wherein the parties had each acted knowledgeably and prudently .....”
presumes that both the buyer and the seller are well informed about the natu re
and characteristics of the asset, its actual and potential uses and the state of
the market as on the date of valuation. Each is further presumed to act for self-
interest with that knowledge, and prudently as to seek the best price for their
respective positions in the transaction. Prudence is assessed by referring to the
state of the market at the date of valuation, not with benefit of hindsight at some
later date.
i) “ ..... and without compulsion .....” establishes that each party is motivated to
undertake the transaction, but neither is under compulsion unduly coerced to
complete it.
2.3.2 Valuation Drivers
 Utility
 Marketability
 Transferability
 Scarcity
 Physical
41
 Legal
 Social
 Economic
 Value means present worth of future benefit
 In valuation of tangible assets- what is valued is intangible right of the
owners or possessor in owning or possessing tangible assets.
2.3.3 Property
A property for the purpose of valuation may be
 Land and building
 Plant and Machinery
 Gems and Jewelry
 Fine arts, Antiques, Furniture and Fixtures
 Stock or Debenture
 All incorporeal rights arising out of the above.
The word “Property” has three different meaning in Appraisal and those are
 The property rights comprised in an ownership;
 The thing, tangible, intangible, or both that is owned;
 A thing , itself, disregarding its ownership.
There is a specific valuation method relevant for each of the categories of
property. Therefore, properties are categorised in the following manner :
Investment Properties and Non-Investment Properties
Investment properties are those that produce net monetary return either in
the flow of net income or as a capital gain, or both. Trading enterprises earn
dividends from year to year. Real estate generates annual net income by way of
rent. Mortgagee earns interest and receives both the principal and interest. The
most important characteristic which is common to all of the properties falling under
this group is that they are produced, acquired or possessed in the expectation that
they will generate anticipated monetary returns to their owners. This category of
property is said to have an earning expectancy. Thus, any property which has an
earning expectancy is classified as an investment property.
Few, if any, of the properties in the second group have the characteristic of
generating monetary returns to its owner but they yield benefits in the form of use
and/or consumption. A single-family residential house is used by the owner till
decay; religious property or public schools are used by their owners and ultimately
wear out in ruins. Gems and jewelry are put into use by way of consumption and
retain an exchange value. The essential and distinguishing characteristic, common
to all the properties in this group, is that they are acquired, held or produced with
the expectation that they will yield benefits to their owners in the form of use
and/or consumption, without direct monetary returns. The property having this
characteristic is classified as non-investment property.
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Marketable and non-marketable properties
All the properties falling under the group of investment property are
marketable as there is always a demand for them at some price; because, it is a
property which has an earning capacity. Exceptions to these are some lease-hold
property and distributor‟s franchise. But, if the contractual or legal restrictions are
removed, they can be sold. For this reason, it is not necessary to classify these
properties under another category like “non -marketable investment property” in the
scheme of classification for the purpose of valuation.
A close scrutiny of the properties in the second group would show that some of
them are marketable in the sense that they are of a type commonly bought and
sold, but the others are not so. On this basis, the non-investment properties can
again be divided into two groups “Marketable” and “Non -marketable” as under:
M arketable non-investment Property Non-marketable non investment property
Single-family owner-occupied Religious property
residential house constructed
on freehold land
Single-family owner-occupied Public school
residential house constructed on
lease-hold land
Private vehicle City hall
Personal clothing Jail
Machinery and equipment Non-commercial hospital
Furniture Machine(specially designed
and built to order)
Office equipment
Gems and jewelry
Furs
Stamp collection
The three major classes of the property which thus arise are :
1. Investment
2. Marketable non-investment
3. Non-marketable non-investment (also termed as a ‘service property’)
In order to decide the method of valuation to be adopted, the tests which are
applied are as follows :
• If the property concerned falls under the category which has no earning
expectancy but can be bought and sold, then it is classified as “marketable non-
investment property”; if it is not marketable, it is classified as “service property”.
• Features of monetary value of the property
- It is a capital amount
- It exists at each point in time during the life of the property
- It is subjective and not objective
- It is dated
43
- in the case of a process plant, the amount of monetary value depends
on the place where these are located
• Differential value characteristics of the three classes of property
- In the case of “a marketable investment property”, the value is
generated and therefore may be derived from the earning capacity.
- In the case of “a marketable non-investment property”, the value is
generated by the expectation of amenities and the satisfaction of a non -
pecuniary character which can be acquired on purchase.
- In the case of a tangible service property, the satisfaction of the owner‟s

non-pecuniary needs or desires is accomplished not by direct purchase
of a completed whole property but by assembly and/or construction of
physical components. It is the possession, use and/or consumption of
the service property which generates its value.
The following table gives the characteristics of property falling under each category:
Property classification Value characteristics
Investment property - Monetary yield to the owner
(similar to interest earned) - Marketability
- Recovery of invested capital
Marketable non- - - Usefulness to the owner without direct
investment property monetary yield
- Marketability
- Non-recovery of original cost in general
Service property - Usefulness to the owner without direct
monetary yield
- Non-marketability
- Non-recovery of original cost in general
Personal clothing Jail
Machinery and equipment Non-commercial hospital
Furniture Machine(specially designed
and built to order)
Office equipment
Gems and jewelry
Furs
Stamp collection
Property classification Primary element of value

Investment property - - Investment value
Marketable non- - Market value
investment property
Service property - Owner value
Only in the case of investment property, there is the expectation of recovery of

the invested capital. This recovery comes from monetary returns.
Ingredients of investment property are Utility, Marketability and Self-liquidity.
A marketable non-investment property has only two value ingredients - utility and
44
marketability. The Service property has only one value ingredient – utility which
produces the value to the owner.
2.3.4 Definition as per International Valuation Standards
Plant
Assets that are inextricably combined with others and that may include
specialized buildings, machinery, and equipment.
Machinery
Individual machines or a collection of machines. A machine is an apparatus
used for a specific process in connection with the operation of the entity.
Equipment
Other assets used to assist the operation of the enterprise or entity.
Examples are Laboratory Equipment, Measuring Equipment, Quality Control
Apparatus, Pressure gauge and Flow meter attached with reactor, etc.
2.3.5 Factors on which the Value of any machinery depends
• Physical - Type, model, capacity, make etc.
• Social - Taste and preference of consumers using products.
• Economic - Demand and supply, availability of money and credit, Interest rate.
• Legal - Taxation policy, regulation of industry, environmental protection.
The rationale for distinguishing existing use assets from other assets in the
valuation process is that a business cannot, as a practical matter, sell assets which
are necessary to its operation and still be productive. The state of such assets
would be inconsistent with continuation of the business.
2.3.6 Basic Approaches to valuation of plant and machinery
a) Cost approach
b) Market approach
c) Income approach
The cost approach is applied primarily with regard to service property which
are not frequently exchanged in the market or do not generate revenue by
themselves. It is also useful on new or special purpose properties. The logic behind
the cost approach is that a prudent investor would pay no more for a property than
the cost of producing a substitute property with the same utility.
The market approach is particularly applied with regard to property that has
established markets for buying and selling. When there is a limited market
indicated by lack of transactions it will obviously be difficult to measure value by
the market approach. We often lack sufficient knowledge regarding sales, although,
there may be sufficient sale transactions taking place. Thus, market data is an
essential prerequisite for application of the market approach to valuation. It means
that a market approach becomes relevant in changing situations that lead to the
development of market data for analysis. Thus using a sale which occurred during
dull economic activities is not valid in a thriving economic period. Usually
properties of non-investment character but having marketability as its attribute are
valued by this approach.
45
The income approach in its simplest form is the estimation of the present
worth of the future benefit accruing to the owner of the plant and machinery or to
the specific interests or rights one enjoys in the property. This approach is relevant
for investment properties having utility, marketability and self liquidi ty. The cost
and market approaches may not measure the full effect of obsolescence which the
income approach may demonstrate. The business enterprise is valued on the basis
of its future income potential. In doing so, it is often necessary to ascertain value on
the aggregation of assets which generate the income stream. This collection of
assets is commonly known as the business enterprise and consists of all
components of the business - working capital, fixed asset and intangible assets.
Ultimately, it is the income that establishes the value of the business and it is worked
out through a series of calculations that take into account all factors that affect the
yield or return. The amount supportable by the business is derived from the income
as determined for all the assets of the business, working in combination.
2.4 REVISION POINTS
 Difference Between Cost, Price and Value
 Investment Properties and Non-Investment Properties
 International Valuation Standards
1. Explain difference between Cost, Price and Value in context of plant and machinery
2. What is difference between marketable and non-marketable properties?
3. What is the importance of income approach for valuation of plant and machinery?
2.6 SUMMARY
Basic principles and methods of plant and machinery valuation and different
classes of properties under valuation are discussed.
1. What is difference between investment and non-investment properties?
2. Explain different approaches of valuation of plant and machinery.
1, www.appraisers.org/Product-Catalog/Product?ID=6158
2. www.amazon.in/Valuing-Machinery-Equipment-Fundamentals...
2.9 ASSIGNMENTS
Discuss the definitions of Plant, Machinery and Equipment in the context of
International Valuation Standards viz-a-viz Accounting Standards
1. Valuation of plant and machinery: Theory and practice by Kirit Budhbhatti
2. Valuation of Plant and Machinery Theory and Practice by Dr. P. C. Gupat
3. International Valuation Guidance note no. 3 (GN-3), Valuation of plant and equipment
4. International Accounting Standard – 16; Property, Plant and Equipment
5. Indian Accounting Standard – 16; Property, Plant and Equipment
International Valuation Standards viz-a-viz Accounting Standards
46
2.12 KEYWORDS
Valuation, Cost, Price, Value, Investment, marketability, plant, machinery
47
LESSON-3
PROCEDURE OF PLANT & MACHINERY VALUATION

3.1 INTRODUCTION
This chapter consists of in depth discussion on the procedure to execute an
assignment of valuation of Plant & Machinery right from getting an instruction from
the client to the submission of Report on Valuation of Plant & Machinery.
Let’s begin with the basic definitions
Plant
Assets that are inextricably combined with others and that may include
specialized buildings, machinery, and equipment.
Machinery
Individual machines or a collection of machines. A machine is an apparatus
used for a specific process in connection with the operation of the entity.
Equipment
Other assets that are used to assist the operation of the enterprise or entity.
Cost
It is the actual expense incurred by the owner to acquire the Asset. It is a fact.
The cost of producing a thing or object is the sum of the costs of all the components
or elements used in its production like materials, labour (i.e. men) and capital (i.e.
money) and considers only the supply side. Simply, Cost means money require to
reproduce the goods or services.
Price
The price of a thing or object is decided or fixed by adding, to the cost of
production, commissions, cost of distribution and reasonable profits as well as by
considering demand for that thing in a market. In simple words, Price means
money paid for the goods or services.
Value
It is not a fact but it is an Estimate. It can be best defined as the estimate of
the PRICE of the asset. Value of a thing or object depends on (i) Utility of that thing
or object which may differ from person to person and hence is subjective (ii)
Scarcity of that thing or object which arises out of demand and supply of that thing
at a particular point of time. In short, Value is an estimate of price as it ought to be
or the present worth of the future benefits.
Market value
Market Value is the estimated amount for which an asset ought to exchange
on the date of valuation between a willing buyer and a willing seller in an arm’s
length transaction after proper marketing wherein the parties had each acted
knowledgeably, prudently and without compulsion.
Historical cost
The purchase price paid at the initial time of acquiring the asset plus additions
made subsequent to purchase.
48
Replacement cost
It is the cost of acquiring an asset at current prices having utility equivalent to
asset under consideration but having materials, standards, design according to
prevalent market.
Reproduction cost
It is the cost of acquiring an identical asset/replica using same material,
design, standards, quality, and workmanship of the asset under consideration. It
carries with it the good and bad attributes of the original.
Scrap value
The amount indicated in terms of money that could be realized from the
property after expiry of economic life sold for its material content, not for a
productive use.
Salvage value
The amount expressed in terms of money that can be expected for components
of the whole item that is retired from the service.
Market value for the existing use
The market value of an asset based on continuation of its existing use,
assuming that the asset could be sold in the open market for its existing use, and
otherwise, in keeping with the market value definition regardless of whether or not,
the existing use represents the highest and best use of the asset.
Market value for the alternative use
The market value of an asset based on its alternative use in a situation when
the existing use of a particular asset becomes uneconomic or non-functional for its
original use.
Gross current replacement cost
It is the cost of replacing an existing asset with the same or substantially
similar new asset having a similar production or service capacity, including costs of
transport, installation, commissioning, consultants’ fees, non-recoverable taxes and
duties and finance cost up to the stage of commercial production. The cost of
design is to be looked from the point of view of plant reconstruction rather than the
cost of the original assets. Provided therefore that the plant has not been valued on
the basis of comparison with a modern equivalent asset, there is no need to allow
for the cost of repeating work that has already been executed and is stored on file.
If the plant is being valued on the basis of modern equivalent asset, however,
relevant design work will form a legitimate item of expenditure.
Depreciation
It is a loss in value, that may caused by deterioration, decay, wear & tear or
damage of any kind which changes the physical condition s so as to reduce usefulness.
Depreciation includes not only physical deterioration but obsolescence as well.
Obsolescence
A factor included in depreciation to cover decline in value of assets due to
invention of new and better processes or machines, changes in demand, in design
49
or in the art, and other technical or legal changes, but not to cover physical
depreciation.
Net current replacement cost
It is established by depreciating the gross current replacement cost in order to
reflect the value attributable to the remaining portion of the total useful economic
working life of the asset, after taking due account of age, condition, obsolescence
and other relevant factors, including residual value at the end of the asset’s useful
economic working life.
Highest and best use
It means utilization of a property to its best and most profitable use. Highest
and best use must satisfy four criteria viz., physically possible, legally permissible,
financially feasible and maximum profitability which results in highest property
value. Highest and best use in relation to Plant & Machinery means that use of the
subject Plant & Machinery which may reasonably be expected to produce the
greatest net return over a specified period of time, and that legal use which will
yield the highest present value.
Standard machinery or general purpose machinery
It is a machine which is able to deal with variety of work and permits wide
range of operations to be performed. It has a good marketability.
Special purpose machinery
It is a machine which is designed for some specific purpose and performs only
a limited range of operation. It suffers from a limited marketability.
Custom built machinery
It is a machine which fabricated as the requirement of the client and performs
only one operation for which it is designed. It has almost no marketability at all.
Economic life
The period up to which machine is economical to use. After this period, the
return is less than the cost to use that machine.
3.2 OBJECTIVES
The main objective of this lesson is to prepare the students thoroughly on
procedure to be followed for practically carrying of plant and machinery valuation.
At the end of lesson the students will learn complete valuation process from
inception to finalization of valuation report.
3.3 CONTENTS
3.3.1 Plant & Machinery and its Valuation
3.3.2 Procedure for the Valuation of Plant & Machinery
3.3.2.1 Instruction
3.3.2.2 Scope of work
3.3.2.3 Location of the plant & machinery
3.3.2.4 Purpose for which valuation is required
3.3.2.5 Date as on which valuation is required
3.3.2.6 Offer
3.3.2.7 Appointment as valuer
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3.3.2.8 Acceptance of the assignment
3.3.2.9 Plan
3.3.2.10 Checklist for the valuation of plant and machinery
3.3.3 Data Collection
3.3.4 Verification with Fixed Asset Register (FAR)
3.3.5 Data Analysis
3.3.6 Basis of Valuation of Plant & Machinery
3.3.7 Sample Calculation
3.3.8 Assumptions & Limiting Conditions:
3.3.9 Report Writing
3.3.10 Conclusion
3.3.1 Plant & Machinery and its Valuation
The physical Plant & Machinery has ‘VALUE’ only if there is an interest of a
human being associated with them. Any business transaction will be based on the
settlement of interests of human beings in various assets and liabilities of the
business entity and hence valuation of Plant & Machinery in isolation of such
interests has no meaning at all. The various interests of human beings in the assets
evolve different forms of Value which mainly depends upon the need, desire and
paying capacity of the person in terested in the Plant & Machinery. To quantify
need, desire and interests of the persons or parties involved with the transaction,
one should consider essential elements like utility, marketability, scarcity,
transferability of the Plant & Machinery along with the physical, legal, social and
economic factors associated with them and hence estimation of VALUE requires the
quantification of all above mentioned qualitative factors. Each factor should be
given an appropriate weightage and the purpose for which valuation is made is the
principal determinants of the quantum of weightage to be given to each factor. In
valuation process, Plant & Machinery as tangible asset is not valued but
intangible rights derived in owning tangible assets are valued.
3.3.2 Procedure for the Valuation of Plant & Machinery:
3.3.2.1 Instruction
Who has given the instruction for valuation or what is the source of instruction
is the important to know. Instruction may be received either from Owner/s, Lessor,
Lessee, Bank, Financial Institution, Official Liquidator, Insurance company, Potential
buyer, Government authority or any concerned person etc. Instruction must be
crystal clear about Scope of work, location of Plant & Machinery to be valued,
Purpose for which valuation is required and date of valuation.
3.3.2.2 Scope of work
It gives information about the assets to be valued under the assignment. Clear
instruction regarding Plant & Machinery only, or Plant & Machinery along with
office equipment, Furniture & Fixture, Commercial and n on-commercial vehicles
etc to be part of the assignment must be required from the client.
3.3.2.3 Location of the plant & machinery
Sometimes it may happen the company has more than one factory unit located
at various places, in such situation, Clear instruction regarding Plant & Machinery
installed at all the units or any particular unit to be valued must be required.
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3.3.2.4 Purpose for which valuation is required
Valuation of Plant & Machinery may require for various purposes like Sale and
Purchase, Lease (either lessor’s interest or lessee’s interest or both), Financial
statement, Security against loan, Insurance, Takeover & Merger, Disinvestment,
Compulsory acquisition, Liquidation, to estimate Realizable value or Scrap value
etc. ‘Purpose’ will have an important bearing on:
i) Enquires to be made at the time of inspection of property and
ii) Information to be collected.
3.3.2.5 Date as on which valuation is required
Valuation of Plant & Machinery is carried out as on specific date of past.
Valuation cannot be done for any future date. The past and future date is with
reference to the date of report.
3.3.2.6 Offer
Once clear instruction is received from the client, submit your offer to the
client for conducting the professional assignment to carry out valuation of Plant &
Machinery mentioning the professional fees for the assignment, mode of payment,
terms and conditions, scope of work, time to be required to execute the assignment
depending upon the volume of the work and availability of data.
3.3.2.7 Appointment as valuer
If your offer is accepted by the client, get the letter of appointment as Valuer in
favour of yourself from the client.
3.3.2.8 Acceptance of the assignment
Once you get the letter of appointment as a valuer from the client, submit a
letter of Acceptance to execute the subject assignment to client.
3.3.2.9 Plan
The valuer will decide the information to be collected from the client based on
the purpose of valuation, scope of valuation, types of industry, types of plant &
machinery and any specific instruction from the client. The general check list
containing the information to be collected from the client to be su bmitted to the
client well in advance by the valuer prior to his plant visit, so client can get the
information ready at the time of valuer’s visit to the plant.
3.3.2.10 Checklist for the valuation of plant and machinery
1. Name of the ownership of assets.
2. History of the company.
3. Purpose for which the assets are utilized.
4. Particulars of each machine like specifications of machines, name and address of
manufacturers / suppliers, 0urchase price with break up, ex-work’s price,
packing and forwarding, excise duty, sales tax, handling, transit insurance,
foundation cost etc; new or second-hand purchase, details of purchase order., etc
5. Daily shifts and working hours, Number of days of working in a year.
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6. Year wise amount spent on repairs & maintenance to Plant and
7. Machinery.
8. Maintenance schedule for Plant and Machinery.
9. Electrical layout giving details of HT / LT distribution and subdistribution
10. along with the type of cable, size of cable, and length of cable.
11. Sanctioned load, connected load in kW / Hp.
12. Installed capacity of the plant and actual production in last 5 years in quantity
as well as in rupees.
13. Fixed Asset Register, details of last physical verification, discrepancy noticed if
any.
14. Copies of annual reports of last five years.
15. Details of plant and machinery sent for repair outside the factory premises.
16. List of imported machinery with year of purchase, purchase price in foreign
currency of the country of origin.
17. Valuer must ask client to furnish the list of Plant & Machinery to be valued
along with original cost with breakup and year of purchase and manufacturing
process flow diagram prior to his plant visit.
18. Valuer has to carry out ABC Analysis of the Plant & Machinery to be valued
and identify the important Plant & Machinery (value-wise), so he can
concentrate more on those Plant & Machinery and try his level best to get all
the relevant information from the plant itself as well as from the market of
those machinery. The experience says that, about 20% to 30% of the total
numbers of Plant & Machinery will cover almost 70% to 80% of total value of
Plant & Machinery in the unit.
19. Process flow diagram is very helpful to understand the sequence of operation
in the manufacturing process and the machinery layout helps in locating the
Plant & Machinery in the factory.
3.3.3 Data Collection
Plant visit & preparation of inventory
First visit the entire factory along with the factory personnel and take the
overview of Factory and then visit the factory alone and inspect the Plant &
Machinery and note down the details of it in the following manner by interviewing
the operators, su pervisors, engineers, sweepers etc. Prepare the inventory of Plant
& Machinery.
Micro Identification needs to be carried out while preparing the inventory.
The ingredients of micro-identification are as under:
- Description
- Model
- Type
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- Size or capacity
- Serial number given by manufacturer
- Name of manufacturer
- Name of supplier
- Year of manufacturing
- Details of attachments/accessories
- Type of drive and details of drive – v-belt, geared motor, gear (ty pe of gear
box, ratio) hp of motor
- Any special foundations,
- Clients’ asset no., identification no.
The sample of description of machinery is given below:
- Name of the machine: CNC Nibbling machine
- Total punch press force
- (Cutting force) : 330 KN
- Maximum cutting capacity : 300 KN
- Length of the stroke : 19 mm : 19 mm
- Speeds (strokes per minute) : 265 & 400/min
- Maximum sheet thickness for
- punching and nibbling : 10 mm
- Maximum diameter punched : 105 mm
- Maximum permissible work piece
- weight : 400 kg
- Working Range (nominal)
- Transverse direction in ---X : 2700 mm
- Longitudinal direction in---Y : 1600 mm
- Taping range : M3 - M16 (meter) : M3 – M16 m
- Speeds
- Maximum path rate : 60 m/min
- Maximum Positioning speed
- axially parallel simultaneous : 48 – 60 m/min
- Maximum Feed rate for nibbling : 6.6 m/min
- Details of Electrical supply
- Voltage supply : 380 V
- Frequency : 50 Hz
- Phase : 3
- Rated output of main drive : 5.5 Kw
- Connected load : 28 KVA
- Pneumatic Equipment
- Compressed Air : 7+1/ - 0.5 Bar
- Air Consumption : 69 N m3/Hr
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- Accuracy:
- Minimum programmable
- Increment : 0 mm
- Positioning accuracy : ± 0.1 mm
- Dispersion : ± 0.03 mm
- Model : X
- Make : Y, Germany
- Company’s Identification No. : A015
- Year of Installation : 1990
Note down the condition of individual machine as under and give the rating
of physical and working conditions of Plant & Machinery based on your experience,
by getting the information from the operator, technical supervisor and maintenance
in-charge of the factory:
 N - Brand new
 E - Excellent / just like new
 V - Very good
 G - Good
 F - Fair
 P - Poor
Inspect all the licenses, permits and consents required to run the factory and
its possibility of renewal for further period. Inspect the report issued by the
authorities like factory inspector, electrical inspector, excise inspector and any
other statutory requirement to run the factory.
3.3.4 Verification with Fixed Asset Register (FAR)
After collecting the inventory of Plant & Machinery, it should be verified with
the Fixed Asset Register of the company, you may find following discrepancies:
a) Plant & Machinery physically existing on site, but account record not
available; for example a Welding machine of the contractor is lying in the
factory premises and
b) Plant & Machinery existing in account record, but physically not available;
for example a single speed shaft grinder is sent for repairing outside the
factory premises.
c) Plant & Machinery used for production activity, not in use condition,
scrapped and surplus. Treat them appropriately.
The valuer needs to settle such discrepancies arise out of verification of FAR
with the help of personnel from Technical and Account/Purchase department and
finalise the list of Plant & Machinery to be valued. Once the required data from the
factory are collected, then it needs to be analysed at your place.
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3.3.5 Data Analysis
Select appropriate valuation approach, basis of valuation and method as per
the types of assets, purpose of valuation and any specific instruction from the
client.
There are three basic approaches to the valuation of Plant & Machinery :
(a) Cost approach
(b) Market approach
(c) Income approach
Cost approach
The cost approach is applied primarily with regard to service property (Non-
Marketable Non-Investment) which are not frequently exchanged in the market or
do not generate revenue by themselves. The cost approach rests mainly on the
principles of substitution.
While using the cost approach the valuer is comparing an existing facility to its
modern machine. Valuer should identify the asset and know the characteristics of
machine and calculate depreciation. It is difficult to quantify economic obsolescence
by using cost approach.
Methods under cost approach
(i) Replacement cost new method
Replacement Cost New (RCN) represents the amount of money in terms of
current labor and materials in order to construct or to acquire new property of
similar utility to the subject property. The replacement cost new method of
valuation is a widely adopted. The procedure to be followed for valuation by the
replacement cost new method may be as follows:
- Computation of replacement cost new
- Computation of depreciation including obsolescence
- Computation of net current replacement cost
The most important factor to arrive at sound valuation is a proper
computation of replacement cost new. The concept of “replacement cost new” is not
the same as the concept of “reproduction cost new.” Reproduction cost new is the
cost to reproduce the plant and machinery that is exact duplicate of the subject
property. It is a replica or the mirror image of the existing one with the same
materials, manufacturing standards, design, quality and efficiency when put to use.
The computation of replacement cost new is the estimated current cost to
manufacture or obtain the plant and machinery with utility and efficiency equivalent
to the existing one using modern materials, standards, design and performance
potential. This is also referred to as in like kind and utility. Costs in such cases are
broken down into direct cost and indirect cost. Direct cost include the cost of
material, labour and manufacturer’s profit. Indirect cost include professional fees,
financing charges, tax levies and carrying charges during installations.
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(ii) Book value method
This method is purely based on past experience of the valuer. This is not an
accurate method. This method mainly based on the valuer’s own experience and his
collection of data. Suppose valuer who has handled a number of pharmaceutical
industries. He has compared net book value in the books of account of the
company with net current replacement cost or market value arrived at by him and
then created a data bank showing a percentage increase in book value. If any of his
clients needs an approximate value of his plant, the valuer would apply an
appropriate factor to the net book value of that company and arrive at the rough
indicator of value.
Market approach
The market approach is particularly applied with regard to property that have
established markets for the transactions. The primary strength of the market
approach lies in the fact that it is the most reliable indicator of value of the
individual item of plant and machinery and is a direct measure of all of its
depreciation aspects. But it often suffers from the difficulty of non -availability of
comparable sales and also the lack of an adequate data base for comparison. Even
when there are sufficient sales, we may not have access to the facts of those sales.
Again, the timing of the sale transaction is another important factor. Using sales
data from the past may not fit in with the economic perspective of the present.
Thus, an objective comparison requires a more expert skill in valuation in order to
make the proper adjustments. Marketable Non - Investment properties are valued
by adopting Market approach. Valuer should take care to identify the age of the
machine, its condition, features including accessories, location, manufacturer,
price, quality, quantity etc. for the purpose of comparison. It is also necessary to
inquire if the sale is induced by compulsion or speculation.
Methods under market approach
(i) Direct sales comparison method
This method is used when direct match of identical asset is a vailable. For
example, valuation of lathe machine can be done by direct sales comparison
method if direct match in respect of manufacturer, model, age, accessories, asking
price is available in the second hand machinery market or in the published journal
or even on internet.
Income approach
The income approach in its simplest form is the estimation of the present
worth of the future benefit accruing to the owner of the plant and machinery or to
the specific interests or rights one enjoys in the property. This approach is relevant
for investment properties having utility, marketability and self liquidity. The cost
and market approaches may not measure the full effect of obsolescence which the
income approach will measure. The business enterprise is valued on the basis of its
future income potential. In doing so, it is often necessary to ascertain value on the
aggregation of assets which generate the income stream. This collection of assets is
commonly known as the business enterprise and consists of all components of the
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business - working capital, fixed asset and intangible assets. Ultimately, it is the
income that establishes the value of the business and it is worked out through a
series of calculations that take into account all factors that affect the yiel d or
return. The amount supportable by the business is derived from the income as
determined for all the assets of the business, working in combination.
Methods under income approach
(i) Capitalisation of earnings method
The capitalisation of earnings method is based on the concept that the value of
plant and machinery is directly related to earnings that the buyer expects to receive
in the future. The two components of this method are:-
- The real earning stream of the plant and machinery in question and
- The rate of return that the buyer expects in order to invest his money
- Find out net income available by using Plant & Machinery and multiply it with
Year’s Purchase( Y.P.) will give you the value of Plant & Machinery.
(ii) Discounted future earnings method
This method determines the value of plant and machinery employed in a
business in the following manner:-
- Estimating the expected income stream for a number of years in the future;
- Determining the present value of such income stream;
- Estimating the terminal value of plant and machinery at the end of the
designated period of future.
The sum of the discounted economic income over the expected remaining
useful life of the Plant & Machinery plus the terminal value represent the value of
subject Plant & Machinery by a discounted future earnings method under income
approach.
3.3.6 Basis of Valuation of Plant & Machinery
The selection of Basis of Valuation mainly depends on the purpose of valuation,
types of Plant & Machinery and any specific instruction given by the client.
(a) Value in existing use in-situ
Means estimate the value of Plant & Machinery for its existing use in the same
situation.
(b) Value in existing use ex-situ
Means estimate the value of Plant & Machinery for its existing use, not in the
same situation, but at a new location. In this situation valuer must consider the
cost of dismantling of the Plant & Machinery from its existing position and reinstall
to new location, means cost of transportation, re -installation, erection,
commissioning, wiring, foundation etc. at new place to be considered.
(c) Value in alternative use ex-situ
Means estimate the value of Plant & Machinery for its alternative use, not in
its existing use, not in the same situation, but at a new location. In this situation
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valuer must consider the cost of dismantling of the Plant & Machinery from its
existing position and reinstall to new location, means cost of transportation,
reinstallation, erection, commissioning, wiring, foundation etc. at new place to be
considered for its alternative use.
(d) Value in alternative use in-situ
Means estimate the value of Plant & Machinery for its alternative use, not in
its existing use at the same situation.
In practice valuation is by and large carried out by cost approach as plant and
machinery generally valued are specialized/special nature and market evidence of
sale of such machinery is hardly available.
Steps to be followed to arrive at final value are as under :
- Ascertain Gross Current Replacement Cost (a)
- Calculate depreciation and obsolescence (b)
- Difference of (a) and (b) indicates Depreciated Replacement cost.
(A) Replacement Cost New can be ascertained by any one of the following two methods
- By floating inquiry or by getting quotations
- By applying price index to historical or original cost.
Replacement Cost New calculated by floating inquiry and getting the quotation
from the supplier is very accurate. For this, it is necessary to provide proper
technical specifications to the supplier. This can only be achieved by obtaining the
following vital data from the clients -
- Technical specifications mentioned in the final purchase order
- Technical specifications from the maintenance or engineering department or
from the technical literature supplied by the manufacturer.
The other method resorted to is applying a price index to the historical or
original cost (trending the historical or original cost). While applying price index to
ascertain trended price, a care should be taken to get the correct historical cost,
otherwise if the historical cost (base) itself is inaccurate, then it will lead towards
wrong estimation of trended price. Historical cost itself is not likely to be accurate
for the following reasons :
- It is inflated to reduce the margin at the time of obtaining a loan for
purchase of plant and machinery or possibly some other reason.
- It can be deflated because a purchase consideration was not fully reflected
due to variety of reasons.
Extra care to be taken in applying a price index
o Many a time a second-hand machine is purchased for which first original cost
(historical cost) is not available. In such cases, it is advisable to obtain a
quotation.
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o Machine purchased in a particular accounting year remained under capital
work in progress for more than one year and capitalised in a subsequent year of
accounting. In order to calculate replacement cost new in such cases, price
Index for the respective years of purchase to be applied to the historical
costs and not to the year of capitalisation.
o In case of imported machine extra care is to be taken, due to following factors
- Difference in price index of country of origin of machine and location of machine.
- Difference in rate of custom duty at the time of purchase and valuation.
- Difference in currency rate at the time of purchase and valuation.
In such a case price index of country of origin is to be applied to purchase
price in foreign currency of machine under consideration, this will give trended cost
in foreign currency; to this; currency rate and custom duty prevailing as on
valuation date are to be applied to arrive at Reproduction Cost New.
The Reserve Bank of India; Department of Economic Affairs, Govt. of India
publishes price indices. If the price indices are available in the following manner,
they are more reliable.
 The machine price index prepared by obtaining the price year by year from
various manufacturers. This will give a proper price index.
 Valuers having their own data bank can present a credible and quantifiable
valuation.
In practice the Valuers find machines falling under following broad categories:
a) Machines identical to the machine under consideration as available in the
market from the original manufacturers.
b) Machines discontinued by the original manufacturer but identical
machines manufactured by different manufacturers.
c) Old and outdated machines discontinued by the manufacturer.
Let us consider the machines falling under category (a) as referred above. In
the case of these machines it is not difficult to ascertain replacement cost and
depreciation may be calculated from the following information :
 Age - chronological or effective
 Usage
 Estimated economic balance life.
The best way to establish the economic life of an equipment is to go through
the records of plant under consideration and collect the information about the
machines scrapped or retired by the company and study the same. However, this is
possible only in case of old plant.
For Machines falling under category (b) as referred above; many a times, it is
observed that the same machine by two different manufacturers are sold at
different prices. The reasons for the difference can be:
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 Brand name
 Better quality
 Percentage of rejection
 Down time
 Maintenance cost.
If the products of the manufacturer other than the original manufacturer are
well comparable with the original manufacturer; replacement cost for a
manufacturer other than the original manufacturer can be accepted. Otherwise,
adjustments will have to be made with good judgments. This is known as
replacement in like kind and utility.
In case of machines falling under category (c) it will be necessary to calculate
obsolescence and for that purpose it will be necessary to carry out the comparison
of machine under consideration with the latest available machine with regard to
following factors :
 Technical specifications
 Direct wages
 Consumption of stores and space
 Consumption of energy
 Fixed cost
 Saving in space
 Down time
After ascertaining replacement cost new, the next step is to calculate the
depreciation and if obsolescence is present, the same needs to be computed
appropriately.
The straight line method of depreciation is widely used method to calculate
physical depreciation of Plant & Machinery. Valuer must find out age of the
machine , estimate proper scrap value and economic life of the machine and
calculate physical depreciation.
Difference of Gross Current Replacement Cost ascertained and Depreciation
calculated as above indicates Depreciated Replacement cost (DRC).
3.3.7 Sample Calculation
Consider the ex-work’s price of a closed M.S. vessel having capacity of 15,000
litre (water capacity) with rubber lining, Anchor type agitator, Elecon make gear, 10
HP Crompton make motor is Rs.3,25,000/-:
1. Ex-works price = Rs.3,25,000/-
2. Packing and forwarding (3 % ) = Rs.9,750/-
3. Excise duty (16.32 % of a + b) = Rs.54,631/-
4. G.S.T (8 % ) = Rs.26,000/-
5. Transportation (Depends on distance, mode, weight, volume) = Rs.5,000/-
6. Transit Insurance (1 % ) = Rs.3,250/-
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7. Handling charges = Rs.3,250/-
8. Erection charges = Rs.5,000/-
9. Cost of foundation (4 % ) = Rs.13,000/-
Total = Rs.4,44,881/-; Say Rs.4,45,000/-
Gross Current Replacement Cost (GCRC) of Open Vessel is Rs.4,45,000/-.
a) Ex-work’s price = Rs.3,25,000/-
b) G.C.R.C. = Rs.4,45,000/-
c) Age = 10 Years
d) Economic balance life = 10 Years
e) Economic life = 20 Years
f) Scrap Value = 10 % of Ex-works
g) Depreciation per annum = (G.C.R.C. - Scrap value)/Economic Life = (4,45,000 -
32,500)/20 = 20,625/-
h) Total Depreciation (10 Years) = 20,625 X 10 = 2,06,250/-
i) Depreciated Replacement Cost (D.R.C.) = GCRC – Depreciation = 4,45,000/- -
2,06,250/- = 2,38,750/-; Say Rs.2,39,000/-
Carry out market survey with respect to product manufactured by the
company. Get the market share of the product of company, demand of the product
manufactured and its sustainability in the market, details of pending orders, details
of competitors, government policy and also conduct the market survey of the Plant
& Machinery installed in the factory with respect to availability of latest machinery,
its advantages, availability of spares and parts, availability of second-hand market,
information about original manufacturer as well as other manufacturers
manufacturing the same machines.
Compute Technological, Functional and Economic obsolescence if any.
Economic obsolescence is computed by “Business Enterprises Equation”; i.e.
Assets = Liabilities + Stockholders equity;
i.e. CA + FA + IA = CL + LTD + SE
CA = Current assets
FA = Fixed Assets (Land, Buildings, Plant and Machinery, Furniture &
Fixtures, Vehicles, Office equipment).
IA = Identified and Unidentified intangible assets
CL = Current liabilities
LTD = Long term debt
SE = Stockholders equity
NWC = Net working capital
BE = Business Enterprises Value
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CA + FA + IA = CL + LTD + SE
(CA-CL) + FA + IA = (LTD + SE)
But, CA-CL = NWC
Means LTD + SE = BE
Therefore, BE-NWC = FA + IA
So, we can say Business Enterprise Value less Net Working Capital represents
the economic support for fixed and intangible assets.
If, (BE – NWC) < (FA + IA), Economic obsolescence exists.
Suppose,
BE = Rs.1,98,60,00,000/- (calculated by capitalization of future net income at
appropriate rate of return, which can be worked out by weighted average of cost of
capital and cost of equity)
 NWC = Rs.18,00,00,000/-
 BE - NWC = Rs.1,80,60,00,000/-
 Market value of Land = Rs.3,96,00,000/-
 Depreciated Replacement
 Cost of Building = Rs.10,57,00,000/-
 Depreciated Replacement Cost of Plant & Machinery = Rs.44,23,95,000/-
 Total value of fixed assets = Rs.58,76,95,000/-
Therefore, (BE – NWC) > ( FA + IA) and Economic obsolescence does not exist.
3.3.8 Assumptions & Limiting Conditions:
While carrying out valuation assignment, valuer can make reasonable
assumptions based on the facts and data available as on date of valuation.
Assumptions are for the data which are not in existence as on date of valuation.
e.g. Valuer can assume the economic balance life of the machine based on his
own experience and judgment, expert’s opinion, physical condition of the machine,
working condition of the machine, scrap record and maintenance record of the
company etc.
Valuer can assume the demand of the product manufactured, future market
condition based on the current market trends, taste and choice of the consumers,
pending orders from the buyers etc. Whereas, some of the relevant information or
data which are in existence as on date of valuation but could not be available to the
valuer due to various reasons are known as Limiting conditions. e.g. Sometime it
may happen, client will not give the details of
Process due to monopoly or secret policy or sometimes machine drawing ,
foundation drawing, electrical layout, piping layout, maintenance records, log book
are not available. These are the limiting conditions for valuer and he has to take
appropriate decision in the absence of such information or data. Give your
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assumptions and limiting conditions in order to carry out valuation assignment and
also mention the remarks.
Finally valuers conclude with opinion or advice clearly, definitely and
unambiguous.
3.3.9 Report Writing
Report Writing means the information and opinion, which the client is seeking
to be put in to words in the best possible manner. Important decisions depend on
the information & advice given in a report. Advice should not be obscurely
expressed, it should be skillfully worded to convey the meaning as intended.
Important points about Report Writing
Essentials of Good Report
(a) Methodical
Report should be methodical. Exact order for presentation of facts should be
decided prior to writing report. Series of complete paragraphs for giving facts are to
be framed. Each paragraph must be independent and logically follows the earlier
paragraphs.
(b) Well set out
The framing of report is in such a way that, one can refer any particular part
without difficulty. Appropriate title, heading and sub headings should be given to
each paragraph.
(c) Continuity
The report should be written in such a way that, the continuity should be
preserved. It should be read as complete narrative from start to finish. There should
not be any jerkiness. No obvious break between various parts. Report is an essay
on technical point written in a simple language/words for the client. Careful use of
schedules and appendices attached to report will help to maintain the continuity of
the report. Schedules and Appendices should not be the part of the main report.
(d) Concise and definite
Keep the report to the length required to impart the facts and opinions needed,
neither longer nor shorter. It should contain definite facts, opinion and advice in
clear and unambiguous manner and words.
Other points to be keep in mind while framing Report
a) Report on valuation is nothing but a carefully phrased simple essay. Certain
dignity of tone to be preserved, so that facts and opinions can be expressed
convincingly. The short and simple sentences should be used. Avoid complex
and long sentences.
b) Choice of words : Use simple words having precise meaning rather than
ornamental words. Pompous expression and longer words create bad
impression. There should be no exaggeration. Avoid meaningless words like
‘Pretty good, Quite fair, Needless to say, In my opinion’ etc.
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c) Personal pronoun : Avoid Personal Pronoun as far as possible. Report should
be in Passive voice. Avoid personal pronoun ‘I’ in the report.
d) Technical phrases : Avoid using Technical Phrases in the report, but explain
the same by using more simple words, because the client or the user of the
report is a common man.
e) Punctuation : Use punctuation at correct places, otherwise wrong punctuation
will mislead the reader of the report.
f) Supporting documents: The written part of the Report can be supported by
wide range of Schedules, Appendices, Tables, Graphs, Maps, Plans,
Photographs, Expert’s report etc. The written report may summarise
information given in detailed appendices. As the Plant & Machinery is subject to
greater analysis, Script alone is inadequate for formulating professional opinion.
Schedules, Appendices, Tables, Graphs, Maps, Plans, Layout, Photographs,
Expert’s report etc. are decisive in achieving effective communication. It is
important for valuer that, the reader should not be drawn in to Data. Always try
to make the written report as short as possible – so that it acts as Summary
with all the details in the Appendices or in schedules. All appendices or
schedules must be clearly identified as to its contents, with appropriate title and
information arranged in effective form.
General structure of the report on Valuation of Plant & Machinery
The report on valuation of Plant & Machinery will be divided in to three parts:
(a) PART I : Preamble
(b) PART II : Statement of Plant & Machinery
(c) PART III : Annexures
(a) PART I : Preamble
It consists of:
a) Reference No. of the report
b) Date of the report
c) Title (it should be like as under) Report on Valuation of Plant & Machinery of XYZ Pvt.
d) Limited situated at Anand – 388 001
e) Instruction
f) Owner/s of the assets
g) Purpose for which valuation is done
h) Date as on which valuation is done
i) Date of inspection
j) Particulars of assets under consideration
k) Exact location of the company
l) Brief profile of the company
m) Information required to carry out valuation (check list) and
n) information furnished by the client
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o) Inventory of Plant & Machinery
p) Collection & verification of data
q) Assumptions & Limiting conditions
r) Basis/ Approach to Valuation
s) Method of Valuation
t) Sample calculation
u) General remark
v) Summary of Valuation
w) Conclusion
(b) PART II : Statement of Plant & Machinery
It is the statement showing list of Plant & Machinery installed at the factory
premises along with Detailed Technical Specifications, Gross Current Replacement
Cost, Depreciation and Depreciated Replacement Cost (DRC).
(c) PART III : Annexures
Generally following Annexures are attached as supporting document at the
end of the report.
1. Location map ( if location is at awkward place)
2. Detailed profile of the company and list of the products
3. manufactured by the company
4. Manufacturing process flow diagram along with process
5. explanation
6. Machinery layout
7. Checklist
8. Computation of Gross Current Replacement Cost
9. Computation of Depreciation & Depreciated Replacement
10. Cost
11. Machine drawing/s
12. Electrical layout
13. Piping layout
14. Quotation of Important Plant & Machinery
Submission of Report
Always submit the report in duplicate or triplicate (as instructed by the client)
to the person who has appointed you as valuer or the person who has instructed
you to prepare valuation report along with the covering letter. Covering letter
should refer to
a) Subject matter
b) Reference to client’s letter/s
c) Brief identification of Plant & Machinery
d) Purpose
e) Date of valuation
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f) Findings/ opinion/conclusion
g) Mention about the professional fees for framing Report on Valuation of
h) Plant & Machinery (with Report reference no. and date). Enclose the
i) bill along with Report.
j) Signature and date
Preservation of Data
Valuer must preserve whatever data he has collected to execute the su bject
assignment by proper filing and giving the same reference number as given to the
report to the file/s, so that it will be easy for him to locate the same in future.
Preserve all the documents like inspection note, inventory book, working papers,
quotations, indices used, remarks, plans, expert’s opinion, whatever documents
furnished by the client, valuer’s own justification about estimation of economic
balance life, market, replacement cost etc. in such a way that he can justify his
opinion during cross examination in the court in future.
3.3.10 CONCLUSION
A Plant & Machinery valuer should follow the above mention procedure to
execute an assignment of Valuation of Plant & Machinery , but make appropriate
modification in the procedure depending on the type of industry, type of Plant &
Machinery, availability of data, the time period within which the assignment to be
executed, purpose of valuation, any specific instruction given by the client.
3.4 REVISION POINTS
 replacement cost and reproduction cost
 general checklist for the valuation of plant and machinery
 important features of plant and machinery valuation report
1. Explain difference between Depreciation and Obsolescence
2. What is difference between replacement cost and reproduction cost?
3. What is difference between market value in existing use and market value in
alternate use?
4. Explain basis of valuation of plant and machinery.
5. Give important features of plant and machinery valuation re port.
6. What are the sources of information of plant and machinery valuation?
3.6 SUMMARY
Compete process of carrying out valuation of plant and machinery has been
discussed.
1. Elaborate the statement “In valuation process, Plant & Machinery as tangible
asset is not valued but intangible rights derived in owning tangible assets are
valued”.
2. List our general checklist for the valuation of plant and machinery.
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3. What you mean by micro data and macro data in the context of plant and
machinery valuation?
4. Explain the importance of Fixed Asset Register (FAR) and its verification in
valuation of plant and machinery.
1. pmvaluations.com.au/asset-valuers/valuation- methodologies
2. rbsa.in/valuation_of_industrial_assets_plant_machinery.
3.9 ASSIGNMENTS
You have been asked to value a chemical plant, cement plant, power plant and
bearing manufacturing plant. List out what micro and macro data you will collect of
each of this kind of plants during the process of valuation.
2. Valuation of Plant and Machinery Theory and Practice by Dr. P . C. Gupat
3. Special Cases of Plant and Machinery Valuation and Thoughts on Professional
Valuation by Dr. P. C. Gupta
4. International Valuation Standard on plant and equipment
5. International Accounting Standard – 16
6. Indian Accounting Standard – 16
To value a chemical plant, cement plant, power plant and bearing
manufacturing plant.
3.12 KEYWORDS
Procedure, Check List, Data Collection, Data Analysis, Basis, Methods, Report
Writing
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LESSON-4
DEPRECIATION OF PLANT AND MACHINERY IN VALUATION

4.1 INTRODUCTION
In the process of valuation of plant and machinery “Depreciation” is a vital
factor and is a universal phenomenon. It is an attribute of all physical objects that
they are subject to wear and tear, whether in use or not in use. Depreciati on is
therefore a premium for existence in the sense that decay cannot be avoided. By the
end of this Chapter students will learn about depreciation, factors affecting
condition of machine, methods of computing depreciation and depreciation under
the Income Tax Act, 1961 and Companies Act, 1956/2013.
4.2 OBJECTIVES
The main objective of this lesson is to prepare the students thoroughly on the
principles, definitions, causes and quantifying depreciation and obsolescence for
plant and machinery valuation.
4.3 CONTENTS
4.3.1 Depreciation
4.3.2 Obsolescence
4.3.3 Depreciation – under Income Tax and Company Laws
4.3.1 DEPRECIATION
It is interesting to take note of different judicial, quasi -judicial and other
pronouncements reflecting on the proper import of depreciation as a phenomenon
of all assets:
Madhya Pradesh High Court in the case of Commissioner of Wealth Tax vs.
Swadeshi Cotton Mills Ltd. decided on March 4, 1968 (reported at page no.152 of
the book, “Cases on Valuation under Direct Tax Laws” Vol. 1 by H.G. Agarwal and
Rani Kharbanda – 1977 edition) has observed that :- “Normally, fixed assets such
as plant and machinery run their utility by lapse of time and wear and tear. There
is a permanent and continuing diminution in the quality or value of suc h assets. A
machine may be kept in high state of efficiency, i.e. by constant overhauling and
prompt replacement of parts, such being always necessary; but the expenditure on
upkeep and preservation can never be a substitute for making provision for the
time when the machine is merely a bundle of scrap iron. These assets suffer
depreciation, although the process may be invisible or gradual. The maintenance of
such assets in a state of efficiency is neither a substitute for the depreciation in
value nor it is sufficient for ensuring their replacement.”
Supreme Court of India in the case of Workmen N.G. Bank vs. N.G. Bank
(reported at AIR 1976 SC 611) has defined ‘depreciation’ as - Decrease in value of
property through wear, deterioration or obsolescence . (Ref. Mitra’s Legal and
Commercial Dictionary by A.C. Sen – 1979 edition, page no. 245).
In the case of Lindheimer et al vs. Illinois Bell Telephone Co. [reported at
(1934) 292 US (SC) 151] the word ‘depreciation’ is defined in the manner : “ Broadly
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speaking, depreciation is the loss, not restored by current maintenance, which is due
to all the factors causing the ultimate retirement of the property. These factors
embrace wear and tear, decay, inadequacy and obsolescence”.
The Federal Communications Commission, U.S.A. has defined ‘depreciation’ as
“Depreciation as applied to depreciable telephone plants, means the loss in service
value not restored by current maintenance, incurred in connection with the
consumption or prospective retirement of a telephone plant in the course of service
from causes which are known to be in current operation, against which the
company is not protected by insurance and the effect can be forecast with a
reasonable approach to accuracy. Among the causes to be given consideration are
wear and tear, decay, action of elements, inadequacy, obsolescence, changes in the
art, changes in the demand and requirements of public authorities”. (Ref. U.S.
Federal Communications Commission, Uniform System of Accounts for Telephone
Companies P.4 Washington D.C. Govt. Printing Press, 1935).
In 1943, the National Association of Railroad and Utilities Commissioners
Committee on Depreciation stated : “Depreciation is the expiration or consumption
in whole or in part of service life or utility of property resulting from the action of
one or more of the forces operating to bring about the retirement of such property
from service, the forces so operating include wear and tear, decay, action of the
elements like adequacy, obsolescence and public requi rements; depreciation results
in a cost of service”. (Ref. National Association of Railroad and Utilities
Commissioners, “Report of Committee on Depreciation” P.30 Washington D.C.
1943.)
The European Group of Valuers of Fixed Assets (TGOVOFA) now known as The
European Group of Valuers of Assets (TGOVOA) under Guidance Note No. GN4A
published in 1988 has defined ‘depreciation’ as – “The measure of wearing out
consumption or other permanent loss of value of fixed asset whether arising from
use, effluxion of time or obsolescence through technology and market changes”.
The Royal Institution of Chartered Surveyors U.K. has published a Manual of
Valuation and Guidance Notes (white book) (March, 1994) (vide VGN 8 A -Annex A)
where ‘depreciation’ is defined as – “The measure of wearing out by consumption or
other reduction in the useful economic life of a fixed asset, whether arising from use,
effluxion of time or obsolescence through technological or other changes”.
It will be seen that different authorities have in cluded obsolescence as a factor
contributing to depreciation, which is only partly true. The valuer has to consider
both of these as separate phenomena and must assess value of assets by separately
considering physical deterioration and obsolescence, if any. This is necessary
because deterioration is due to actual wear and tear to the plant and machinery
under consideration whereas obsolescence is due to technological, functional and
economic factors which are internal as well as external to the plant and machinery
under consideration.
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“Depreciation” may be defined as under:
Besides 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. While some of this deterioration
may be possible to be controlled it cannot altogether be avoided. This is taken as
depreciation. Many refer to this difference as Curable and Incurable. A valuer has
to make a routine observation about condition and it is interesting to note that,
there are two conditions viz.,
Many a time actual and perceived (appearance) conditions are different due to
the following reasons :
 The machine is recently painted. It may appear new, though it may not be so.
 In oil extraction plants, equipment made out of M.S. or S.S. plates can be
manufactured from second-hand plates.
 It is not possible to assess real performance of a machine and its deterioration
in working condition due to excellent upkeep.
A valuer has also to consider three major factors to arrive at the condition of
the equipment : Environment , Usage, Maintenance
Environment
What is the state of surrounding area housing the equipment? Is it sufficient
to protect the equipment? These are major questi ons posed by the environment.
Surrounding weather conditions also contribute to balance life and performance of
machinery viz., nearness to salt water or nearness to corrosive atmosphere.
Usage
Is the equipment used strictly as per manufacturer’s recommended capacity?
This question has to be answered in the context of usage.
Maintenance
What is the system of maintenance? Is it routine breakdown maintenance or
preventive maintenance? Has the company adopted the system of maintenance
audit? These are the pertinent questions within the realm of maintenance.
It is noteworthy to mention that, the standard of maintenance is, to a certain
extent, inter-linked with the condition of the machine. An experienced valuer will be
able to form an early impression in this respect during the course of his survey.
Probably the best indicator of all is to look at the maintenance department – if it is
well equipped, clean and efficiently organized, it is a reasonable assumption that
the production plant will be maintained to a suitably high standard. If, on the other
hand, the maintenance shop is poorly equipped, dirty and positively groaning under
the weight of a disorganized collection of ancient bits and pieces, current spares
and assorted parts and generally resembles a junk yard, it is more than likely that
standard of maintenance will be poor.
The general impression created by the organization within the factory as a
whole also gives a fairly good indication of the probable standards of maintenance.
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Answer to all the above questions will lead to a determination of whether the
equipment is under normal wear and tear or abnormal wear and tear. This
determination plays a crucial role in arriving at sound value.
Maintenance and additions compared
The aspect of maintenance has to be sharply distinguished from additions or
repair work which often are clubbed in the accounting procedure in the same
heading of maintenance. The distinction between maintenance and repair work
(debited directly to production expenses) on the one hand, an d addition or
betterment work (debited to capital investment accounts) on the other hand
involves a border line area almost as off-white colour as can pass on as white. The
accounting classification between maintenance and construction operations is
usually based on the following criteria:
 Size of the physical property involved
 Number of units involved
 Cost of the work performed
 Frequency of occurrence of the operation
 If the depreciation rate is based upon retirement of the property involved in the
operation
If the physical size of the maintenance work spans over heavy quantities as
respects weight, area, volume, or length, the maintenance is virtually a
construction operation. So also is the case with other criteria as laid down above. If
the cost incurred in maintenance is too high or frequency too often, the operation is
virtually an addition and not maintenance as such. In general, operations which
leave the property in better condition for profitable service than when it was new,
are classified as additions and betterments, a form of construction creating new
investments; operations which only restore property to a former serviceable state
are maintenance operations. For instance, the replacement of a roof could be
classed as a maintenance in accordance with predetermined accounting policies,
which specify that the cost of the new roof would be charged to maintenance of
investment.
The accounting system has to respond to the actual happening in the physical
front. But, if it does not do so, the val uer must be equipped to read through the
accounting method adopted to discover the actual state of affair for distinguishing
expenditures for maintenance from that on capital additions. In the former
classification, the cost is expensed immediately and affects the current statement of
profit and loss also. When classed as a capital addition, the cost affects future
statements of profit and loss through the depreciation.
When long-lived property is added or retired through the maintenance
accounts, the stated investment in the property eventually will not agree with the
property in service. In order to keep investment accounts in agreement with the
property in service, the necessary debit and credit entries to the property accounts
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must be made for all property installed or retired, regardless of whether the plant
work is done by maintenance forces or by contracts.
It is necessary to codify the conditions in various categories:
Codifications
1. N = Brand new
2. E = Excellent, just like brand new
3. VG = Very good with no repairs required in foreseeable future. Longer time than
average before any maintenance required.
4. G = Good condition requiring standard routine maintenance.
5. F = Fair condition, below average but can be operated by continuous repairs
and maintenance.
6. P = Poor condition may or may not work, needs immediate repairs and may or
may not work or even may require maintenance for limited use.
7. S or X = Scrap condition and cannot be used for intended use.
Therefore, it is necessary to discuss with clients all relevant aspects before
framing an opinion for adopting a depreciation method.
Methods of computing depreciation used in practice are
 Observed Deterioration
 Straight Line
 Decline and Balance
Observed deterioration (also known as the 0 – 100% method)
In this method, each piece of equipment is inspected in running condition in
order to estimate deterioration. This is based on valuer’s judgment and lot of
subjectivity is involved. Lump sum figure of depreciation as per codification given
earlier can be adopted as:
Condition Depreciation %
New (N) 0-5
Excellent (E) 6 - 10
Very Good (VG) 11 - 20
Good (G) 21 - 50
Fair (F 51 - 60
Poor (P) 61 - 90
Scrap (S) 91 - 100
Let us consider a case of machine:
Gross current replacement cost (GCRC) Rs.1,00,000/-
It is in excellent condition and depreciation on above method is estimated to be
10% which works out to Rs.10,000/- and Net Current Replacement Cost (NCRC)
works out to Rs.90,000/-.
Straight line method
In this method, scrap value is estimated first. When it is con sidered to be 10%
of replacement cost; the balance 90% is depreciated for estimated total economic
life of the equipment. If Depreciation and Net Current Replacement Cost of above
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machine having age 5 years, total economic life 15 years and scrap value is
considered by straight line method then it will be as under:
 Age 5 years
 Depreciation per annum (% ) = (100– ScrapValue)/ To tal Economic Life = (100-
10)/15 = 6%
 Depreciation for 5 years = 30% = Rs.30,000/-
 Gross Current Replacement Cost = Rs.1,00,000/-
 Depreciation = Rs.30,000/-
 Net Current Replacement Cost = Rs.70,000/-
Decline and balance method
(This is also known as written down value/diminishing balance) :
Let us consider a case of machine having replacement cost of Rs.100/-; it is
depreciated at 10% . Depreciation for 5 years old machine at 10% per annum
decline and balance method will be as under :
 Total depreciation for 3 years = 27
 Depreciation for 4 th year = 7
 Depreciation for 5 th year = 6
 Total depreciation = 40% = Rs.40,000/-
 GCRC = Rs.1,00,000/-
 Depreciation = Rs.40,000/-
 NCRC = Rs.60,000/-
Now the question is which method of depreciation to be adopted? The question
of selecting the appropriate depreciation method arises subsequent to taking
inventory, completing collection and verification of data and going through the
records of maintenance, ascertaining usage, standard of maintenance etc.
Therefore, after taking into consideration all relevant aspects discussed in the
foregoing paragraphs, the valuer, on his best judgement and experience, has to
select the appropriate method for computing depreciation.
The method of reckoning depreciation in case of plant and machinery has to be
determined by a valuer with due regard to the parameters indicated below:
 Age and estimated economic balance life;
 Present capital value to be recouped in installments during the remaining life of
the asset and not the lump sum amount at the end of life;
 Value of plant and machinery to decline slowly in the beginning and faster
during mid-life and maximum at the end;
 History of repairs and maintenance;
 Rate of yield declining during the remaining life;
 Number of working hours per shift per day;
 Wear and tear vis-à-vis maintenance;
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 Effect of surrounding weather conditions, and environment;
 Anticipated scrap value.
Let us consider a case of brand new car purchased by three persons A, B, C on
same day for Rs.2,00,000/-. After three years each one had run the car for 50,000
kms. The maintenance of A was excellent, B inferior to A and C inferior to B. Each
of the cars were sold by satisfying market value definition as under (current price of
brand new car on date of sale is Rs.3,00,000/-)
A - Rs.1,25,000/-
B - Rs.90,000/-
C - Rs.60,000/-
The depreciation from market derived data in each of the cases will be as under:
A - (3,00,000 - 1,25,000) = Rs.1,75,000/-
B - (3,00,000 - 90,000) = Rs.2,10,000/-
C - (3,00,000 - 60,000) = Rs.2,40,000/-
Let us assume that the rate of depreciation adopted for motor cars in books of
account is 20% on decline and balance (WDV) method.
The depreciation for 3 years at 20% on purchase price and current price of
brand new car will be as under:
Depreciation for 3 years (20% Depreciation for 3 years 20%

WDV) on Purchase Price WDV) on Current Price
A -98,000 1,47,000
B -98,000 1,47,000
C -98,000 1,47,000
The statement showing Book Value (Purchase Price - Depreciation),
Depreciated Replacement Cost (DRC) (Current Price of brand new motor car i.e.
Replacement Cost New - Depreciation) and Market Value is given below:
Book Value D.R.C. Market Value
(Rs.) (Rs.) (Rs.)
A. 1,02,000 1,53,000 1,25,000
B. 1,02,000 1,53,000 90,000
C. 1,02,000 1,53,000 60,000
Book Value of each of the three cars is same. DRC also of each of three cars is
same. But market value is different.
The reasons for the difference are:-
1. Amount spent on maintenance is not a capital expenditure and therefore not
added to purchase price of a machine.
2. Amount spent on maintenance affects balance life.
3. Market Value depends on market condition i.e. demand and supply.
In practice, many a times ‘DRC’ and ‘Market Value’ are used interchangeably,
treating DRC as ‘Market Value’.
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The above illustration makes it absolutely clear that DRC and Market Value
not to be used interchangeably.
The above statement indicate that the technical depreciation computed from
market derived data is quite different than accounting depreciation. Because
technical depreciation takes into consideration demand, supply condition which
decides value.
4.3.5 OBSOLESCENCE
Meaning of ‘Obsolescence’
A factor included in depreciation to cover decline in value of assets due to
invention of new and better processes or machines, changes in demand, in design
or in the art, and other technical or legal changes, but not to cover physical
depreciation.
There are three types of obsolescence
 Technological (Many times considered as same as functional or incorporated
with functional).
 Functional
 Economic
Technological obsolescence
Technological obsolescence is due to change in design and materials of
construction of the plant and machine ry under consideration. Latest sophisticated
equipment with reduced occupancy, improved efficiency or optimum energy
consumption are common in plant and machinery. Technological obsolescence may
arise out of development of new technology which bring in changes in rate of
production or reduction of operating cost. The need for adequate familiarity of the
valuer with such a situation is more emergent in present high tech environment
than before. Enough exposure to and background experience of technology is
essential for a valuer. In case he is not fully competent, he shall refer appropriate
matters to experts.
Functional obsolescence
Functional obsolescence arises when a machine already in function loses its
optimum capacity owing to a decline in co-operation from its operating
counterparts. It may arise due to variety of internal reasons. The company may
have been compelled to commission a machine of high-rated capacity simply
because a low-rated one is not available and the operating counterparts, whether it
is labour or capital, are not geared to give the highly rated machine the opportunity
for optimum output. Functional obsolescence may also arise due to faulty design or
wrong location of industrial undertaking. It is a comparison to its more current
replacement. Functional obsolescence is also known as decrease in value due to
nonavailability of spares or accessories, or any other allied factors. Operating
obsolescence is known as the present worth of the future excess operating cost of a
machine. The valuer is expected to appropriately account these factors with
relevant data to arrive at a credible presentation.
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Economic obsolescence
This is due to factors external to the plant and machinery itself. This could be
due to change in demand of the product manufactured or shrinkage in supply of
raw materials and labour, legislation affecting taxes or duties, environmental or
zoning controls etc.
Economic obsolescence is not to be confused with sickness in industry. In
India, sickness of industries has been the subject matter of a legislation entitled,
“The Sick Industrial Companies (Special Regulation) Act, 1985 wherein the
expressions “sick industrial undertaking” has been defined as follows:
“Sick Industrial Company” – means an industrial undertaking (being a
company registered for not less than five years) which has at the end of any
financial year accumulated losses equal to or exceeding its entire net worth.
Explanation:
For the removal of doubts, it is hereby declared that an industrial company
existing immediately before the commencement of the Sick Industrial Companies
(Special Provisions) (Amendment) Act, 1993, registered for not less than five years
and having, at the end of any financial year, accumulated losses equal to or
exceeding its entire net worth, shall be deemed to be a Sick Industrial Company. It
would appear that sickness is based on the concept of erosion of net worth and
negative return on investment over a specified period of time. This may be due to
obsolescence of any description or a man agement failure. Thus sickness by itself
does not lead us anywhere in the computation of obsolescence which has to be
assessed from a different angle of vision.
Business specific economic viability should not be confused with economic
obsolescence.
Economic viability is often a management question. An undertaking which is
not viable economically can be converted into a viable one through sales promotion,
advertisement and the like and in such cases, economic obsolescence may not be
present. But on the other hand, if there is a definite change in trend or fashion
affecting demand of a product the situation may not be reversible by managerial
efforts or adopting a better technique of management. This is how economic
obsolescence is distinguished from the aspects of economic viability.
Economic obsolescence can be properly measured for a business with a
“Business Enterprise Equation” as stated below:
Assets = Liabilities + Stockholders Equity
or
Where,
CA = Current assets
FA = Fixed assets
IA = Identified and unidentified intangible assets
CL = Current liabilities
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LTD = Long-term debt
SE = Stockholders’ equity
NWC = Net working capital
BE = Business enterprise
Subtracting CL from both sides of the above equation, we have:
(CA - CL) + FA + IA = LTD + SE
Because CA - CL is net working capital (NWC) and LTD + SE is defined as the value
of the business enterprise (BE), then:
BE = SE + LTD = NWC + FA + IA
If we rearrange terms, the equation becomes :
BE - NWC = FA + IA
Business Enterprise Value less Net Working Capital represents the economic
support for fixed and intangible assets. Economic obsolescence exists, if the
economic support for fixed and intangible assets is less than that of fractional
values of the underlying identified assets, as individually estimated by the
depreciated replacement cost and sales comparison methods.
Economic obsolescence is thus algebraically expressed as BE - NW C < (FA + IA)
Whenever economic obsolescence is established to exist, it is necessary to
reduce the individual asset values to the level of indicated economic support as
contributing to the operation. This adjustment is called an economic penalty. If
there is excess economic support for the underlying identified assets, it is
concluded that unidentified intangible value exists, which is generally considered to
be goodwill or going concern value.
The terminology used as technological, functional, economic is not important
but it is important to consider obsolescence in totality whatever may be the
nomenclature used. However, they can be calculated individually or in total
(accrued) depending upon the valuation method and required support.
4.3.6 Depreciation – under Income Tax and Company Laws
Accounting concept of depreciation
Besides the revenue expenditure which are incurred for the purpose of earning
any business income, the assessee has also to incur capital expenditure for
acquisition of fixed assets for the said purpose. In order to determine the real
profits of the business for an accounting year, a portion of such expenditure is to
be allocated over the life of the assets. Such allocation is required on account of the
diminution in the value of the assets due to wear and tear because of its use and
efflux of time. Portion of that cost of a fixed asset which is allocated to a particular
accounting year is called depreciation. According to American Institute of Certified
Public Accountants (AICPA) : “Depreciation Accounting is a system of accounting
which aims to distribute the cost or other basic value of tangible capital assets, less
salvage value (if any) over the estimated useful life of the unit (which may be a
group of assets) in a systematic and rational manner. It is a process of allocation,
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not of valuation, depreciation for the year is portion of the total charge under such
a system that is allocated to the year.”
The Institute of Chartered Accountants of India (ICAI) in AS-6 defines
depreciation as “a measure of the wearing out, consumption or other loss of value
of depreciable asset arising from use, efflux of time or obsolescence through
technology and market changes. Depreciation is allocated so as to charge fair
proportion of the Depreciation (Depreciable) amount in each accounting period
during the expected useful life of the asset.”
Under Cost Accountancy
In the cost accounts, depreciation charge is taken as the cost of utilizing the
fixed assets for the purpose of production. Thus, in cost accountancy it is
considered as production cost. If no depreciation is charged, the cost of production
will be understated, profit will be high and there will be lack of funds for replacing
the asset when required.
Following points should be kept in mind for treatment of depreciation in cost
accounts:
1. The life of an asset should be reviewed periodically and depreciation should
be charged in cost accounts.
2. Depreciation should be calculated considering extra shift allowance.
3. Depreciation should give regard to: (i) efficiency (ii) production.
Under Company Law
Under income-tax Act, to arrive at true profit or correct income it is necessary
that depreciation has to be provided in books of accounts. Similarly under the
Companies Act, depreciation has to be provided. Under Companies Act the
depreciation is provided so as to declare dividend. It states that the amount of
depreciation is to be calculated with reference to the written -down value of the
assets as shown by the books of the company at the end of the financial year or
subsequent year at the rate specified in Schedule of Companies Act. Thus there is
no strict provision as regards method which is to be followed, an individual may
follow either straight line method or written down value method.
Under Income Tax Law
Under the Income-tax Act, it is recognized principle that the true profits of a
business cannot be determined without deducting from the gross profits certain
sums representing the value of the physical depreciation of the asset.
Purpose of providing Depreciation
a) Under Income Tax Law, to find out assessable profits and to derive assessable
profit it is necessary that the depreciation has to be provided.
b) Under Accountancy, the assets get depreciated in their value over a period of
time due to various factors. In order to present a true state of affairs of the
business, the assets must be shown in the balance sheet at their correct value.
Further assets used in the business require replacement after the expiry of their
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life. By providing depreciation, profits of the business are kept in the business,
which can be used in future for purchase of new assets when the old assets
become useless.
Causes of Depreciation
(a) In case of mineral mines, oil well, etc.
An asset may be exhausting through working. This generally happens with
mineral mines, oil wells, etc. On account of continuous extraction of minerals or oil,
generally a stage comes where the mine or oil well is completely exhausted and
nothing is to be found being left.
(b) In case of plant and machinery, furniture, etc.
These assets are generally used in a business organization and get worn or
torn out due to constant use.
(c) Patents or copyrights
Some assets get decreased in their value with the passage of time. This is true
in case of assets like lease-hold properties, patents etc.
(d) In case of inventions
Assets may be discarded before they are worn out because of changed
conditions. For example, an old plant which is workable can be replaced by a new
machine because of the latter being more efficient. Such type of loss on account of
abrupt new inventions and changing fashions is termed as loss on account of
obsolescence.
4.4 REVISION POINTS
Depreciation and Deterioration
physical, functional and economic obsolescence
1. Explain difference between Depreciation and Deterioration
2. What is difference between physical, functional and economic obsolescence?
3. What are the methods of depreciation followed and which is/are relevant of
valuation of plant and machinery?
4.6 SUMMARY
The principles, definitions, causes and quantifying depreciation and
obsolescence for plant and machinery valuation have been discussed.
1. How will you measure technological obsolescence?
2. How will you measure functional obsolescence?
3. How will you measure economic obsolescence?
1. https://www.scribd.com/.../Valuers-Perception-of-Depreciation-and-
Obsolescence-in-P...
2. eprints.utm.my/12202/1/KholimSahrayMFKSG2009.pdf
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4.9 ASSIGNMENTS
You are advised to thoroughly study following illustrative case study and
asked to develop similar case study of any plant and machinery or industry you
have specialization or reasonable knowledge.
4. International Valuation Guidance Note - 3
5. International Accounting Standard – 16
Illustrative Case Study
Measuring Curable and Incurable Physical Deterioration
The task is to value a crude oil tank that is part of a tank farm in an oil
refinery, under a market value in continued use concept using the cost approach.
The storage capacity requirements of a modern refinery are the same as those of the
subject with the only difference being that a modern refinery would use fewer, but
larger, individual tanks to meet those storage requirements. A replacement cost
new is developed based on the configuration of the storage requirements of the
modern refinery. The valuer has concluded that the replacement cost new is
approximately 10% less than the reproduction cost new for the equivalent storage
capacity. For this example, then, the replacement cost new for the individual tanks
is simply the reproduction cost new minus 10% .
The valuer has also learned that one crude oil tank has a small leak in its
bottom because of corrosion from the saltwater that is naturally present in this type
of crude oil and this tank has been pumped out and is being prepared for
maintenance. Preliminary indications are that the entire bottom as well as the first
course of the side walls will need to be either patched or replaced, depending on the
wall thickness. The planned expenditure for this repair work is approximately Rs.
3,50,00,000, which includes the costs associated with removing the tank from
service, cleaning, preparing a safe work environment to make the repairs, and
removal and replacement of the corroded areas.
The reproduction cost new for this tank is Rs. 20,00,00,000 and since
replacement cost new is 10% less than reproduction cost new, its replacement cost
new is Rs. 18,00,00,000. The next step is to determine the physical deterioration.
In this case, we have a physical problem that is curable: replacement or patching of
the tank bottom and portions of the side walls. The total physical deterioration of
the tank should be deducted from reproduction cost new, since this is the specific
property that is being valued. The result, expressed as a percentage of reproduction
cost new, should be applied to replacement cost new. In this way, we are measuring
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the actual physical deterioration and deducting it proportionally from replacement
cost.
The first step is to deduct the cost to cure the physical problem:
 Reproduction Cost New = Rs. 20,00,00,000
 Less Curable Physical Deterioration = Rs. 3,50,00,000
 Reproduction Cost New of Incurable Portion of Tank = Rs. 16,50,00,000
The Rs. 16,50,00,000 remaining is the cost of the portion of the tank su bject
to incurable deterioration. The incurable deterioration may be estimated using the
observation or formula/ratio techniques.
Assume that the tank is 10 years old and that the valuer estimates at least
another 15 years of remaining physical life (remember that these areas of the tank
would not be affected by the saltwater). The total incurable physical deterioration is
40% or Rs.6,60,00,000, calculated as [ 10 years Effective Age / (10 years effective
age + 15 years remaining useful life)] x 100 == 40% .
Finally Composite Physical Deterioration of 51% is worked out as [(Curable +
Incurable Deterioration)/ Reproduction Cost New] x 100.
Several methods of estimating physical deterioration have been discussed,
namely observation, age/life, use/total use, and direct dollar. All are valid given
certain facts, sufficient information, and an appropriate amount of time in which to
analyze the data. In theory, all the methods should be considered, but this is not
always practical. The facts and circumstances will dictate the appropriate method
or methods to be used in the valuation assignment.
4.12 KEYWORDS
Depreciation, Obsolescence
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LESSON-5
AGE, LIFE AND REMAINING LIFE OF PLANT AND MACHINERY IN VALUATION

5.1 INTRODUCTION
Age and life are two vital factors in arriving at sound valuation , because
valuation whether performed on income approach or cost approach or market
approach, invariably involves a life analysis.
In an income approach, the projection period for economic income leads to the
yield capitalization. In cost approach again the estimated measure of cost must be
performed after taking into consideration the remaining useful life. In market
approach too, the consideration of remaining useful life enters into the bargain for
transactions as because a property which has been used is not general ly worth as
much as an identical property if new.
The importance of estimating service life in valuation of property arises also
due to the fact that properties are often withdrawn from useful service due to
retirement. Property may be retired by removal physically owing to accident,
catastrophe or otherwise. But the effect is the same. The remaining useful service
life of the property ends with its retirement. Hence the aspect of age, life and
remaining life are pertinent issues in the field of valuation.
By the end of this chapter student will learn about following and its relevance
in valuation parlance,
 Age
 Life
 Factors influencing estimation of life
 Retirement and remaining life
 Factors affecting retirement
5.2 OBJECTIVES
The main objective of this lesson is to prepare the students thoroughly on the
principles and factors to be considered for estimating age, life and remaining life of
plant and machinery for valuation.
5.3 CONTENTS
5.3.1 Age, Effective Age
5.3.2 Life
5.3.3 Retirement and remaining life
5.3.1 Age, Effective Age
Age
The value of plant and machinery generally declines with age, that is to say,
older the plant and machinery the less the value, provided such decline in value is
not offset by other factors. The method of reckoning of age is explained by the
following illustrations:
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Example - I
A new machine purchased in one accounting year installed in the same year,
say, 1971:
Example - II
A new machine purchased in one accounting year, say, 1971, but installed in
1972:
Example - III
A new machine purchased and installed in 1971 but expenses incurred in 1973
and 1975 for additions, updating etc. Again, major modifications, overhaul etc. were
carried out in 1978 by replacing certain original parts in the following manner:
Expenses
Year
Incurred (Rs.)
1971 40,000
1973 5,000
1975 8,000
1978 15,000
Date as on which valuation is made is 31-12-1981 in each example.
The age for calculating depreciation will be 11 (Eleven) in Example -I, 10 (Ten)
in Example-II and in case of Example-III, the effective age will be 9 (Nine) years.
Computation of effective age
Apply cost index of respective year to arrive at trended cost as under: 1960 = 1.0
Year Purchase Price Cost Index Trended Cost
1971 40,000 2.50 1,00,000
1973 5,000 2.10 10,500
1975 8,000 1.75 14,000
1978 15,000 1.50 22,500
68,000 1,47,000
Rs. 68,000/- and Rs.1,47,000/- are misleading as they include some
redundant investment due to overhaul in 1978. For example, if a motor costing
Rs.15,000/- is replaced in 1978, the cost is included in 1971 as well as 1978
indicating duplication. It is therefore necessary to rectify duplication as under:
1.5
15,000   Rs. 9,000
2.5
The figures after removing duplication will be as under:
Year Price Purchase Price Cost Index Trended Purchase

1971 31,000 x 2.50 77,500
1973 5,000 x 2.10 10,500
1975 8,000 x 1.75 14,000
1978 15,000 x 1.50 22,500
59,000 1,24,500
The next step is to age the investment as under:
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Trended Age of Investment W eighted
Year
Purchase Price Years Investment
1971 77,500 11 8,52,500
1973 10,500 9 94,500
1975 14,000 7 98,000
1978 22,500 4 90,000
1,24,500 11,35,000
The effective age of asset being valued will be –
11,35,000
 9.11years say,9 years
1,24,500
Note: It is very seldom that this information is available for proper
interpretation. the most common method is to estimate a percentage by observation
or with the aid of company personnel.
Example - IV
A machine installed is a second-hand purchase. In order to decide the age pf
second-hand machine the valuer shall take into consideration following parameters:
 Year of manufacture;
 Total number of years in service since the year of manufacture;
 Details of renovations, modifications carried out.
 Estimated economic balance life.
5.3.2 Life
Life can be classified into following categories :
 Total economic working life;
 Total physical working life;
 Useful life;
 Economic balance life or remaining useful life.
Total economic working life means -
“It is the Life from new to the time up to which it will become uneconomical to
run”. Economic life is different from physical life. It is quite possible that machine is
in operation even after the economic life is over, by repairing and replacing parts
which in turn will increase maintenance cost. Technical and functional
obsolescence will make the machine uneconomical to run. Economic life can be
established by inquiries with plant personnel of the company and going through the
records of machines scrapped by the company in the past; moreover, personal
experience of valuer while valuing similar assets will play an important role in
establishing total economic life.
While establishing economic life, the usage of machine for working in one, two
or three shifts, environmental conditions, maintenance facilities, inspection of
maintenance audit records are to be property weighed.
Total physical working life means -
It is Life from new to the time up to which it can be run. This life is more than
economic working life.
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Useful life means -
The estimated period over which a depreciable asset is expected to be
economically used, or the benefits represented by the assets are expected to be
economically derived in the business of entity, or alternatively, The estimated total
service expressed in terms of production or similar units that is expected to be
economically obtained from the asset whilst employed in the business of the entity.
Economic balance life or remaining useful life means -
It is Unexpired portion of total economic working life or useful life. It is very
difficult to ascertain accurately economic balance life and reasons for the same can
be inferred from the example cited below:
Let us consider the case of a company which installed three identical pieces of
equipment on the same day and usage is also the same but operators are different.
Each operator used different maintenance schedules. One was good, the other
was medium, and the third one was bad. Conditions of the three machines were
accordingly different when valued. The estimated economic balance life in each case
will be different as would be the physical life.
In order to be a good valuer, maintaining a proper data bank is a must. Values
are professionals having talent in collecting data. They have inbuilt expertise of
functioning as observers and excellent investigators. A Professional valuer may not
have precise knowledge of the process or machine. However, possession of an
excellent data bank can convert a novice into an expert.
How to gather data? From the stage of starting a career as a trainee, a valuer
must form a habit of collecting data and discussing with people known to him as
connected with a wide spectrum of industries. Learn from their experiences.
There is a vast difference in what is given in the books and that actually
experienced in the practical field. There are many questions requiring appropriate
solution. One of the important points to be borne in mind by the practitioners is that
clients appoint them for practical solutions and not for carrying out an academic
exercise. Generally an assignment is to be completed in a limited time and there may
be insufficient data to make an analysis academically. Many a time, data is not
simply available. It is the experience of many valuers that when a question is posed
to the clients as to when the report is expected, they simply say, immediately.
Factors influencing estimation of life
a) Condition
b) Standard of maintenance
c) Usage
d) Finite resources
e) Market trend
(a) Condition
Careful inspection will give an idea about general condition of the equipment.
Unusual sound, eccentric shaft movement, rusting of steel work, stress cracks or
corrosion are important factors for deciding condition. Interpretation of the signs of
wear and tear depend exclusively on the valuer’s experience, however, discussions
with plant maintenance personnel is always useful.
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(b) Standard of maintenance
This is to a certain extent linked with condition. The experienced valuer can
form an early opinion while doing the survey. The best indicator of this can come
from the maintenance department itself. How organized is it? Is it well equipped?
Clean, efficient and well organized? If answers to all of the above questions is yes,
then one can presume that the process/production plant has been properly
maintained.
(c) Usage
This will depend on the duration it works. Machinery can be classified as given
below on their workload as per shift working to which equipment is subjected :
 One shift
 Two shifts
 Three shifts
 Combination of one, two or three shifts as per requirements
 One shift - eight hours’ duration
 Number of days it works in a year
In order to arrive at proper estimate of economic or physical balance life, the
valuer has to take into account likely future workload.
Note: Valuer should adopt economic balance life and not the physical balance
life for valuation purposes.
(d) Finite resources
Let us consider the case of an equipment that is one year old. It is established
that such machines have a total economic life of 20 years which gives an economic
balance life of 19 years. But raw material processed by the machine will only be
available for the years. it has no alternative use. Under such circumstances, would
the estimated economic balance life be 19 or 5 years? Obviously, 5 years. Therefore,
finite resources have a direct bearing on value.
(e) Market trend
Tastes and preferences of the people decide market trend which generally
fluctuate on demand and supply of equipment used and this need to be properly
weighed.
5.3.3 Retirement and remaining life
Property in service gives up some of its potential usefulness. This is measured
in terms of depreciation and a function of age. Retirement from service or active life
on attainment of an advanced age is integral to existence of human beings. But
such retirement can he hastened by unforeseen contingencies like illness,
handicaps etc. death causes a total disappearance from service life. A machine
similarly retires on being written out of investment account owing to contingencies
like accident, catastrophe, termination of need or forced abandonment otherwise.
Even after such retirement the property may be reinstalled in another service.
Generally speaking, the property is not considered to have been finally retired u ntil
the accounting department credits the retirement in the property asset account.
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The situations in which retirement of property takes places may be categorised
as follows:
(a) Physical condition
 Accident, explosion, fire, collapse etc.
 Catastrophe, collision, fall etc.
 Deterioration due to sudden causes like breakdown, mishandling etc.
 Wear and tear from use.
(b) Functional situations
 Inadequacy due to misjudgment
 Obsolescences - economic, functional or technological
(c) Situation unrelated to the property
 Termination of the need
 Abandonment of the enterprise
 Acquisition by the public authority
When damage is partial, the cost of repairs or reconstruction is weighted against
the cost of replacement to determine if the property should be retired totally or not.
Retirements are important to all industry because the act of retirement signifies the
end of service usefulness of a machine or property as determined by the
management. However, these are all important issues in valuation because the date
of ending the service life is that date which controls depreciation or replacement
accounting; and it also denotes the minimum value of the property to the owner.
Typical examples of how retirement of property takes place under different
situations may bring home its significance for valuation purposes. Sudden damage
from disasters, such as fire, storms, floods or earthquakes render property
completely unfit for any further use. This requires immediate writing off of the losses.
If the enterprise decides to continue its activities a replacement becomes obviously
due. But it may quite happen that the remaining state of the property permits its
reuse in some form or other after good repair. This is noteworthy by a valuer.
Again, the salinity of a particular climate zone may cause a speedy decay of
property due to rusting or salination. The physical deterioration due to exposure is
more destructive in such case than with normal use and a retirement is hastened.
but the situation can be mitigated by protective arrangements, if feasible. Wear and
tear may be accentuated from friction, impact, vibration, stress or fatigue of
materials disproportionate to normal use owing to various factors like faulty
installations, overuse and the like.
Mismanagement in inventory control may cause a lot of mischief to the
residual life of machinery. It is quite possible that some vital capital assets are
required to be imported and other ancillaries domestically procured. If at the time
scheduled for the commencement of production the convergence of all components
does not synchronies, one or the other machine may suffer from congenital
malfunction. All these are relevant in the matter of retirement of property and are
also issues in valuation.
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5.4 REVISION POINTS
 Age and Life
 Life of plant and machinery
1. Explain difference Age and Life.
2. What are your concepts of accounting life and estimating life for valuation of
plant and machinery?
3. Discuss: “The useful life is also based on judgment”
5.6 SUMMARY
The principles and factors to be considered for estimating age, life and
remaining life of plant and machinery for valuation have been discussed.
1. Explain Remaining Life of plant and machinery.
2. Discuss: “The useful life is also based on judgment”
1. pmvaluations.com.au/asset-valuers/property-plant-and-machinery-
definitions/
2. www.investopedia.com/terms/u/usefullife.asp
5.9 ASSIGNMENTS
 Write an essay with illustrations on: “The purpose of depreciation is to
distribute the Depreciated current Replacement Cost of tangible capital assets
over their remaining useful lives in a systematic and rational manner for the
purpose of valuation of plant and machinery”.
 Justify with illustration: “A machine may become obsolete because of
technological innovation; it may someday be more efficient to replace the
machine even though it is far from worn out. If the probability is high that such
obsolescence will occur in the near future, the shortened economic life should
be considered for valuation.”
 Valuation of plant and machinery: Theory and practice by Kirit Budhbhatti
 Valuation of Plant and Machinery Theory and Practice by Dr. P. C. Gupat
 Special Cases of Plant and Machinery Valuation and Thoughts on Professional
 International Valuation Guidance Note – 3
 International Accounting Standard – 16
“A machine may become obsolete because of technological innovation; it may
someday be more efficient to replace the machine even though it is far from worn
out. If the probability is high that such obsolescence will occur in the near future,
the shortened economic life should be considered for valuation.”
5.12 KEYWORDS
Age, Life, Remaining Life
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LESSON-6
VALUATION FOR BANKS

6.1 INTRODUCTION
Sourcing money may be done for a variety of reasons. Traditional areas of need
may be for capital asset acquirement - new machinery or the construction of a new
building or depot. The development of new products can be enormously costly and
here again capital may be required. Normally, such developments are financed
internally, whereas capital for the acquisition of machinery may come from external
sources. In this day and age of tight liquidity, many organizations have to look for
short term capital in the way of overdraft or loans in order to provide a cash flow
cushion. Interest rates can vary from organization to organization and also
according to purpose.
This chapter intended to provide:
 An introduction to the different sources of finance available to
management, both internal and external
 An overview of the advantages and disadvantages of the different sources of
funds
 An understanding of the factors governing the choice between different
sources of funds.
This chapter starts by looking at the various forms of "shares" as a means to
raise new capital and retained earnings as another source. However, whilst these
may be "traditional" ways of raising funds, they are by no means the only ones.
There are many more sources available to companies who do not wish to become
"public" by means of share issues. These alternatives include bank borrowing,
government assistance, venture capital and franchising. All have their own
advantages and disadvantages and degrees of risk attached.
6.2 OBJECTIVES
The main objective of this lesson is to equip the students with knowledge of
various kinds of funding or financing of plant and machinery by banks, investors,
etc. which the valuer must know while valuing plant and machinery.
6.3 CONTENTS
6.3.1 Sources of funds
6.3.2 Ordinary (equity) shares
6.3.3 Deferred ordinary shares
6.3.4 New shares issues
6.3.5 Rights issues
6.3.6 Preference shares
6.3.7 Loan stock
6.3.8 Debentures with a floating rate of interest
6.3.9 Security
6.3.10 The redemption of loan stock
6.3.11 Retained earnings
6.3.12 Bank lending
6.3.13 Leasing
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6.3.13.1 Operating leases
6.3.13.2 Finance leases
6.3.13.3 Why might leasing be popular
6.3.14 Hire purchase
6.3.15 Government assistance
6.3.16 Venture capital
6.3.17 Franchising
6.3.18 Role of Banks in Secured Landing
6.3.18.1 Secured v/s Unsecured Loans
6.3.18.2 Role of Banks
6.3.19 Asset Conversion Lending
6.3.20 Credit Analysis Features
6.3.21 Cash Flow Lending
6.3.23 Valuation for Secured Lending
6.3.24 Examples of economic disasters led by poor valuation
6.3.25 Valuation for Secured Lending and Role of Valuers
6.3.1 Sources of funds
A company might raise new funds from the following sources:
1. The capital markets:
 new share issues, for example, by companies acquiring a stock market
listing for the first time
 rights issues
2. Loan stock
3. Retained earnings
4. Bank borrowing
5. Government sources
6. Business expansion scheme funds
7. Venture capital
8. Franchising.
6.3.2 Ordinary (equity) shares
Ordinary shares are issued to the owners of a company. They have a nominal
or 'face' value, typically of Rs. 10 or 100. The market value of a quoted company's
shares bears no relationship to their nominal value, except that when ordinary
shares are issued for cash, the issue price must be equal to or be more than the
nominal value of the shares.
6.3.3 Deferred ordinary shares
The deferred ordinary shares are a form of ordinary shares, which are entitled
to a dividend only after a certain date or if profits rise above a certain amount.
Voting rights might also differ from those attached to other ordinary shares.
Ordinary shareholders put funds into their company either by paying for a new
issue of shares or through retained profits. Simply retaining profits instead of
paying them out in the form of dividends offers an important simple low -cost
source of finance although this method may not provide enough funds, for
example, if the firm is seeking to grow.
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A new issue of shares might be made in a variety of different circumstances:
A. The company might want to raise more cash. If it issues ordinary shares
for cash, should the shares be issued pro rata to existing shareholders, so
that control or ownership of the company is not affected? If, for example,
a company with 200,000 ordinary shares in issue decides to issue 50,000
new shares to raise cash, should it offer the new shares to existing
shareholders, or should it sell them to new shareholders instead?
i. If a company sells the new shares to existing shareholders in
proportion to their existing shareholding in the company, we have
arights issue. In the example above, the 50,000 shares would be
issued as a one-in-four rights issue, by offering shareholders one new
share for every four shares they currently hold.
ii. If the number of new shares being issued is small compared to the
number of shares already in issue, it might be decided instead to sell
them to new shareholders, since ownership of the company would
only be minimally affected.
B. The company might want to issue shares partly to raise cash, but more
importantly to float' its shares on a stick exchange.
C. The company might issue new shares to the shareholders of another
company, in order to take it over.
6.3.4 New shares issue
A company seeking to obtain additional equity funds may be:
a) an unquoted company wishing to obtain a Stock Exchange quotation
b) an unquoted company wishing to issue new shares, but without obtaining
a Stock Exchange quotation
c) a company which is already listed on the Stock Exchange wishing to issue
additional new shares.
The methods by which an unquoted company can obtain a quotation on the
stock market are
1. An offer for sale
2. A prospectus issue
3. A placing
4. An introduction.
An offer for sale is a means of selling the shares of a company to the public.
An unquoted company may issue shares, and then sell them on the Stock
Exchange, to raise cash for the company. All the shares in the company, not just
the new ones, would then become marketable.
Shareholders in an unquoted company may sell some of their existing shares
to the general public. When this occurs, the company is not raising any new funds,
but just providing a wider market for its existing shares (all of which would become
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marketable), and giving existing shareholders the chance to cash in some or all of
their investment in their company.
When companies 'go public' for the first time, a 'large' issue will probably take
the form of an offer for sale. A smaller issue is more likely to be a placing, since the
amount to be raised can be obtained more cheaply if the issuing house or other
sponsoring firm approaches selected institutional investors privately.
6.3.5 Rights issue
A rights issue provides a way of raising new share capital by means of an offer
to existing shareholders, inviting them to subscribe cash for new shares in
proportion to their existing holdings.
For example, a rights issue on a one-for-four basis at Rs. 280 per share would
mean that a company is inviting its existing shareholders to subscribe for one new
share for every four shares they hold, at a price of Rs. 280 per new share.
A company making a rights issue must set a price which is low enoug h to
secure the acceptance of shareholders, who are being asked to provide extra funds,
but not too low, so as to avoid excessive dilution of the earnings per share.
6.3.6 Preference shares
Preference shares have a fixed percentage dividend before any dividend is paid
to the ordinary shareholders. As with ordinary shares a preference dividend can
only be paid if sufficient distributable profits are available, although with
'cumulative' preference shares the right to an unpaid dividend is carried forward to
later years. The arrears of dividend on cumulative preference shares must be paid
before any dividend is paid to the ordinary shareholders.
From the company's point of view, preference shares are advantageous in that:
1. Dividends do not have to be paid in a year in which profits are poor, while this
is not the case with interest payments on long term debt (loans or debentures).
2. Since they do not carry voting rights, preference shares avoid diluting the
control of existing shareholders while an issue of equity shares would not.
3. Unless they are redeemable, issuing preference shares will lower the company's
gearing. Redeemable preference shares are normally treated as debt when
gearing is calculated.
4. The issue of preference shares does not restrict the company's borrowing power,
at least in the sense that preference share capital is not secured against assets
in the business.
5. The non-payment of dividend does not give the preference shareholders the
right to appoint a receiver, a right which is normally given to debenture holders.
However, dividend payments on preference shares are not tax deductible in the
way that interest payments on debt are. Furthermore, for preference shares to be
attractive to investors, the level of payment needs to be higher than for interest on
debt to compensate for the additional risks.
For the investor, preference shares are less attractive than loan stock because:
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 they cannot be secured on the company's assets
 the dividend yield traditionally offered on preference dividends has been
much too low to provide an attractive investment compared with the interest
yields on loan stock in view of the additional risk involved.
6.3.7 Loan stock
Loan stock is long-term debt capital raised by a company for which interest is
paid, usually half yearly and at a fixed rate. Holders of loan stock are therefore
long-term creditors of the company.
Loan stock has a nominal value, which is the debt owed by the company, and
interest is paid at a stated "coupon yield" on this amount. For example, if a
company issues 10% loan stock the coupon yield will be 10% of the nominal value
of the stock, so that Rs. 100 of stock will receive Rs. 10 interest each year. The rate
quoted is the gross rate, before tax.
Debentures are a form of loan stock, legally defined as the written
acknowledgement of a debt incurred by a company, normally containing provisions
about the payment of interest and the eventual repayment of capital.
6.3.8 Debentures with a floating rate of interest
These are debentures for which the coupon rate of interest can be changed by
the issuer, in accordance with changes in market rates of interest. They may be
attractive to both lenders and borrowers when interest rates are volatile.
6.3.9 Security
Loan stock and debentures will often be secured. Security may take the form of
either a fixed charge or a floating charge.
1. Fixed charge; Security would be related to a specific asset or group of assets,
typically land and buildings. The company would be unable to dispose of the
asset without providing a substitute asset for security, or without the lender's
consent.
2. Floating charge; With a floating charge on certain assets of the company (for
example, stocks and debtors), the lender's security in the event of a default
payment is whatever assets of the appropriate class the company then owns
(provided that another lender does not have a pri or charge on the assets). The
company would be able, however, to dispose of its assets as it chose until a
default took place. In the event of a default, the lender would probably appoint a
receiver to run the company rather than lay claim to a particular asset.
6.3.10 The redemption of loan stock
Loan stock and debentures are usually redeemable. They are issued for a term
of ten years or more, and perhaps 25 to 30 years. At the end of this period, they will
"mature" and become redeemable (at par or possibl y at a value above par).
Most redeemable stocks have an earliest and latest redemption date. For
example, 18% Debenture Stock 2007/09 is redeemable, at any time between the
earliest specified date (in 2007) and the latest date (in 2009). The issuing company
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can choose the date. The decision by a company when to redeem a debt will depend
on:
1. how much cash is available to the company to repay the debt
2. the nominal rate of interest on the debt. If the debentures pay 18% nominal
interest and the current rate of interest is lower, say 10% , the company may try
to raise a new loan at 10% to redeem the debt which costs 18% . On the other
hand, if current interest rates are 20% , the company is unlikely to redeem the
debt until the latest date possible, because the debentures would be a cheap
source of funds.
There is no guarantee that a company will be able to raise a new loan to pay
off a maturing debt, and one item to look for in a company's balance sheet is the
redemption date of current loans, to establish how much new finance is likely to be
needed by the company, and when.
Mortgages are a specific type of secured loan. Companies place the title deeds
of freehold or long leasehold property as security with an insurance company or
mortgage broker and receive cash on loan, usually repayable over a specified
period. Most organizations owning property which is unencumbered by any charge
should be able to obtain a mortgage up to two thirds of the value of the property.
As far as companies are concerned, debt capital is a potentially attractive
source of finance because interest charges reduce the profits chargeable to
corporation tax.
6.3.11 Retained earnings
For any company, the amount of earnings retained within the business has a
direct impact on the amount of dividends. Profit re -invested as retained earnings is
profit that could have been paid as a dividend. The major reasons for using retained
earnings to finance new investments, rather than to pay higher dividends and then
raise new equity for the new investments, are as follows:
a) The management of many companies believes that retained earnings are funds
which do not cost anything, although this is not true. However, it is true that the
use of retained earnings as a source of funds does not lead to a payment of cash.
b) The dividend policy of the company is in practice determined by the directors.
From their standpoint, retained earnings are an attractive source of finance
because investment projects can be undertaken without involving either the
shareholders or any outsiders.
c) The use of retained earnings as opposed to new shares or debentures avoids
issue costs.
d) The use of retained earnings avoids the possibility of a change in control
resulting from an issue of new shares.
Another factor that may be of importance is the financial and taxation position
of the company's shareholders. If, for example, because of taxation considerations,
they would rather make a capital profit (which will only be taxed when shares are
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sold) than receive current income, then finance through retained earnings would be
preferred to other methods.
A company must restrict its self-financing through retained profits because
shareholders should be paid a reasonable dividend, in line with realistic
expectations, even if the directors would rather keep the funds for re -investing. At
the same time, a company that is looking for extra funds will not be expected by
investors (such as banks) to pay generous dividends, nor over-generous salaries to
owner-directors.
6.3.12 Bank lending
Borrowings from banks are an important source of finance to companies. Bank
lending is still mainly short term, although medium-term lending is quite common
these days.
Short term lending may be in the form of:
1. an overdraft, which a company should keep within a limit set by the bank.
Interest is charged (at a variable rate) on the amount by which the
company is overdrawn from day to day;
2. a short-term loan, for up to three years.
Medium-term loans are loans for a period of from three to ten years. The rate
of interest charged on medium-term bank lending to large companies will be a set
margin, with the size of the margin depending on the credit standing and riskiness
of the borrower. A loan may have a fixed rate of interest or a variable interest rate,
so that the rate of interest charged will be adjusted every three, six, nine or twelve
months in line with recent movements in the Base Lending Rate.
Lending to smaller companies will be at a margin above the bank's base rate
and at either a variable or fixed rate of interest. Lending on overdraft is always at a
variable rate. A loan at a variable rate of interest is sometimes referred to as
a floating rate loan. Longer-term bank loans will sometimes be available, usually for
the purchase of property, where the loan takes the form of a mortgage. When a
banker is asked by a business customer for a loan or overdraft facility, he will
consider several factors, known commonly by the mnemonic PARTS.
P The purpose of the loan A loan request will be refused if the purpose of the loan
is not acceptable to the bank.
A The amount of the loan. The customer must state exactly how much he wants to
borrow. The banker must verify, as far as he is able to do so, that the amount
required to make the proposed investment has been estimated correctly.
R How will the loan be repaid? Will the customer be able to obtain sufficient income
to make the necessary repayments?
T What would be the duration of the loan? Traditionally, banks have offered short-
term loans and overdrafts, although medium-term loans are now quite common.
S Does the loan require security? If so, is the proposed security adequate?
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6.3.13 Leasing
A lease is an agreement between two parties, the "lessor" and the "lessee". The
lessor owns a capital asset, but allows the lessee to use it. The lessee makes
payments under the terms of the lease to the lessor, for a specified period of time.
Leasing is, therefore, a form of rental. Leased assets have usually been plant
and machinery, cars and commercial vehicles, but might also be computers and
office equipment. There are two basic forms of lease: "operating leases" and "finance
leases".
6.3.13.1 Operating leases
Operating leases are rental agreements between the lessor and the lessee
whereby:
1) the lessor supplies the equipment to the lessee
2) the lessor is responsible for servicing and maintaining the leased equipment
3) the period of the lease is fairly short, less than the economic life of the asset, so
that at the end of the lease agreement, the lessor can either
i. lease the equipment to someone else, and obtain a good rent for it, or
ii. sell the equipment second hand.
6.3.13.2 Finance leases
Finance leases are lease agreements between the user of the leased asset (the
lessee) and a provider of finance (the lessor) for most, or all, of the asset's expected
useful life.
Suppose that a company decides to obtain a company car and finance the
acquisition by means of a finance lease. A car dealer will supply the car. A finance
house will agree to act as lessor in a finance leasing arrangement, and so will
purchase the car from the dealer and lease it to the company. The company will
take possession of the car from the car dealer, and make regular payments
(monthly, quarterly, six monthly or annually) to the finance house under the terms
of the lease.
Other important characteristics of a finance lease:
1. The lessee is responsible for the upkeep, servicing and maintenance of the
asset. The lessor is not involved in this at all.
2. The lease has a primary period, which covers all or most of the economic
life of the asset. At the end of the lease, the lessor would not be able to lease
the asset to someone else, as the asset would be worn out. The lessor must,
therefore, ensure that the lease payments during the primary period pay for
the full cost of the asset as well as providing the lessor with a suitable
return on his investment.
3. It is usual at the end of the primary lease period to allow the lessee to
continue to lease the asset for an indefinite secondary period, in return for
a very low nominal rent. Alternatively, the lessee might be allowed to sell
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the asset on the lessor's behalf (since the lessor is the owner) and to keep
most of the sale proceeds, paying only a small percentage (perhaps 10% ) to
the lessor.
6.3.13.3 Why might leasing be popular
The attractions of leases to the supplier of the equipment, the lessee and the
lessor are as follows:
1. The supplier of the equipment is paid in full at the beginning. The equipment is
sold to the lessor, and apart from obligations under guarantees or warranties,
the supplier has no further financial concern about the asset.
2. The lessor invests finance by purchasing assets from suppliers and makes a return
out of the lease payments from the lessee. Provided that a lessor can find lessees
willing to pay the amounts he wants to make his return, the lessor can make good
profits. He will also get capital allowances on his purchase of the equipment.
3. Leasing might be attractive to the lessee:
i. if the lessee does not have enough cash to pay for the asset, and would have
difficulty obtaining a bank loan to buy it, and so has to rent it in one way or
another if he is to have the use of it at all; or
ii. if finance leasing is cheaper than a bank loan. The cost of payments under a
loan might exceed the cost of a lease.
Operating leases have further advantages:
a) The leased equipment does not need to be shown in the lessee's published
balance sheet, and so the lessee's balance sheet shows no increase in its
gearing ratio.
b) The equipment is leased for a shorter period than its expected useful life. In
the case of high-technology equipment, if the equipment becomes out-of-
date before the end of its expected life, the lessee does not have to keep on
using it, and it is the lessor who must bear the risk of having to sell obsolete
equipment secondhand.
The lessee will be able to deduct the lease payments in computing his taxable
profits.
6.3.14 Hire purchase
Hire purchase is a form of installment credit. Hire purchase is similar to
leasing, with the exception that ownership of the goods passes to the hire purchase
customer on payment of the final credit installment, whe reas a lessee never
becomes the owner of the goods.
Hire purchase agreements usually involve a finance house.
i. The supplier sells the goods to the finance house.
ii. The supplier delivers the goods to the customer who will eventually
purchase them.
iii. The hire purchase arrangement exists between the finance house and the
customer.
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The finance house will always insist that the hirer should pay a deposit
towards the purchase price. The size of the deposit will depend on the finance
company's policy and its assessment of the hirer. This is in contrast to a finance
lease, where the lessee might not be required to make any large initial payment.
An industrial or commercial business can use hire purchase as a source of
finance. With industrial hire purchase, a business customer obtains hire purchase
finance from a finance house in order to purchase the fixed asset. Goods bought by
businesses on hire purchase include company vehicles, plant and machinery, office
equipment and farming machinery.
6.3.15 Government assistance
The government provides finance to companies in cash grants and other forms
of direct assistance, as part of its policy of helping to develop the national economy,
especially in high technology industries and in areas of high unemployment.
6.3.16 Venture capital
Venture capital is money put into an enterprise which may all be lost if the
enterprise fails. A businessman starting up a new business will invest venture
capital of his own, but he will probably need extra funding from a source other than
his own pocket. However, the term 'venture capital' is more specifically associated
with putting money, usually in return for an equity stake, into a new business, a
management buy-out or a major expansion scheme.
The institution that puts in the money recognises the gamble inherent in the
funding. There is a serious risk of losing the entire investment, and it might take a
long time before any profits and returns materialise. But there is also the prospect
of very high profits and a su bstantial return on the investment. A venture capitalist
will require a high expected rate of return on investments, to compensate for the
high risk.
A venture capital organization will not want to retain its investment in a
business indefinitely, and when it considers putting money into a business venture,
it will also consider its "exit", that is, how it will be able to pull out of the business
eventually (after five to seven years, say) and realize its profits.
When a company's directors look for help from a venture capital institution,
they must recognise that:
i. the institution will want an equity stake in the company
ii. it will need convincing that the company can be successful
iii. it may want to have a representative appointed to the company's board, to look
after its interests.
The directors of the company must then contact venture capital organizations,
to try and find one or more which would be willing to offer finance. A venture
capital organization will only give funds to a company that it believes can succeed,
and before it will make any definite offer, it will want from the company
management:
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a) a business plan
b) details of how much finance is needed and how it will be used
c) the most recent trading figures of the company, a balance sheet, a cash flow
forecast and a profit forecast
d) details of the management team, with evidence of a wide range of management
skills
e) details of major shareholders
f) details of the company's current banking arrangements and any other sources
of finance
g) any sales literature or publicity material that the company has issued.
A high percentage of requests for venture capital are rejected on an initial
screening, and only a small percentage of all requests survive both this screening
and further investigation and result in actual investments.
6.3.17 Franchising
Franchising is a method of expanding business on less capital than would
otherwise be needed. For suitable businesses, it is an alternative to raising extra
capital for growth. Franchisors include Budget Rent-a-Car, Rent DG set, Amul, and
Pizza Inn.
Under a franchising arrangement, a franchisee pays a franchisor for the right
to operate a local business, under the franchisor's trade name. The franchisor must
bear certain costs (possibly for architect's work, establishment costs, legal costs,
marketing costs and the cost of other support services) and will charge the
franchisee an initial franchise fee to cover set-up costs, relying on the subsequent
regular payments by the franchisee for an operating profit. These regular payments
will usually be a percentage of the franchisee's turnover.
Although the franchisor will probably pay a large part of the initial investment
cost of a franchisee's outlet, the franchisee will be expected to contribute a share of
the investment himself. The franchisor may well help the franchisee to obtain loan
capital to provide his-share of the investment cost.
The advantages of franchises to the franchisor are as follows:
1. The capital outlay needed to expand the business is reduced substantially.
2. The image of the business is improved because the franchisees will be
motivated to achieve good results and will have the authority to take
whatever action they think fit to improve the results.
The advantage of a franchise to a franchisee is that he obtains ownership of a
business for an agreed number of years (including stock and premises, although
premises might be leased from the franchisor) together with the backing of a large
organization’s marketing effort and experience. The franchisee is able to avoid some
of the mistakes of many small businesses, because the franchisor has already
learned from its own past mistakes and developed a scheme that works.
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6.3.18 Role of Banks in Secured Landing
6.3.18.1 Secured vs. Unsecured Loans
There are two basic categories that most loan types fall into – Secured and
Unsecured.
Secured loans are those loans that are protected by an asset or collateral of
some sort. The item purchased, such as a home or a car, can be used as collateral,
and a lien is placed on such item. The finance company or bank wi ll hold the deed
or title until the loan has been paid in full, including interest and all applicable
fees. Other items such as stocks, bonds, or personal property can be pu t up to
secure a loan as well.
Secured loans are usually the best (and only) way to obtain large amounts of
money. A lender is not likely to loan a large amount with assurance that the money
will be repaid. Putting your home or other property on the line is a fairly safe
guarantee that you will do everything in your power to repay the loan.
Secured loans are not just for new purchases either. Secured loans can also be
home equity loans or home equity lines of credit. Such loans are based on the
amount of home equity, which is simply the current market value of your home
minus the amount still owed. Your home is used as collateral and failure to make
timely payments could result in losing your home.
Secured loans usually offer lower rates, higher borrowing limits and longer
repayment terms than unsecured loans. As the term implies, a secured loan means
you are providing "security" that your loan will be repaid according to the agreed
terms and conditions. It's important to remember, if you are unable to repay a
secured loan, the lender has recourse to the collateral you have pledged and may be
able to sell it to pay off the loan.
Examples of Secured Loans: Mortgage, Home Equity Line of Credit, Auto Loan
(New and Used), etc.
On the other hand, unsecured loans are the opposite of secured loans and
include things like credit card purchases, education loans, or personal (signature)
loans. Lenders take more of a risk by making such a loan, with no property or
assets to recover in case of default, which is why the interest rates are considerably
higher. If you have been turned down for unsecured credit, you may still be able to
obtain secured loans, as long as you have something of value or if the purchase you
wish to make can be used as collateral.
When you apply for a loan that is unsecured, the lender believes that you can
repay the loan on the basis of your financial resources. You will be judged based on
the five (5) C's of credit -- character, capacity, capital, collateral, and conditions –
these are all criteria used to assess a borrower's creditworthiness. Character,
capacity, capital, and collateral refer to the borrower's willingness and ability to
repay the debt. Conditions include the borrower's situation as well as general
economic factors.
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Examples of Unsecured Loans: Credit Cards, Personal (Signature) Loans,
Personal Lines of Credit, Student Loans (note that tax returns can be garnished to
repay delinquent student loans), Some Home Improvement Loans, etc.
6.3.18.2 Role of banks
For secured landing the main function on the banks and financial institutions
is Credit Analysis. The major purpose of credit analysis is to:
 Identify risk in lending situations,
 Draw conclusions as to the likelihood of repayment, and
 Make recommendations as to the proper type and structure of the loan facility.
Analysis of a loan proposition may involve three steps:
1. Assessment to involve the following:
 The historical performance of the managers of the business,
 Determine the major risks factors, and
 Evaluate how well these risks have been mitigated in the past.
The past performance evidences factors influencing the firm’s present condition
and past performance that may foreshadow difficulties, or indicate the likelihood of
success, in the borrower's ability to repay a bank loan at some future time.
2. Analysis of the loan proposition;
 To enable reasonable projection of the probable future financial condition of
the company
 To estimate the company's ability to service proposed levels of debt.
3. Assessment of:
 The firm's creditworthiness and a proposal for structuring a loan facility that
can be amortized given the firm's projected cash flows
 The ‘offer’ from the borrower of sufficient protection against loss and control of
the lending relationship.
Financiers are always faced with three generic lending situations, or
rationales, based on:
 The purpose of the loan,
 The source of repayment,
 The risk inherent in the situation,
 The structure of the loan.
These lending rationales are:
 Asset conversion
 Cash flow
 Asset Protection Lending
For each of the lending rationales, look out for the following identification factors:
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 Source of cash used to repay a bank loan. The specific source of repayment is
dependent on the purpose of the loan, or the use to which the proceeds of the
loan are applied.
 The specific financing need elicits the nature of the risk to the lenders, who
must be certain to evaluate carefully the factors that will mitigate that risk and
protect them against loss.
 The repayment source, loan purpose, and risks dictate the form of protection,
monitoring and control employed by the bank.
 ACE primary purpose in distinguishin g these three lending rationales is to
provide the Bank analyst with support for determining those areas or issues
that might be of primary concern when evaluating a particular credit and to
provide an approach to analysis.
 It is essential to recognize that lending rationales are used to characterize a type
of loan proposition or credit facility and not a type of borrower.
 Thus, a company is not a "cash flow company" or an "asset Protection Lending
Company". The same company may have several different loans with the bank;
each made on the basis of a different lending rationale.
6.3.19 Asset Conversion Lending
 For most businesses the flow of funds from the completion of sales transactions
or the rendering of services is the main source finance for the purchase of raw
materials, wage/salary payments, and other expenses involved in conducting
business operations.
 In many cases, this unevenness of the flow of funds is not of sufficient
magnitude to create a need for outside financing, as the firm's normal cash
position is large enough to absorb these short-term fluctuations.
 In other cases, particularly in seasonal businesses a temporarily builds up of
inventory and then accounts receivable above normal levels, is expected at a
given time of the year. There is then a significant difference between the inflows
and outflows of funds for short periods of time, necessitating the use of short-
term, temporary funds from outside sources.
 Where provided by, say, a bank such short-term temporary financing derives
payback from the cash collected when the receivables arising from the sale of
inventory are liquidated at the completion of the asset conversion cycle. This
form of Asset conversion lending is a main stay of bank business lending to the
commodity trade.
 Asset conversion loans are short-term, self-liquidating loans and are made to
finance a temporary build-up of current assets - inventory and accounts
receivable - above the permanent level the firm normally keeps on hand.
 The loans are generally unsecured, and the primary protection against loss is:
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o The bank's confidence in management's ability to complete the asset
conversion cycle and
o The liquidity of the assets being financed.
LOAN PURPOSE
To finance seasonal working investment build up, i.e. the difference between
working Investment at low point (the permanent level) and working investment at
high point (the seasonal peak).
PRIMARY SOURCE OF REPAYMENT
Cash received from the successful completion of the asset conversion cycle, i.e.
the recovery of costs at the end of a major selling season.
RISKS
 Inability to complete the asset conversion cycle successfully due to risks in the
supply, production, sales, or collection segment of the asset conversion cycle.
PROTECTION
 The quality (liquidity) of the working assets in the asset conversion cycle and the
ability of management to mitigate the risks inherent in cycle.
LOAN STRUCTURE AND CONTROL
Use of a line of credit, with borrowings on demand or short-term notes, which
allows the lender to review the financial condition of the company frequently during
the cycle before renewing the notes or adding new borrowings.
The series of notes should correspond to the length of the asset conversion
cycle, that is, the expected time needed to convert the assets to cash and repay the
loan.
6.3.21 Cash Flow Lending
 Cash flow lending is lending to finance a firm's permanent, i.e. long-term needs.
Apart from seasonal needs, permanent needs are associated with:
i. Permanent level of working investment
ii. Capital expenditures
iii. Investment activities
 Cash flow lending by a bank is usually medium-term, with loan terms of u p to
seven or eight years in most cases
 The "support" assets such as plant and equipment that are being financed are
expected to produce other, "working", assets which, when converted to cash
through the successful completion of successive asset conversion cycles, will
generate sufficient cash to repay the loan. For example new equipment,
financed in anticipation of higher productivity to boost sales and profitability.
 In the case of permanent levels of working investment, an increase in sales
volume will usually require an increase in the permanent level of working
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investment. It is expected that the increased level of sales will result in
additional retained earnings that will repay the term loan.
 Cash flow lending, then, is essentially lending to repeated asset conversion
cycles, and payback is dependent on the firm's ability to generate (and retain in
the business) sufficient cash over a number of ye ars of profitable operations to
make required interest and principal payments on the loan.
 Assessing a firm's creditworthiness for a term loan to be repaid out of cash flow
requires making reasonable projections of the firm's future sales prospects and
cash flow and determining the amount of cash that will probably be available to
service debt in the future.
 Long-term loans present greater risk to the lender than short-term loans since
the longer into the future that payback is scheduled, the greater the chance of
unforeseen events intervening and jeopardising the safety of the loan.
 The primary justification for a cash flow loan is the reasoned expectation of the
firm's future ability to generate sufficient cash flow, not its historical ability to
do so. Therefore, Covenants in the loan agreement are often included a ‘trigger’
to signal to the lender a deteriorating situation so that corrective action may be
taken.
Loan Purpose
 To provide external financing for permanent needs, this will support or enhance
the generation of internal net cash inflows from profitable operations.
Primary Source of Repayment
 Cash flow (primarily from additional profits) over time.
Risks
 Inability to generate and/or retain sufficient cash from operations to amortise
debt because of, for example, selling problems arising from competition, product
failure OR
 Obsolescence or inability of management to efficiently and prudently manage
the sources and uses of cash.
Protection
 Primary protection against loss is the stability of profit generation and
preservation of the strength of the firm's financial position.
 Covenants in the loan agreement establish conditions necessary to preserve
cash flow and financial strength and serve to signal deterioration in these areas
that may threaten payback.
 Cash flow lending by a commercial bank is medium-term, up to 7 or 10 years
(long-term loans of up to 40 years are made by insurance companies, pension
funds, governments, and the public (through bond offerings).
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 Lenders are often willing to refinance the individual debt issues, depending on
the perceived ability of the firm to service the debt and, thus, a serviceable level
of medium - and long-term debt can be a "permanent" source of capital.
 Usually term loans will call for amortisation of a portion of the loan annually or
quarterly, and each long-term debt issue will have a series of notes
corresponding to the timing in the amortisation schedule.
Form of Control
 Covenants in the term loan agreement, which set paramete rs within which the
borrower must work to assure strength in the overall financial condition.
Asset Protection Lending
 Asset Based lending is a method of financing a relatively permanent need with a
short-term vehicle. The permanent need normally consists of a stable, but
revolving, level of current assets.
 The asset based loan thus combines features of the asset conversion loan (a
short-term vehicle) and the cash flow, or term, loan (a permanent financing
need), but is quite istinct from these forms of len ding.
ASSET PROTECTION LENDING COMPARED WITH ASSET CONVERSION LENDING
 Asset based lending differs from asset conversion lending, in which the
financing need is temporary and pay back is expected in full at the completion of
the asset conversion cycle.
 The need financed by the asset protection loan is, by contrast, a permanent
level of current assets, and the bank is essentially financing an on -going stream
of asset conversion cycles.
 This position necessitates that the, loan is continuously rolled over. The loan
could not be paid back in full without reducing the normal level of the firm's
current assets and thus seriously disrupting the firm's operations.
 The fundamental paradox of Asset Based Lending is that the repayment of a
permanent level or principal is not expected as long as the business is a going
concern, although individual transactions or promissory notes within that level
are expected to be self-liquidating.
ASSET PROTECTION LENDING COMPARED WITH CASH FLOW LENDING
 Asset Based lending also differs from cash flow lending. Although both finance a
permanent need, in an Asset Base situation, the company does not generate
sufficient cash flow to amortise a substantial term loan.
 The bank, however, has confidence in the ability of the firm to repay the loan, if
necessary, from the liquidation of the assets being financed, and, therefore,
makes funds available through a short-term vehicle in order to exert greater
control, similar to that inherent in asset conversion loans.
 It is therefore of critical importance that the creditworthiness of the Borrower
company in relation to competence and integrity of the firm's management is
not taken for granted.
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 Ordinarily, the bank should lend only when it is assured of the firm's ability to
successfully complete rapidly successive asset conversion cycles and to
continue in the future as a viable concern.
 Asset based lending also requires that the bank be assured that the net
realisable value (in a forced sale or liquidation) of the assets being financed is
sufficient to fully satisfy the amount of the loan, given sufficient senior creditor
status.
 This requirement of asset based loans is designed to protect the bank against
loss in the event of bankruptcy or liquidation.
 Asset Based loans may be secured or unsecured depending on the strength of
the borrower, the quality of the assets being financed, and the nature of the
transaction cycle.
WHEN WOULD ASSET PROTECTION LENDING BE APPROPRIATE?
i. Merchant businesses
 Where the business acts as an intermediary between buyer an d seller,
supplier and manufacturer, saver and investor, etc. The Asset Based loan is
then required to finance the permanent level of current assets requirement.
 In these businesses there is little value added during the asset conversion
process and there is, therefore, low profit per transaction and low retained
earnings and equity, with profits generated primarily by high volume. The
high financial leverage that is characteristic of these businesses implies high
risk to the lender.
 The lender, however, will advance under the Asset Based rationale if it is
assured of the viability of the business as a going concern and if the quality
of the assets is such that, if liquidated, the net realisable value would be
sufficient to repay senior claims.
ii. Uncertainty about the borrower’s ability to generate sufficient cash flow to
amortise a term loan or, where the level of borrowing is so high that there is an
unstable financial condition in the near term.
 Then the lender will take security in assets with a liquidation value
adequate to repay the loan, if necessary. For example a personal mortgage,
which is amortised primarily by the borrower's earnings but is also
supported by the liquidation value of the home and property being financed
(other forms of asset-based financing, such as leasing, would also fit this
broad category).
iii. Where the bank has reason to doubt the firm's cash flow potential.
 An example would be a start-up manufacturer, for which the bank might
finance plant, equipment, or permanent working investment with a secured
term loan, expecting sufficient profits over time to pay back the debt, but
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due to the uncertainty of the new enterprise, takes security in the
company's assets to assure payback should the firm prove unprofitable.
 Another example might be a firm that had recently experienced cash flow
problems that injected new uncertainty into its prospects for future
profitability to an extent that disqualified if for consideration for an
unsecured term loan.
Purpose
6.3.23 Valuation for Secured Lending

The success of a market economy is reflected in its extent of property
ownership and the dynamism of its secured lending process. The effectiveness of
real property as a security against lending offers a great opportunity of its being a
safety valve against the lending risks. The level of the risk is measured by the
valuation of the property. The value of the property serves as a yardstick as to how
much to lend. For obvious reasons the more advanced is the economy of a country
the more it is exposed to the dynamism of a secured lending process. Property
valuation therefore plays a very crucial role during an upsurge of economic activity
and the growth of a nation.
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Problems of property valuation are different for different world economies. The
IVSC and other bodies recognize a number of factors that contribute to property
valuation being difficult particularly in the developing economies. Chief among
these are the nonpublication of data on property transaction, prohibitive cost of
obtaining property information, market volatility, non-existence of valuation
manuals, lack of appropriate training opportunities for valuers, violation of building
bylaws and planning laws destabilizing the legal permissibility of valuation, old
legal framework of property laws, frauds and other legal infringements and black
money etc.
6.3.24 Examples of economic disasters led by poor valuation
Failure to perceive the trends of the property market and consequently the
market value of properties have led to serious economic disasters in both the
developing and the developed world. In some cases these failures have shattered
the national or even the international economic scenario. For example in 1973 the
commercial rent control introduced in UK caused the commercial property market
to collapse and brought down the forward march of the British economy. The
valuers could not predict the market after control beforehand, and so many
investments in commercial property development were in jeopardy. It was as a
consequence of this event that the RICS came up with their 1 st appraisal and
valuation manual, the Red Book of valuation. In the USA similar situation as this
arose when crisis of the “Savings and Loan Associations”(thrift institutions in the
USA) surfaced in the 1980s. Funds advanced on the security of property valuation
transpired to be largely non recoverable. This threatened the solvency of the major
banks. The standards of valuation and the professional conduct expected of the
valuers again came under the sharp focus of controversy. The USA responded by
introducing state certification of all valuers and a uniform standard of Professional
Appraisal Practice.
Not long before the south east Asian region was again rocked by a catastrophic
property market debacle. In 1997 the Bangkok Bank of Commerce crumbled under
its property loans. The event hit all the South East Asian Tigers. The property
market collapse in Thailand owing to poor valuation standards brought about the
collapse of the stock markets in South Korea, Indonesia and Malaysia since surplus
fund from Thailand was no more available for investment. The effect however
spread much beyond and even affected the economies of America and Russia
because of globalisation.
However the biggest shock in recent times in property market le d disaster of
economies originated by the fall of Lehman Brothers in USA, the investment
bankers, who collapsed under their property loans under what is identified as a
sub-prime crisis. The Investment bankers began to purchase all kinds of secondary
mortgages from the prime banks irrespective of their merit without judging the
repayment capacity of the borrowers. Since property market in USA never went
down since 1989 there was a firm belief that one can never be wrong about
property investment. And even if the borrower is unable to refund the loan from his
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earnings the escalation in the property market will surely make good the loss as
property prices doubled in 4 to 5 years. But the bu bble suddenly burst in July
2008 when investment bankers discovered that there were no takers for property in
auction sales. The glut in the property market suddenly caused a reversal of prices,
Consequently first the insurance companies including the biggest insurance
company in USA the AIG (American International Group) whe re the mortgages
were insured failed. Then all investment bankers including the giants like Lehman
Brothers and Merrill Lynch failed to pay back depositors' money along with many
others. The crisis spread like wildfire all over the world and stock markets all over
the world tumbled. Property prices rolled on even after three years now and there is
little sign of recovery particularly in the more advanced nations. So far as India is
concerned it was hit by the global meltdown initiated by the Lehman brothers and
investments in the share market was suddenly withdrawn causing a collapse of the
market. But the market recovered in two years' time rather significantly.
So far as property market is concerned this sector too showed rather quick
recovery after an initial set back. Thus the twin peaks are again being maintained
although with a very cautious approach. Different cities in India showed different
rates of recovery.
The importance of valuation as a safety valve and a risk management tool has
not been perceived by stakeholders in many parts of the globe. As globalisation
advances a consistent need of valuation standards and skill has been more
prominent so that the trans-border investors can invest more safely and
confidently. Of late some countries have taken a serious view of the situation.
6.3.25 Valuation for Secured Lending and Role of Valuers
IVS 310 under the International Valuation Staofndards 2011 (9th Edition) lays
down the guidelines for valuation for secured lending. In general the basis of
Market Value has been adopted to be the basis of valuation. The Market Value has
already been defined in the earlier chapter.
A valuation for secured lending may not be the same as one made for financial
reporting purposes. This is true although a similar base such as market value may
be applicable. The assumptions under which the valuation is made in this case is
different from that of financial reporting. E.g. for financial reporting purposes the
underlying principle for valuation of an enterprise is that the entity will continue as
a going concern but this assumption will not be appropriate for valuation
undertaken for lending purposes generally. Particularly for the specialised assets
this holds very appropriately where the value of the individual secured property in
the open market when divorced from the business as a whole is very limited.
For the purpose of secured lending the valuers will normally provide the
Market Value of such property in accordance with International Valuation
Standards as per directives of the IVSC.
The Market Value determination through any valuation method should
incorporate the market elements as regards the data and other aspects. Thus a
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method of comparison should take into account the data available on market
investigation. The income capitalisation approach should take into account the
market rental values and the market yields evaluated from market analysis. The
cost-based approaches should be based on market-based estimates of cost and
accumulated depreciation.
Although the basis of valuation for mortgage purposes should be market value,
the lenders may sometimes require a forced sale valuation for the mortgaged
property. A forced sale occurs under a compulsion to sell where the time period of
marketing may be severely restricted. The valuation for the forced sale is dependent
on the time and other constraints at the point of time when a forced sale occurs in
future. But such time and other constraints cannot be predicted beforehand and
hence the valuer is not at the date of valuation in a position to estimate a forced
sale value. Such a valuation should therefore be avoided.
The International Valuation Standards recognize valuation for secured lending
on special assumptions. The special assumptions are valid on the date of valu ation
only and may not hold good on any future date. The following paragraph is quoted
from the International Valuation Standards that gives an idea of such special
assumptions (IVS 310, Valuation for Secured Lending, Scope of Work, paragraph 5).
“5. Valuations for secured lending are often required on the special
assumption that there has been a change in the state or condition of the property.
To comply with the requirement to state any assumption in IVS 101 para 2(i) any
special assumptions that are necessary shall be included in the scope of work.
Examples of special assumptions that are commonly made in secured lending
valuation include:
a. that a proposed building had been completed at the valuation date,
b. that a proposed lease of the property had been c ompleted at the valuation date,
c. that a specified occupancy level had been reached by the valuation date,
d. that the seller had imposed a time limit for disposal that was inadequate for
proper marketing.”
Reporting for valuation for secured lending should be made in accordance with
requirements of the IVS 103 Reporting (International Valuation Standards under
http://www.ivsc.org). In addition the IVS requires that certain other factors as are
relevant should also be mentioned in the report. Examples of such factors are laid
down under IVS and are reproduced below (IVS 310, Valuations of Real Property
Interests for Secured Lending, paragraph 7).
“Reporting (IVS 103)
7. In addition to those matters required by IVS 103 Reporting, a valuation
report for secured lending shall include appropriate references to matters
addressed in the scope of work in accordance with paras 2 to 5 above. The report
shall also include comment on factors that are relevant to a lenders assessment of
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the performance of security over the li fe of the proposed loan. Examples of these
factors include.
a. current activity and trends in the relevant market,
b. historic, current and anticipated future demand for the type of property and
location,
c. any potential, and likely demand for, alternative uses that exist or can be
anticipated at the valuation date,
d. the impact of any events foreseeable at the valuation date on the probable
future value of the security during the loan period. An example would be a
tenant exercising an option to break a lease,
e. where the market value is provided subject to a special assumption, the report
shall include:
i. an explanation of the special assumption,
ii. a comment on any material difference between market value and the market
value subject to the special assumption,
iii. a comment that such value may not be realisable at a future date unless the
factual position is as described in the special assumption.”
All the three approaches of valuation are generally applicable for secured
lending but the cost approach should be scarcely u sed for a secured lending
valuation. Properties that are valued by cost approach only are unlikely to have a
market for sale and hence are not desirable as a security for secured lending,
because if the borrower defaults it is difficult to realize anything on sale. Specialized
properties that are used for very limited purposes are valued by cost approach only
and are not good securities for secured lending.
6.4 REVISION POINTS
“Cash Flow Lending”.
“Finance Lease” and “Operating Lease”.
“Hire Purchase” and “Lease”.
1. Explain various sources of funding plant and machinery.
2. Define “Lease” and differentiate “Finance Lease” and “Operating Lease”.
3. Discuss “Cash Flow Lending”.
4. Differentiate “Hire Purchase” and “Lease”.
5. Differentiate Secured and Unsecured Loans
6. What is the role of valuer in secured lending following International Valuation
Standard?
6.6 SUMMARY
Kinds of funding or financing of plant and machinery by banks, investors, etc.
have been explained.
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1. Define “Lease” and differentiate “Finance Lease” and “Operating Lease”.
2. Discuss “Cash Flow Lending”.
3. Differentiate “Hire Purchase” and “Lease”.
1. www.stern.nyu.edu/~adamodar/pdfiles/papers/finfirm09.pdf
2. www.slideshare.net/pankajbaid17/valuation-of-banks
6.9 ASSIGNMENTS
Explain: “How you, as a valuer, play important role in valuation of plant and
machinery for the purpose of secured lending?”.
1. IVS 310 under the International Valuation Standards 2011 (9th Edition)
2. Financial Management - Theory and Practice by Prasanna Chandra
3. Financial Management by C. Paramsivam and T. Subramanian
Explain: “How you, as a valuer, play important role in valuation of plant and
machinery for the purpose of secured lending?”.
6.12 KEYWORDS
Shares, Loan, Debentures, Earning, Bank Lending, Lease, Venture Capital,
Hire Purchase, Secured Lending
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LESSON-7
VALUATION FOR INSURANCE

7.1 INTRODUCTION
The insurance is an effective mechanism of protection of property unless the
insurance policies respond in full measure in case of claims against inadequacies in
scope of coverage and sum insured. Therefore, there is a need to properly
understand the relation between the indemnity provided and the sum insured
under the insurance policies. The indemnity provided can be on market value,
reinstatement value or agreed value basis. The principle of average will apply if the
sum insured does not correctly reflect the value of assets and the same is treated as
under insured. Hence Proper valuation of asset for the purpose of fixing sum
insured is very important. This article discussed the various methods of valuation
in general and specifically those related to material damages insurance policies and
consequential loss (known well as Loss of Profit) insurance policies.
7.2 OBJECTIVES
The main objective of this lesson is to equip the students thorough
understanding of principles of valuation for the purpose of insurance and loss
assessment.
7.3 CONTENTS
7.3.1 Why insurance?
7.3.2 The sum insured and its adequacy
7.3.3 Asset Valuation
7.3.4 Asset valuation for fixing sum insured
7.3.4.1 Building, Furniture, Fixtures and Fittings (FFF), etc.
7.3.4.2 Plant & machinery
7.3.4.3 Insurance on Residual Value
7.3.4.4 Inventory Valuation
7.3.5 Valuation for Consequential Losses
7.3.6 Valuation for Insurance -- Art, Science & Practice
7.3.7 Periodicity of Asset Valuation for Insurance
7.3.8 Conclusion
7.3.1 Why Insurance?
The insurance provides protection to the properties against damages caused
due to perils like fire, natural calamities, machinery breakdown, theft/ burglary,
etc. as covered under the insurance policy. The physical assets are insured for one
of the following two reasons:
1. The replacement of asset or income or both lost through the occurrence of
specified contingencies / perils.
2. Relief from legal liabilities incurred through the occurrence of specified
contingencies / perils.
The Loss of Profit (LOP) insurances are insured for protection from loss of
income of the owners’ consequent to the material damages. Due to some of the
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disastrous events the insured is not in a position to run its business operations for
quite a substantial periods leading to heavy loss of income. The LOP insurances
protest the insured against the fixed (standing) expenses which are anyway
continued even the business is not operating and loss of owners’ income.
7.3.2 The sum insured and its adequacy
The sum insured under an insurance policy serves as:
a) an amount on which premium is charged,
b) the maximum liability of the insurance company (the insurer) within the
policy, and
c) the basis for the calculation of under insurance in the event of claim
Insurance provides full protection only when the sum insured is adequate both
when the insurance is first purchased as also at every subsequent renewals. The
adequacy of sum insured is very critical to the insured if the policy is “subject to
condition of average”. The implications of no adequacy of sum issued are:
1. If the sum insured is too low (under insurance), the insured would end up
receiving a settlement which would be substantially less than the full
settlement of the claim thereby defeating the very purpose of insurance.
2. Over insurance would only mean over payment of premium and anyway no
benefits will accrue at the time of claim.
The adequacy of sum insured is not only of great concern from the view of the
insured but also from the view of point of the insurers. The insured feels cheated if
he does not get adequate indemnity because of under insurance and it may strain
the insurer’s relationship with clients. Clients expect necessary advice on this
account from the insurer who they believe are experts and must exhibit
professionalism. However, there is tendency on the part of the insured also to save on
premium. But the insurers are also expected to render their part of the duty on
advising on sum insured to avoid stress in relationship with the insured at the time of
claim and at the same time building image of the insurance company in the market.
7.3.3 Asset Valuation
The assets are required to be valued for different purposes like taxes, balance
sheet, merger and acquisition, etc., so as for insurance. Though there exist various
methods of valuation, appropriate valuation method depends upon the purpose of
valuation as also on the nature of assets involved. The various methods employed
for valuation is reviewed here and then examined the current practices being
followed in respect of valuation of assets for the purpose of insurance. The various
methods used for valuation are as under:
1. Valuation based on replacement cost basis: Here the cost of a new machine of
similar nature, make and capacity if available is found out. This cost will
represent the value on replacement cost basis.
2. Good as new: There are situation where machine/plant is working satisfactorily
because of good maintenance. In such si tuation, this valuation method is used
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which represents the original actual cost less depreciation but adding back the
maintenance cost.
3. Sum of part valuation: This method of valuation is used where the equipment
is not of composite nature. In this method all the different units / component
are valued separately and then added up to arrive at the composite value. But
this method has the inherent risk of technological process in that if one part is
damaged but not available, the entire assembly becomes scrap. The loss in such
situation is not limited to that part only.
4. Fair value method: This represents the value in exchange. This method of
valuation is applicable to assets that can be currently exchanged in the market
for value e.g. whatever may be the cost of production of an item, its value in the
market for sale in exchange for cash is the fair value.
5. Depreciation methods:
a. Book Value: This represents the written down value of the assets in the books
of accounts. In the first year of acquisition, this represents the actual cost of
the asset and with each passing year appropriate depreciation is charged and
the value of the asset is reduced accordingly. Over a period of time, the asset
value becomes so low that it will not reflect the true worth of asset.
b. Market Value: In this method depreciation is allowed on current replacement
value of the asset for the number of years it has been in use to arrive at
market value.
7.3.4 Asset valuation for fixing sum insured
For insurance purpose generally market value concept is employed. However,
incidentally in its first year the book value and the market value may be the same.
Market value represents the amount at which assets of the same age and
specification can be bought and sold. It generally takes into account depreciation
because of use and appreciation because of inflation. The depreciation may also
take into accident technological obsolesce.
Fixing of sum insured must take into account covering complete indemnity in
case of claim. The basis of indemnity under fire and engineering class of business is
generally provided on either of the following two methods:
1. Indemnity basis, 2. Reinstatement value basis
Under certain circumstances, if agreed upon by the insurance company, the
indemnity is also provided on “Agreed Value” basis.
Indemnity Basis: The value here is related to the age, present condition and
suitability for use of the asset and hence depreciation because of age and use is
taken into account. In case of claim, there will be financial strain on the insured.
Reinstatement value basis: No depreciation is deducted and the settlement of
claim is on “new for old” basis. It will reflect the cost of replacing the existing asset
by a new asset of similar kind, capacity and utility. The insured here will have least
financial strain.
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Agreed value basis: Under special circumstances, policies are issued on
agreed value also e.g. residual value insurance.
For the purpose of valuation of assets for fixing sum insured under material
damage insurance policies, the assets are generally divided into the following groups:
1. Building, furniture, fixture, etc.
2. Plant & machinery
3. Stocks
This division is useful because each group has its own peculiarities &
characteristics and hence need a separate treatment for valuation purpose.
7.3.4.1 Building, Furniture, Fixtures and Fittings (FFF), etc.
For insurance of building –
 Value of the land is to be excluded.
 The plinth and foundation do not get damaged in fire and hence may be
excluded. Value of compound wall is to be included. But for earthquake
extension, the same is to be insured as a separate item without corresponding
insurance against fire perils.
 Sum insured of building above ground level building should be the same for
both earthquake extension and the main fire policy.
 The value of embedded items either under the ground or in the walls/ roofs
should form part of the valuation and by way of suitable wordings in the policy
this intent should be reflected and made clear.
The buildings are generally insured on one of the following basis by the insured
1. Original cost basis 2. Book value basis
3. Market value basis 4. Reinstatement value basis
Original cost basis for buildings, FFF, etc.
This is the historical cost at which the building was acquired / constructed
and capitalized. This can be the basis of sum insured during the first year of its
acquisition / construction. With the passage of time this value has to be adjusted
for depreciation due to its age and appreciation in value due to inflation.
Book value basis for buildings, FFF, etc.
The book value represents the written down value of assets after providing for
depreciation on the original cost from year to year basis. This will lead to heavy
under insurance with the passage of time except in case of new building in its first
year of insurance.
Market value basis for buildings, FFF, etc.
This represents the amount at which property of the same age and condition
can be bought or sold. This value takes into account depreciati on to the physical
asset as well as appreciation due to inflation. The current cost of construction of
similar building is taken and depreciation is applied for age, usage, maintenance,
wear & tear, etc. The generally accepted method currently in use for building is to
apply unit cost rate to the gross external areas of the building or cubic
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measurement of building and adjust subsequently to suit particular circumstances
(built up area and construction specifications).
Reinstatement value basis for buildings, FFF, etc.
This represents the value of similar new property – No depreciation is charged
and hence if the fire policy is taken under “reinstatement values” clause the
property will be replaced without financial strain to the insured.
From the above it is clear that for a new building during its first year any
valuation method would do for the purpose of insurance. But in subsequent years,
it has to be preferably on reinstatement value basis.
7.3.4.2 Plant & machinery
Working out the sum insured for plant and machinery especially old one pose
serious problems. For brand new plant and machinery for its first year of
insurance, the original capital cost may be adequate. But this cost may require
upward revision at the time of renewal of the very first insurance. However in case
of very large industrial risks, which takes years to complete, the capitalized cost in
the first year itself may not be sufficient to cover the replacement cost in case of
claim. Insurance companies generally insure plant and machinery on either
“market value basis” or “reinstatement value basis.”
Market value for P & M
This method is suitable for machines of common type, used for general
purposes, freely available in the market for sale / purchase. On the current
replacement cost of the machines / plant is applied suitable depreciation (for age,
use, wear and tear, etc.) to arrive at market value. The market value, thus, refers to
the cost at the current price level of the asset of similar type and nature. Obviously
this method is not suitable for plant and machinery of special nature that are not
regularly bought and sold in the market.
Reinstatement value basis for P & M
The reinstatement value is represented by the cost of replacing the asset by
new items of similar nature and capacity. Thus it gives new price of an old machine
if available as new today. In case of old plant and machinery, we have serious
problems in working out the reinstatement value i.e. the price cost of the original
plant and machinery on current day replacement cost of a new similar plant and
machinery. Obviously original cost of capitalization can not necessarily be a basis
for sum insured. The problems associated with such exercise are:
1. Manufacturer stopping production of such machines
2. Manufacturer could have gone out of existence
3. Technological improvements taking place in the machines resulting
a. Higher output / productivity
b. Lesser manpower requirement
c. Lesser fuel consumption and operating cost
d. Additional range of function / compactness of machine, etc.
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4. The machinery and technology may have become obsolete
a. Functional obsolescence: Improved and efficient new version of the
machine replaces the older machines that suffer from functional
obsolescence.
b. Economic obsolescence: External factors (such as government planning &
industrial policy, legal environment, indigenous developments, etc.) which
brings about absence of demand for products / machine thereby creating
economic obsolescence.
Special treatment required in working out reinstatement value of P & M when:
1. The current price of similar machine / plant is available:
Suitable adjustment to be made for technological advancements from the
current price of similar machine / plant to which is added current landed cost plus
installation costs, etc.
2. The current price of similar machine / plant is not available:
In such situation, use is made of what is called escalation method. If the
insured’s capital block account is maintained up-to-date, the appropriate
replacement cost of the entire plant and machinery can be computed by applying a
rate of escalation which is in tune with RBI index and which takes care of concerns
on account of custom duty / rate of exchange, etc.
7.3.4.3 Insurance on Residual Value
For very old plant & machinery, which has run its life as per manufacturers
prescription may have reached zero value. But because of good maintenance the
plant and machinery is performing its duty. In such situation the insurance is
sometimes done on residual value, which represents 25% to 50% of the actual
cost, the balance being treated as depreciation. Such policies in insurance parlance
are treated as agreed value basis. There can also be agreed value policies covering
work of art, etc.
7.3.4.4 Inventory Valuation
Valuations of stock for insurance do not pose much difficulty. Stocks are
normally categorized into:
- Raw material
- Stock in process
- Finished goods
Raw materials are valued at net cost of acquisition at which the raw material is
available to the insured.
Stocks in process are valued at – the maximum value of stock in process ‐ the
cost of raw materials, other inputs and processing cost at any given time.
Finished goods are valued at – Net manufacturing cost including factory
overheads.
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7.3.5 Valuation for Consequential Losses
Fire and Machinery Breakdown Insurances are concerned with CAPITAL LOSS
following destruction of Building, Plant & Machinery, Stock in Process, Finished
goods. Fire Loss of Profit insurance is concerned with LOSS OF EARNINGS
consequent upon the capital loss as also any increase in cost of working incurred to
minimize the loss of earnings. Only with both “Fire & Fire Loss of Profit (FLOP)” and
“Machinery Breakdown & Machinery Loss of Profit (MLOP)” insurance FULL
PROTECTION is obtained
If the building, machinery or other property of the business be destroyed or
damaged by the perils covered under the Fire Policy or Machinery Breakdown Policy
and the business carried on by the Insured at the premises in consequences thereof
be interrupted or interfered with then the Insurer will pay to the Insured, amount of
loss resulting from such interruption or interference in accordance with the
provisions of the policy.
General definitions under LOP policies are as under:
 Turnover - The money paid or payable to the Insured for goods sold and
delivered and for services rendered in course of the business at the premises.
 Insured’s loss (termed as Gross profit) - Net Profit and Standing Charges on the
Turnover lost.
 Net Profit - The profit before tax
 VARIABLE Charges : These are expenses that vary in proportion with the rise or
fall in Turnover
 STANDING Charges: These are expenses that remain FIXED IRRESPECTIVE of
the rise or fall in Turnover.
 Policy Period is the period within which an indemnified loss occurs it will be
admissible as a claim. It is invariably 12 months.
 Indemnity Period - is the maximum period of Interruption for which the
Insurers would respond and has to be selected by an Insured.
Sum insured represents the annual GROSS PROFIT. This can be arrived at by
any one of the following methods:
Addition Method
Gross Profit = Net Profit + Standing Charges
Under this method standing charges to be insured are to be listed.
Difference Method
Gross Profit = Turnover - Variable Expenses
Inadequacy of Sum Insured will proportionately reduce the loss payable.
7.3.6 Valuation for Insurance -- Art, Science & Practice
From the above, it is clear that asset valuation for the purpose of insurance is a
complicated and tricky affair. While theoretically it is easy to work out an algorithm
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for calculating the sum insured and its revision at every renewal, in practice it is a
time consuming complicated job calling for acumen and specialized skill.
Fire insurance policies are generally sold on either market value (indemnity)
basis or reinstatement value basis. As far as insurance company is concerned, it
only wants the sum insured figure to be declared by the insured. In any case, the
onus of proof lies with the insured in the event of the claims. Inadequate sum
insured, therefore, has serious implication for the insured.
In case of old plant of high value and specialized nature fixing of sum insured, is
of critical nature and should be handled carefully. There is therefore a need to engage
a trained professionally approved valuer for this job. It has many advantages:
1. Confirmation that it has been assessed in accordance with good practice and
sound methodology.
2. The valuation will provide an accurate basis for adjusting the sum insured at
subsequent renewals of policies.
3. Take care of the avoidable outgo of premium because of over insurance and
inadequate compensation because of under insurance in the event of claim.
4. While carrying out the valuation exercise, measurements, detail s of
construction, important information about machinery and installation and other
critical details are recorded can be of great use in the event of claim.
5. Valuation done by a professional valuer becomes a sound basis for negotiation
of claims.
6. Valuation of each building separately provides basis for calculation of fire
premium which depends upon type of construction and occupancies.
7. Valuation for LOP insurances calls for professional competence of proper
understanding of business operations in totality and adequate knowledge of
financial and cost accounting.
7.3.7 Periodicity of Asset Valuation for Insurance
It is desirable that organization have a program to revalue assets every
three/five years and review those at every renewal. Review should include
assessment of the assets current condition, required maintenance and estimated
remaining useful life. This is an exercise which should form part of the risk
management approach of the organizations. Inflationary trend should be kept in
mind while adjusting sum insured at least at the time of renewal of insurance
policy, mostly annual.
7.3.8 Conclusion
The author has made an attempt to highlight the importance of adequacy of
sum insured which has serious implication for the insured. The insurers would be
failing in their professional duty towards their clients if they do not educate and
inform them on this account. Insurance policies are issued on market value i.e.
indemnity basis or reinstatement value basis. Special situation will require specific
special approach. There cannot be “fit all” approach for all eventualities and
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situation keeping in view the principle of indemnity. In compl ex situations,
“valuation” by an outside professional expert will certainty extend great comfort to
both the insurer as well as the insured. The author has experienced that most of
the insureds, while settlement of claims, have faced the problem of under insurance
having not covered adequate value of insured sum for the properties under material
damage insurance and gross profit under LOP insurances.
7.4 REVISION POINTS
 Reinstatement Value
 Book Value
 Agreed Value
 Indemnity
1. Explain the importance of insurance.
2. Explain main two valuation instance arise for the purpose insurance
3. What are types of values of plant and machinery insured in an insurance policy?
4. Write short notes on
a. Reinstatement Value
b. Book Value
c. Agreed Value
d. Indemnity
5. What is your understanding about valuation for settlement of consequential loss
incurrence claim?
7.6 SUMMARY
The principles of valuation for insurance purpose have been explained.
1. Explain main two valuation instance arise for the purpose insurance
2. What are types of values of plant and machinery insured in an insurance policy?
7.8 SUPPLEMENTARY MATERIAL
1. www.columbia.edu/.../Analysis%20and%20Valuation% 20of% 20Insurance%20C
ompa
2. https://www.actuariesindia.org/.../Valuation%20of%20Life%20Insurance% 20C
ompan
7.9 ASSIGNMENTS LEARNING ACTIVITIES
1.A project of 500 MW thermal power plant with expected cost of completed
project to be Rs. 2500 crores is going to be executed wherein number of suppliers/
EPC contractors/ subcontractors / labour are going to be involved and planned to
be commissioned in a period of 3 years. You have been engaged as insurance
advisor. Study the project insurance policies/ coverages available in India and then
prepare a comprehensive report for your client advising how and what should be
insured with what clauses/conditions, sum insured for different risks. Also advise
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to cover Advanced Loss of Profit coverage had the project gets delayed due to perils
covered under the insurance policy.
7.10 SUGGESTED REFERENCES
4. Patel R. K.; Marine Insurance - policies. losses and claim procedure;
Management Accountant (ICWAI), 2000
5. Patel R. K.; Valuation of Stocks and Stock-in-Process for the purpose of Loss
Settlement by an Insurance Company under Fi re Insurance Policies (A Case
Study); All India National Seminar of the Institution of Valuers; 20012
6. Patel R. K., “Valuation of Assets for Material Damage Insurance”, published in
journal “Indian Valuer” of January 2010.
7. Patel R. K., “Valuation of Sum In sured and Assessment of Loss of Profit under
Business Interruption Insurance Policy – A Case Study on Wind Power Plant”,
on occasion of 44th All India National Seminar on Valuations 2013, organised
by the Institution of Valuers at Chennai (Tamilnadu), 212-29 December 2013
A project of 500 MW thermal power plant with expected cost of completed
project to be Rs. 2500 crores is going to be executed wherein number of suppliers/
EPC contractors/ subcontractors / labour are going to be i nvolved and planned to
be commissioned in a period of 3 years. You have been engaged as insurance
advisor. Study the project insurance policies/ coverages available in India and then
prepare a comprehensive report for your client advising how and what shou ld be
insured with what clauses/conditions, sum insured for different risks. Also advise
to cover Advanced Loss of Profit coverage had the project gets delayed due to perils
covered under the insurance policy.
7.12 KEYWORDS
Insurance, Sum Insured, Reinstatement Value, Consequential Loss, Adequacy
of Sum Insured
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LESSON-8
RELEVANT VALUATION STANDARDS FOR VALUATION ON PLANT & MACHINERY

8.1 INTRODUCTION
In this lesson discuss about the valuation standards on plant and machinery
8.2 OBJECTIVES
The main objective of this lesson is to equip the students with knowledge of
various valuation standards and guidance notes for valuation of plant and
machinery. At the end of lesson the student will be able to read and interpret
various provisions, definitions and methodologies generally followed and accepted.
8.3 CONTENTS
8.3.1 The International Valuation Standards Committee (IVSC)
8.3.2 Objectives and Scope of International Valuation Standards (IVSs)
8.3.3 Under various IVSs, the IVSC has issued guidance note - 3 (GN-3) for
valuation of Plant and Equipment
8.3.4 General guidelines given in the guidance note
8.3.5 Relationship to Accounting Standards
8.3.1.The International Valuation Standards Committee (IVSC)
In 2003, the IVSC became an incorporated association, comprising
professional valuation associations from around the world, and bound by Articles of
Incorporation.
The objectives of the International Valuation Standards Committee (IVSC) are
twofold:
 To formulate and publish, in the public interest, valuation Standards for
property valuation and to promote their worldwide acceptance; and
 To harmonise Standards among the world’s States and to identify and
make disclosure of differences in statements and/or applications of
Standards as they occur.
8.3.2 Objectives and Scope of International Valuation Standards (IVSs)
The development of the International Valuation Standards (IVSs) has been
guided by three principal objectives:
 To facilitate cross-border transactions and contribute to the viability of
international property markets by promoting transparency in fi nancial
reporting as well as the reliability of valuations performed to secure loans and
mortgages, for transactions involving transfers of ownership, and for
settlements in litigation or tax matters;
 To serve as a professional benchmark, or beacon, for Valuers around the world,
thereby enabling them to respond to the demands of international property
markets for reliable valuations and to meet the fi nancial reporting requirements
of the global business community; and
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 To provide Standards of valuation and fi nancial reporting that meet the needs
of emerging and newly industrialised countries.
Users of valuations under IVSs should be able to rely on such valuations as
having been carried out by competent professionals who subscribe to high
standards of ethical conduct. As the scope of valuation practice becomes broader,
the term property valuation has gained currency over the more restrictive term
asset valuation, a term referring to valuations performed primarily for use in fi
nancial reporting. A Professional Property Valuer is a person who possesses
necessary qualifi cations, ability, and experience to estimate property value for a
diversity of purposes including transactions involving transfers of property
ownership, property considered as collateral to secure loans and mortgages,
property subject to litigation or pending settlement on taxes, and property treated
as fi xed assets in fi nancial reporting. A Professional Property Valuer may also
possess the specifi c expertise to perform valuations of other categories of property,
i.e., personal property, businesses, and fi nancial interests.
The International Valuation Standards represent accepted,or best, practice in
the Valuation profession, also known as Generally Accepted Valuation Principles
(GAVP). Valuer compliance with the IVSs may be voluntary, mandated by law or
regulation, or at the instruction of clients, intended users, and/or national societies
or organisations. Having no enforcement power of its own, the IVSC looks to
national institutes and fi nancial professionals and authorities to enforce
standards. It is intended that the International Valuation Standards and the
national standards of respective Member States shall be complementary and
mutually supportive. The IVSC advocates that differences between statements
and/or applications of national and International Valuation Standards be disclosed.
Detailed examination of methodology and i ts application to specifi c property
types or markets is the province of specialist education and literature. For this
reason, the IVSC encourages all professional Valuers to avail themselves of
continuing education programs throughout their careers. The International
Valuation Standards prescribe what Valuers do rather than explain how specifi c
procedures or methodologies are applied. The IVSs recognise that every application
is tied to a specific valuation problem, the solution of which depends on the
Valuer’s ability to select relevant techniques and exercise appropriate judgment.
Where the standards of other disciplines, such as accounting, may apply to
Valuations, the IVSC advises Valuers to understand the accounting use to which
their valuations are put.
8.3.3 Under various IVSs, the IVSC has issued guidance note - 3 (GN-3) for valuation
of Plant and Equipment
The GN-3 preambles plant and equipment assets have particular
characteristics that distinguish them from most types of real property and that
influence both the approach to and reporting of their value.
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Plant and equipment are typically capable of being moved or relocated and
often will depreciate at a significantly faster rate than real property. Frequently, the
value will differ notably depending on whether an item of plant or equipment is
valued in combination with other assets within an operational unit or whether it is
valued as an individual item for exchange, and where it may be considered as either
in-situ (in place) or for removal.
This Guidance Note focuses on the application of the approaches, principles
and bases described in the Standards to the valuation of plant and equipment
assets of both private-sector and public-sector entities. It further qualified that the
following Guidance Notes may also be relevant to the valuation of plant and
equipment:
GN 4, Valuation of Intangible Assets
GN 5, Valuation of Personal Property
GN 6, Business Valuation
GN 7, Consideration of Hazardous and Toxic Substances in Valuation
GN 8, The Cost Approach for Financial Reporting—(DRC)
Definitions as per IVS
Plant and Equipment: Tangible assets, other than realty, that:
1. are held by an entity for use in the production or supply of goods or services, for
rental by others, or for administrative purposes; and
2. are expected to be used over a period of time.
The categories of plant and equipment are:
Plant: Assets that are inextricably combined with others and that may include
specialised buildings, machinery, and equipment.
Machinery: Individual machines or a collection of machines. A machine is an
apparatus used for a specific process in connection with the operation of the entity.
Equipment: Other assets that are used to assist the operation of the
enterprise or entity.
Market Value:The estimated amount for which a property should exchange on
the date of valuation between a willing buyer and a willing seller in an arm’s-length
transaction after proper marketing wherein the parties had each acted
knowledgeably, prudently, and without compulsion.
IVS also refers International Financial Reporting Standards Definitions as
under:
Property, Plant and Equipment: Tangible items that:
1. are held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes; and
126
2. are expected to be used during more than one (accounting) period.
(International Accounting Standards IAS 16, para. 6)
Fair Value: The amount for which an asset could be exchanged between
knowledgeable willing parties in an arm’s length transaction (IAS 16, para. 6).
Finance lease: A lease that transfers substantially all the risks and rewards
incidental to ownership of an asset. Title may or may not be eventually transferred.
(IAS 17, para. 4)
Operating Lease: A lease other than a finance lease. (IAS 17, para. 4)
8.3.4 General guidelines given in the guidance note.
Valuations of plant and equipment can be carried out using any of the
following approaches:
1. the sales comparison approach.
2. the cost approach (depreciated replacement cost) (see GN 8); and
3. the income capitalisation approach.
For many purposes, including compliance with IFRSs, the most appropriate
basis of value is Market V alue. However, Marke t Value simply stipulates that an
exchange is assumed to take place on an arm’s-length basis between
knowledgeable and willing parties; it is silent as to how the particular asset is to be
presented for sale or any of the other specific circumstances that could have a
fundamental effect on the valuation. When undertaking a valuation of plant and
equipment, the Valuer must therefore establish and state the additional
assumptions that are appropriate, having regard to the nature of the asset and the
purpose of the valuation. These assumptions may include the state of the business
in which the plant and equipment are currently utilised, or the extent to which
individual items are aggregated with other assets. Examples of assumptions that
may be appropriate in different circumstances, or for different valuation purposes
include:
 that the plant and equipment are valued as a whole, in-situ (in place) and as
part of the business as a going concern;
 that the plant and equipment are valued in-situ but on the assumption that the
business is closed; or
 that the plant and equipment are valued as individual items for removal from
their current location.
For assets in the pu blic sector, the assumption equivalent to a business
continuing as a going concern is that the pu blic sector assets will continue to be
used for the provision of the relevant public good or service.
The list of assumptions above is not comprehensive. Because of the diverse
nature and transportability of much plant and equipment, Market Value will need
appropriate qualifying assumptions to describe the state and circumstances in
which the asset is offered to the market. These assumptions should be discussed
127
with the client and must be included in the report. Frequently, it may be
appropriate to report on more than one set of assumptions, e.g., in order to
illustrate the effect of business closure or cessation of ope rations on the Market
Value of plant and equipment assets, where closure or cessation is not yet definite.
Other factors that can affect the Market Value of plant and equipment include:
 the costs of installation and commissioning where plant and equipment
are valued in situ;
 where they are valued for removal, any allowance made for the costs of
decommissioning, removal, and possible reinstatement following
removal, and which party is to bear those costs. In some cases, these
costs can be substantial and therefore the Valuer should reach an
agreement with the client as to how they should be reflected and which
specific assumption(s) are to be made.
Factors such as finite sources of raw materials, the limited life of the buildings
or limited tenure of the land and buildings housing the plant, and statutory
restrictions or environmental legislation can also have a significant impact on the
value of plant and equipment. These factors will need to be taken into account by
the Valuer and any necessary assumptions will have to be made.
Some plant and equipment connected with the supply or provision of services
to a building will normally be included in any exchange of the real estate interest.
Examples include plant for the supply of electricity, gas, heating, cooling or
ventilation and equipment such as elevators. Although the value of these items
would normally be reflected in the value of the real estate interest, for certain
purposes, such as depreciation accounting, it may be necessary to value these
items separately. Where this is the case, the Valuer should make it clear that the
separate valuation and treatment of these items will affect the value of the real
estate interest. When different Valuers are employed to carry out valuations of real
estate assets and plant and equipment assets at the same location, careful liaison
is necessary to avoid either omissions or double counting.
Intangible assets fall outside the definition of plant and equipment. However,
intangible assets may have an impact on the value of plant and equipment; for
example the value of patterns and dies is often inextricably linked to associated
intellectual property rights. In such cases the Valuer should establish what
assumptions are appropriate as to the availability of those intangible assets before
reporting a valuation. Operating software, technical data, production records and
patents are examples of intangible assets that can have an impact on the value of
plant and equipment, depending on whether or not they are included in the
transfer.
An item of plant and equipment may be subject to a financing arrangement,
such as a finance lease. Accordingly, the asset cannot be sold without the lender or
lessor being paid any balance outstanding under the arrangement. This payment
128
may or may not exceed the unencumbered value of the item. Items of plant and
equipment subject to such arrangements should be separately identified from
assets that are unencumbered, and their value separately reported. Items which are
subject to operating leases or are otherwise the property of third parties are
normally excluded as the benefits of ownership are not transferred to the lessee.
Market Value does not imply any particular method of sale, as for example, by
private treaty, tender, auction, etc. The conceptual framework in IVS 1 makes it
clear that Market Value assumes a sale after proper marketing in the most
appropriate manner. It is implicit in this definition that the method of sale will be
the one that will achieve the highest price for the asset or the defined group of
assets in a given set of circumstances. A willing and knowledgeable seller would not
voluntarily choose a method of sale that did not maximize the price. However, if the
exchange is to take place under circumstances that prevented the se ller from
choosing the optimal method of disposal, the anticipated realization will not be the
Market Value unless the constraint on the seller was one common to all sales in
that particular market at that time. A constraint specific to a particular seller or
asset, coupled with a requirement to sell subject to that constraint, may result in a
forced sale situation.
Plant and equipment assets are more likely to be subject to forced sale
circumstances than real estate interests. For example, assets sometimes have to be
disposed of in a time frame that precludes proper marketing because the current
owner of the assets has to vacate or surrender the land and buildings where they
are located. If such a scenario has actually arisen, or is reasonably foreseeable, it
may be appropriate for the Valuer to provide advice on the price that could be
anticipated or that should be accepted, although before doing so the Valuer will
need to establish the exact nature of the constraint on the vendor and understand
the consequences for the vendor of failing to dispose of the assets within the
stipulated time limit. For example, the assets may be subject to forfeit or the owner
may be subject to a specific financial penalty. It may also be necessary to consider
any alternatives to sale, for example, the practicality and cost of removing the items
to another location for disposal. Without knowledge of the actual or anticipated
circumstances, the Valuer cannot give meaningful advice since the exchange may
fall outside the definition of Marke t Value. Assumptions regarding the realisation of
a transfer under forced sale circumstances must be carefully considered and clearly
stipulated.
8.3.5 Relationship to Accounting Standards
Under International Financial Reporting Standards (IFRSs), Property Plant and
Equipment may be included on an entity’s balance sheet at either cost less
depreciation less impairment or at fair value at the date of revaluation less
depreciation less impairment (IAS 16, paras. 29, 30 and 31). The fair value of ite ms
of plant and equipment is usually their market value determined by appraisal (IAS
16, para. 32). Plant and equipment, together with other fixed assets, may be subject
to other IFRSs, including IAS 2, Inventories; IAS 17, Leases; IAS 36, Impairment of
129
Assets; IFRS 3, Business Combinations; and IFRS 5, Non-Current Assets Held for
Sale and Discontinued Operations. The Indian Accounting Standards (IndAS)
published by the Institute of Chartered Accountants of India (ICAI) are more or less
now converged to IAS.
8.4 REVISION POINTS
 International Valuation Standards for valuations
 Accounting standards for valuation of plant and machinery
1. Explain importance of International Valuation Standards for valuations.
2. Discuss importance of accounting standards for valuation of plant and
machinery.
3. Explain International Guidance Note – 3 regarding valuation of Plant and
Machinery with special reference to Specialized Assets
4. Explain in brief “Depreciated Replacement Cost Approach” for valuation for the
purpose of Financial Reporting
5. How environmental factors affect the valuation of plant and machinery?
6. Sometimes values of P & M specifically constructed for monopolistic products
are more governed by intangibles therein rather than their value by cost
approach. Explain.
8.6 SUMMARY
The International Valuation Standards and the Accounting Standards
generally referred for valuation of plant and machinery have been discussed .
1. Discuss importance of accounting standards for valuation of plant and machinery.
2. Explain International Guidance Note – 3 regarding valuation of Plant and
Machinery with special reference to Specialized Assets
3. How environmental factors affect the valuation of plant and machinery?
1. iopcg.me/images/IVS_2011.pdf
2. www.iasplus.com/en/binary/resource/0511ivsc.pdf
8.9 ASSIGNMENTS
Take a case of a specialized plant and machinery you are conversant with and
having sufficient data. Prepare valuation report.
1. International Valuation Standards 2011 (9th Edition)
2. Accounting Standards
3. Patel R. K., “Property Valuation Under IFRS – Opportunities and Challenges”,
published in journal “Indian Valuer” of September 2009
130
4. Patel R. K., “Revaluation of Property, Plant & Equipment under IFRS”,
published in journal “Indian Valuer” of September 2010
5. Patel R. K., “Fair Value in IFRS”, published in journal “Indian Valuer” of Feb. 2010.
6. Patel R. K.’ “Cost Model and Revaluation Model for Valuation of Property, Plant
and Equipment under IFRS”, published in journal “Indian Valuer” of June 2011.
7. Patel R. K; “Valuation of 1470 MW Thermal Power Plant for Mortgage Purpose”,
International Workshop on Valuation of Infrastructural and Utility Properties
organised by Thai Appraisal Foundation at Bangakok, July 23-24, 2007 and
also published in journal “Indian Valuer” of October 2007.
Take a case of a specialized plant and machinery you are conversant with and
having sufficient data. Prepare valuation report.
8.12 KEYWORDS
International Valuations Standards, Accounting Standards
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LESSON-9
CASE STUDIES OF PLANT AND MACHINERY VALUATIONS

9.1 INTRODUCTION
In this lesson deals about case studies of plant and machinery valuations
9.2 OBJECTIVES
The main objective of this lesson is to appraise the students about practical
case studies and equip them to handle different kinds of assignments in practice
9.3 CONTENTS
9.3.1 Report on Valuation of Windmill Machinery/ Plant
9.3.2 Report on Valuation of Fixed Assets of Power Transmission Network
9.3.3 Valuation of Land, Buildings, Plant & Machinery of Sugar Mill
9.3.4 Loss Assessment of Damages to Boiler under Boiler and Pressure Vessels
Insurance
9.3.1 Report on Valuation of Windmill Machinery/ Plant
1. Purpose for which : To know fair market value of the plant for negotiations with
valuation is made the financial institutions.
2. Date as on which : December 11, 2002
valuation is made
3. Name of the owner of : M/s Sree Plastics Pvt. Ltd.
the machinery/ plant MUMBAI
under valuation
4. If the asset is under : Not Applicable
joint ownership/ co-
ownership, share of
each owner
5. Description of the : The owner has installed a 200 kW ca pacity wind turbine
machinery/ plant and generator (WTG) plant at Lamba site, Ta. Kalyanpur, Dist.
the purpose for which Jamnagar (Gujarat State) at total investment of Rs. 98.57
it is utilized lacs. The plant was erected and commissioned in March
1995 for ca ptive consumption un der the wind power
privatization policy of the Gujarat State. The plant is
generating electricity through wind energy. The plant
consists of a 200 kW ca pacity WTG with associated
electrical plant of switchyard, 250 kVA transformer and
transmission line upto GEDA substation. The detailed
identifications of the major plant equipments are as under:
 Make of WTG: BHEL – NORDEX
 Capacity: 200 kW, 28 m rotor diameter, 30 M tower height.
 Blades nos. & make: 530, 532 & 535 of LM Glass Fiber A/S
 Generator no. & make: GE-009108 of BROOK CROMPTON
 Gear Box no. & make: 421-404-122-1-8 of FLENDER
 Controller no. & Make: 1994-09-04-S4P-UPS of NORDEX
However the plant was severely affected during
cyclones of 1998 an d 2001 during which it underwent
major repairs of Rs. 23 lacs an d Rs, 2 lacs respectively.
Further the earthquake of 2001 had shaken the foun dation
of the WTG, involving expenditure of Rs. 1 lac.
Since then the WTG technology has developed quite
well all over the world. Today the WTGs available are
capacities ranging from 25 0 kW to 1500 kW capacity an d
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tower heights of 50 M and a bove. The new technology is
more sophisticated with better power performance
characteristics at lower installed cost per kW installed.
Further the plant is located in Gujarat an d compared
to that State the other State Governments have announced
better incentives for promotion of wind power generation.
Considering all the above points if the market value of
the said plant is to be derived the position of the owner of
the plant is no better than that of the distress seller.
6. Valuation of the : The said plant of the owner is certified to have fair market
machinery/ plant value of Rs. 19,35,000/- (Rupees nineteen lacs thirty five
thousand only)
The market value of the said plant is arrived at as the one
lowest of the values worked out by two methods:
(1) Cost Construction Method, and
(2) Expected Revenue Method.
Cost Construction M ethod:
Presently if an investor installs a new WTG plant the
nearest/ smallest capacity WTG plant available is 225 /
250 kW at total installed cost of Rs. 90 lacs. Considering
the discounts for lower capacity (20%), economic life
already utilized/ passed (40%), damages due to cyclones
and earthquake (30%) an d better optional technology/
sites/ incentives available for new plant (20%); the fair
market value works out to be Rs. 19.35 lacs.
Expected Revenue M ethod:
Assuming that a prospective buyer of the said ready
available for captive consumption, the criteria considered
are:
1.The generation capacity factor of the 14%. p.a. base d on
previous performance;
2.Electricity tariff of GEB is Rs. 4.50 per kWh escalating at
10% p.a.;
3. O & M cost per annum Rs. 1 lac today escalating at 10% p.a.;
4.Insurance cost per annum Rs. 1 lac today escalating at
10% p.a.;
5.Discounting future net benefits @ 20% net IRR plus
@8.33% for recovery of depreciation charge for the
remaining economic life of 12 years;
6.The present value of net benefit is further discounted for
damages due to cyclones and earthquake (30%) and
better optional technology/ sites/ incentives available for
new plant (20%);
The fair market value works out to be Rs. 20.77 lacs.
9.3.2 Report on Valuation of Fixed Assets of Power Transmission Network
Preamble
The state owned corporation owns extra- high voltage (EHV) , high voltage (HV)
lines and associated Sub- Stations, including cable wires, accumulators, plants,
motors, meters, apparatus, computers and materials connected with transmission
of electricity. It is in the business of supply of electrical energy, communication and
tele-metering equipment, to undertake for and behalf of others, the erection,
operation, maintenance, management of extra high voltage, high voltage lines and
associated sub-stations, equipment, apparatus, cables and wires.
133
With the objective of approaching various financial institutions and banks in
order to raise long-term loans against mortgage/ hypothecation of assets, the
Company instituted for valuation of assets of their one of the transmission net work
circle (called TR Circle).
Purpose and Basis of Valuation
The purpose of this valuation is to approach various financial institutions for
raising long-term loans against mortgage/ hypothecation of assets. Thus the basis
of valuation is to get PRESENT REALISABLE VALUE of the assets of the subject TR
circle.
Methodology of Valuation
The Company is properly maintaining the Asset Registers in order to properly
capitalise the cost of acquisition of assets at relevant time of execution and being
updated year by year with additions and deletion as per The Electricity (Supply)
Annual Accounts Rules, 1985. We thoroughly scrutinized these asset registers of
the said transmission circle and original / capitalised costs were taken as base.
We also visited selected properties at circle office, transmission divisions,
substations and transmission lines for physical inspection of various buildings and
equipments and gathered relevant information from the concerned circle/ divisional
managers/ engineers/ officers.
The Realizable values of the assets have been derived as under:
a) Calculate the present market value of the assets as if new.
b) Wherever necessary price of new similar kind and capacity
equipments/ plants / building have been considered.
c) Depreciate (a) and (b) to arrive at present realizable value.
For this purpose we have taken base of:
1. Original cost of the assets as per asset registers maintained by the Company.
2. Annual addition and deletion in assets made during the period.
3. Original costs/ additions/ deletions have been inflated by applying appropriate
cost inflation indices and wholesale price indices to relevant asset type defined
Present Day Replacement Cost (PDRC) of new similar kind of assets.
4. The PDRC has been depreciated for the life of the asset at straight-line
depreciation rates as per the Electricity (Supply) Act, 1948 and as notified by
the Central Electricity Regulatory Commission.
5. Due weightage is given to the life span as specified by the Electricity (Supply)
Act and the present conditions/ serviceability of the assets.
6. For valuation of Land we inquired with local market and established the
current market value, keeping in view the economic developments of the
respective localities.
For the purpose of valuation we have categorised the assets into four major
heads, so as also specified as per prescribed account heads:
134
Account Heads Under Which The Assets Have Been Categorised
For The Purpose of Valuation
Sr. Account Category of the Assets
No. Code
1 101 Land
2 102 Building
3 103 Hydraulic Works
4 104 Other Civil Works
5 105 Plant & Machinery
6 106 Lines & Cables
7 107 Vehicles
8 108 Furniture, Fixtures & Elect. Installations
9 109 Office Equipments
The values were derived account head-wise and sub-account head-wise for
each division of the circle.
The whole circle is divided into divisions/ sub divisions for the purpose of
valuation, so recognised by the Company for their accounting purpose, for all the
technical records and administrative/ managerial purpose
Valuation
Thus, Present Realisable Value of the assets under the subject TR Circle is
certified to be Rs. 132802.10 Lacs as on 28/2/2013.
9.3.3 Valuation of Land, Buildings, Plant & Machinery of Sugar Mill
(A) Lease Hold Land
The government has given land to the sugar co–operative society on perpetual
lease. The land has restricted use for the purpose of running sugar mill only. The sell
of the same is not legally permitted. The quantity of land in possession is 67.03 Ha.
Being the perpetual lease the lessee is going to enjoy benefi ts of the said land
for the life time; the market value should be estimated in the hands of the lessee.
A perspective agriculturist in the said area would earn estimate revenue of Rs.
18750 /- Per Ha. So, the same can be considered as the Net Maintainable Rent
(NMR) of the subject land under lease hold interest in the hands of the lessee.
Out of 67.03 ha of land only 12.02 ha of land on which constructions have
been made:
Factory Area : 10.45
Colony : 1.21
Roads : 0.36
12.02 Ha
If it seems that more than 90% of the leased land is open. So the value of the
said lease land will have premium of about 10% , since the same land can be put in
use for expansion of plant & machinery enhancing capacity and or for revenue
generation by plantations, etc.
So, for the purpose of valuation of said perpetual leasehold land, the Net
Maintainable Rent (NMR) can be taken as Rs. 18500 /- + 10% , i.e. Rs. 20350 per Ha.
135
Since it is perpetual leasehold land, the multiplying factor for the purpose of
working the present market value can be taken as “10”.
The market value of the said leasehold land in the hands of lessee can be
taken as:
= land area * NMR * M.F.
= 67.03Ha. * 20350 * 10
= Rs. 13640605 /-
Say Rs. 1, 36, 00,000 /-
(B) Buildings
The buildings are in good condition but needs some repairs to put in service.
The details of the buildings are given at Annexure – 1. Considering types of
construction, used life, expected future life, etc. the market value of the same is
estimated to be Rs. 7,45,00,000/-.
(C) P & M
Observations:
1. Machineries & Plant seem to be serviceable
2. Though not in use, the plant & machinery are kept in clean conditions &
corrosion has not been so severe.
3. Since not in use for almost 3 Years, the whole plant would need major work of
overhauling & repairs before the same can be put in use. Some spares would
need to be replaced, like insulation of piping & ducting, boiler tubes, etc…
4. In general the condition of P & M is good, (details at ANNEXURE- 2)
Other details:
1. The present day cost of installation of the said plant & machinery is
estimated to be Rs. 42, 00, 00,000 /-
2. The plant was installed in 1987 – 88
3. Life used for 20 Years
4. Expected future life of 20 years after proper overhauling
5. The estimated cost of overhauling is Rs. 5, 00, 00,000 /-
Market values of P & M
Present cost (New Plant) Rs. 42,00,00,000 /-
Less: Depreciation
20 * 42,00,00,000
 Rs.21,00,000/ 
20  20
Less: Cost of Overhauling to put in service mode = 5,00,00,000 /-
MARKET VALUE = 16,00,00,000 /-
136
(D) Roads
The roads are WBM, but the same needs repairs and strengthening to put in
regular use. The area is about 3540 sq.m. The present day cost of construction is
Rs. 10,00,000/-. After considering 10% of that as cost of repairs and strengthening
and depreciating the same for 50%, the market value can be taken as Rs. 4,00,000/-.
(E) Gates and Fencing
The whole of the factory area is fenced by the barbed wire fencing and also
provided with steel gates. Estimated market value is Rs. 10,00,000/-.
SUMMARY
Indicated Market Value

Sr. Property
Rs. Lacs
No.
1. Leasehold Land 136.00
2. Buildings 745.00
3. P&M 1600.00
4. Road (WBM) 4.00
5. Gates and Fencing 10.00
TOTAL 2495.00
9.3.4 Loss Assessment of Damages to Boiler under Boiler and Pressure Vessels
Insurance
The insured is mainly engaged in the business of Edible Oil under a very
popular branded name. The insured intimated to the insurers on 20/12/2005 that
Oil Fired Boiler, ABC Make, Model NUK HP 1250 was damaged/ failed due to
backfire/ explosion.
What happened?
As per the explanations of the insured, the 600 TPD Refinery Unit # was in
normal operations. At around 9.00 a.m. on 20/12/2005, while processing of edible
oil was going on in refinery unit-I oil fired boiler of ABC make installed in Deodorizer
section suffered damage due to backfire/ explosion. After that the insured
immediately stopped the electrical main supply of the panel. The insured inspected
the damages’ like Top cover of ABC boiler, Burner, Fuel Pump Feeding to ABC Boiler,
all the accessories attached with oil supply line to the burner & water tube coil were
damaged and steam/ water was coming out from bottom side of the boiler.
The Cause of Damage
Based on the circumstances observed at relevant time, the explanations of the
insured, the kind of damages happened, the said accident has happened due to
backfire/ explosion in the fire chamber of the said boiler damaging the parts/
components of the said boiler.
On further analysis the probable causes of such damages was concluded as
under:
1. Backpressure created probably due to choking of chimney. But the same
was found OK, so this possibility was ruled out.
2. Backpressure created probably due to unburnt gases. However the burning
was going well as per the insured, hence this possibility was also ruled out.
137
3. Backpressure created probably due to leakages of high-pressure steam.
This could be possible since it was observed that the water tube coil was
damaged and water was coming out.
Survey Observations
The subject Boiler was installed at Deodorizer section of 600 TPD Refinery Unit # 1.
The following damages to the said Boiler were identified:
1. Top cover of ABC boiler was damaged.
2. Burner was totally damaged.
3. Fuel pumps feeding to ABC was damaged.
4. Water tube coil was damaged.
5. Ring main system with heater got damaged.
6. All pressure equipment got damaged.
7. Air gas separator got damaged.
8. Air coil of boilers are damaged.
The affected oil fired boiler attached to 600 TPD Refinery Plant at sr. no. 1 of
the policy schedule was identified. The insured had total 5 nos. of boilers installed
in the Refinery Plants I & II together, as under:
Sr. Sum Insured
Type of Boiler Location
No. (Rs. in lacs)
01. Oil Fired ABC Boiler 50.00 In 600 TPD Refinery I - Plant
04. Steam Boiler 765.00 Near Old Boiler House
05. Steam Boiler 120.00 Near New Boiler & Turbine House
The insured had covered the above 5 boilers under “Boiler & Pressure Plant”
Policy No. YY009XXX. The boiler at sr. no. 1 above was affected, the same was
insured for Rs. 50,00,000/-.
The insured argued that the boiler being closed steam – condensate circuit, it
was not possible to cut only coil system and install new ones, the entire boiler was
needed replacement. However the equipments “switch board” and “safety control
panel” were reusable. The methodology for repairs proposed was replacement of
boiler except the reusable equipments, replacement of burner and replacement of
ring main system with header. The insured accordingly invited offers and
quotations from the prospective parties.
The insured further argued out that complete reinstatement of damages would
take considerable time, hence they opted for settlement of claim on depreciated
(market) value basis.
Accordingly the loss to the insured and net liability of the insurers was
assessed on depreciated value basis and/or constructive total loss basis.
Warranty Clauses Complied by the Insured
For the purpose of compliance of the warranty clauses, collected copies of
following Reports/ Certificates of the said affected boiler duly inspected and issued
by the Steam Boiler Inspectorate, Government of Gujarat:
138
Allowed Certificate Valid
Sr. Boiler Boiler Sr. No. of
Pressure
No. Registration No. Manufactures From To
Kg/ cm²
01. GT-4409 GK-10-8201 76.45 22/10/05 21/4/06
02. GT-4409 GK-10-8201 76.45 21/4/05 20/10/05
03. GT-4409 GK-10-8201 76.45 21/10/04 20/4/05
04. GT-4409 GK-10-8201 76.45 22/4/04 20/10/04
The competent attendants/ operators attending boilers were as under:
Sr. Class of Certificate Date of
Names of Boiler Attendants
No. Competency No. Certificate
01. Mr. Mangal Devram First 1497/96 8/8/1996
02. Mr. Jiteshkumar B. Siddhapura First 2141/2000 8/8/2000
03. Mr. Ramteerath Rampyare Roy First 2615/2003 24/2/2003
Thus the warranty clauses of the Boiler Policy were observed/ complied with
by the insured.
Adequacy of Sum Insured
The said boiler installed at 600 TPD Refinery Unit No. 1 was insured for Rs.
50,00,000/- The boiler was installed in October 2000. The stipulated life of the said
boiler at the time of installation was taken as 25 years. The cost of new boiler of
same kind and capacity with all the attachments, except steam and feed water
piping was worked out to be Rs. 49,53,654/- as under:
Sr. Amount
Particulars Rate
No. (Rs.)
1. As per quotations of new boiler with all EURO 64,700 34,84,095
attachments
(CIF Mumbai) Exchange Rate Rs. 53.85/- Euro
2. Freight, C&F 1% on (1) 34,841
3. Total (1) + (2) 35,18,936
4. Custom Duty 15% on (3) 5,27,840
5. Total (3) + (4) 40,46,776
6. Counter Veiling Duty (CVD) 16% on (5) 6,47,484
7. Education Cess on CVD 2% on (6) 12,950
8. Education Cess on C. D. 2% on (4) 10,556
9. Total (5)+(6)+(7)+(8) 47,17,766
10. Add: Erection and Commissioning 5% on (9) 2,35,888
11. Total erected Cost (9) + (10) 49,53,654
Assessment of Loss
Since the insured opted to settle the claim on depreciated value basis, the loss
to the insured was assessed considering two aspects:
(A) Settlement of claim on Repairs basis.
(B) Settlement of claim on Constructive Total Loss basis.
(A) Assessment of Loss on “Repair Basis”
As per quotation of repairs, submitted by the insured, the net loss payable to
the insured worked out to be Rs. 39,96,849/- as detailed below:
139
Sr. Amount
Description
No. in Rs.
(1)
Cost of Repairs
a
ABC boiler complete new set 28,30,752
b
Oil burner without inbuilt switchgear & air 8,74,097
c
Ring Man System 2,62,000
d
Erection and Commissioning 80,000
Total “1”
(please refer annexure for details) 40,46,849
(2) Deduction of Salvage of damaged items only 50,000
(4) Loss net of Salvage & Depreciation 39,96,849
(5) Less: Under Insurance 0
(6) Less: Excess 0
(7) Net Admissible Loss on repair basis 39,96,849
(B) Assessment of Loss on “Constructive Total Loss” basis
As per quotation of new similar boiler, submitted by the insured, the net loss
payable to the insured worked out to be Rs. 34,09,984/- as detailed below:
Sr. Amount
Description
No. (Rs.)
(1) Cost of new boiler with attachments 49,53,654
(2) Deduction of Depreciation:
Total life: 25 years
Life used: 5.25 years
Depreciation Deducted: 21% 10,40,267
(3) Deduction of Salvage
a) Undamaged Items
50% on undamaged items (i.e. Total Cost of New Boiler
– Repairs/ Replacement Cost;
i.e. 50% on (Rs. 49,53,654/- less Rs. 40,46,849/-)
Rs. 4,53,403/- plus Damaged items Rs. 50,000/- 5,03,403
(4) Loss net of Salvage & Depreciation 34,09,984
(5) Less: Under Insurance 0
(6) Less: Excess 0
(7) Net Admissible Loss 34,09,984
Hence, the claim was settled as per (B) above; i.e. for Rs. 34,09,984/-; since
the liability on repair loss basis was more than the liability on constructive loss
basis.
9.4 REVISION POINTS
 methodology of valuation for bank purpose and insurance purpose
 valuation of standalone machine/ equipment differs from valuation of whole
plant and machinery
Depreciated Replacement Cost Approach
1. Explain how valuation of standalone machine/ equipment differs from valuation
of whole plant and machinery.
140
2. Is there any difference in methodology of valuation for bank purpose and
insurance purpose? If so, explain difference .
3. Explain impairment of Asset with special reference to International Accounting
Standard – 36 on Impairment Loss.
5. Do you think the P & M value must have also knowledge of valuation of land
and building used for special purpose of that P & M under valuation ? Why?
9.6 SUMMARY
Various practical case studies have been discussed.
1. Explain impairment of Asset with special reference to International Accounting
Standard – 36 on Impairment Loss.
1. landsterling.com/plant-machinery-valuation-case-study
2. www.emeraldinsight.com/doi/abs/
9.9 ASSIGNMENTS LEARNING ACTIVITIES
Based on your practical experience or literature survey, prepare at least five
case studies on valuation of plant & machinery for presenting before valuation
professional and/or defending in the court of law as expert witness and/or to
convince end-users/ stakeholders and/or while peer review.
1. Valuation of plant and machinery: Theory and practice by Kirit Budhbhatti.
2. Valuation of Plant and Machinery Theory and Practice by Dr. P. C. Gupat.
Valuation by Dr. P. C. Gupta.
4. “Indian Valuer”, monthly journals published by the Institution of Valuers, New Delhi.
Based on your practical experience or literature survey, prepare at least five
case studies on valuation of plant & machinery for presenting before valuation
professional and/or defending in the court of law as expert witness and/or to
convince end-users/ stakeholders and/or while peer review.
9.12 KEYWORDS
Valuation of plant and machinery.
886E160
ANNAMALAI UNIVERSITY PRESS : 2016-2017

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\\Sri kumar\E:\Sri\Lessons\2016-17\M.Sc.

Pl ant a nd Ma chinery Valuation\106-Valuation of Pla nt & Ma chi nery-I\106- Va l ua ti on of Pl a nt a nd

M.Sc. PLANT AND MACHINERY VALUATION

VALUATION OF PLANT AND MACHINERY - I

VALUATION OF PLANT AND MACHINERY - I

Dr. G. Ganesan Dr. A. Prabaghar

Dr. M . Arulselvan Dr. K. Srinivasan

VALUATION OF PLANT AND MACHINERY - I

VALUATION OF PLANT AND MACHINERY - I

1 Overview of industrial structure in India 1

2 Fundamentals of Valuation of Plant & Machinery 38

3 Procedure of Plant & Machinery Valuation 46

4 Depreciation of Plant and Machinery in Valuation 67

5 Age, Life and Remaining Life of Plant and Machinery in Valuation 81

6 Valuation for Banks 88

7 Valuation for Insurance 112

8 Relevant Valuation Standards for Valuation on Plant & Machinery 122

9 Case Studies of Plant and Machinery Valuations 130

OVERVIEW OF INDUSTRIAL STRUCTURE IN INDIA

(Figures in Lakh Rs.)

FUNDAMENTALS OF VALUATION OF PLANT & MACHINERY

- In the case of a tangible service property, the satisfaction of the owner‟s

Property classification Primary element of value

Only in the case of investment property, there is the expectation of recovery of

PROCEDURE OF PLANT & MACHINERY VALUATION

DEPRECIATION OF PLANT AND MACHINERY IN VALUATION

Depreciation for 3 years (20% Depreciation for 3 years 20%

AGE, LIFE AND REMAINING LIFE OF PLANT AND MACHINERY IN VALUATION

Year Price Purchase Price Cost Index Trended Purchase

VALUATION FOR BANKS

6.3.23 Valuation for Secured Lending

VALUATION FOR INSURANCE

RELEVANT VALUATION STANDARDS FOR VALUATION ON PLANT & MACHINERY

CASE STUDIES OF PLANT AND MACHINERY VALUATIONS

Indicated Market Value

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