Economic obsolescence in an injection moulding plant: utilisation versus market evidence
An injection moulding company owns 40 hydraulic machines, each with a current replacement cost new of ₹1.05 crore. The machines were installed in 2018 and have a 12-year technical life. Twelve machines have been idle for 24 months. The company’s average utilisation is 48% of installed capacity; the industry’s normal utilisation is 78%. Imported moulded components are 12% cheaper than the company’s products, and customers are shifting to them. Recent dealer transactions for similar six-year-old machines are ₹38–42 lakh ex-works, with 5% selling costs. The company wants a fair value under Ind AS 16 for a revaluation surplus that will support bank covenants. The CFO argues that because the machines are only six years old, fair value should be at least 50% of replacement cost.
1. Compute RCNLD before economic obsolescence.
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Replacement cost new.
40 machines × ₹1.05 crore = ₹42.00 crore.
Physical deterioration.
Age ÷ life = 6 ÷ 12 = 50%.
RCNLD before economic obsolescence = ₹42.00 crore × (1 − 0.50) = ₹21.00 crore.
Interpretation. This figure assumes the machines are in average physical condition and that the business can use all 40. It does not reflect idle capacity, import competition, or the fact that a buyer would not pay for surplus machines. The CFO’s 50% floor is therefore only a starting point; it is not the fair value conclusion.
2. Quantify economic obsolescence using the utilisation method and discuss the 12 idle machines.
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Utilisation method.
Obsolescence = 1 − (subject utilisation ÷ normal utilisation)
= 1 − (48% ÷ 78%) = 1 − 0.6154 = 38.46%.
Deduction = ₹21.00 crore × 38.46% = ₹8.08 crore.
Indicated value = ₹21.00 crore − ₹8.08 crore = ₹12.92 crore.
Problem with applying this to all 40.
The method assumes all 40 machines are needed for the current business. Twelve machines are idle, so a going-concern buyer would not pay RCNLD for them. A more defensible split is:
- Active 28 machines: RCN = ₹29.40 crore; physical depreciation 50% = ₹14.70 crore; economic obsolescence 38.46% = ₹5.65 crore; value = ₹9.05 crore.
- Surplus 12 machines: value at the used-machine market. At the midpoint dealer price of ₹0.40 crore each, gross = ₹4.80 crore; less 5% selling cost = ₹4.56 crore.
- Total = ₹13.61 crore.
The two methods give a similar order of magnitude, but the split is more transparent. The valuer should disclose whether the 12 idle machines are truly surplus or held as standby; if standby, a lower functional allowance may be appropriate.
3. Reconcile the result with the dealer transaction range and advise on the fair value conclusion.
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Market cross-check.
Dealer range ₹38–42 lakh; midpoint ₹40 lakh.
40 × ₹0.40 crore = ₹16.00 crore gross.
Less 5% selling costs = ₹15.20 crore.
Reconciliation. The market cross-check is higher than the DRC indications of ₹12.92–13.61 crore. Possible reasons: dealer prices may be asking prices rather than completed transactions; the range may relate to running machines, while 12 are idle; and the market may be thin. The valuer should adjust the dealer evidence for condition, volume, and negotiation.
Fair value conclusion. Under Ind AS 16, fair value is the price in an orderly transaction between market participants. Where an active market exists, the market approach is generally more direct than a cost approach. Here the market evidence is usable but not deep. A defensible conclusion is a range of ₹13.5–15.2 crore, with the final point selected after adjusting dealer quotes to transaction evidence. The CFO’s 50% floor of ₹21.00 crore is not supportable because it ignores economic obsolescence and the idle machines. The valuer should state that the revaluation surplus is sensitive to the utilisation assumption and the reliability of dealer data.