Developing the Cost Index Developing the Cost Index & Depreciation & Depreciation SchedulesSchedulesBy Dave DutyProperty Valuation Specialist IINorth Carolina Department of RevenueLocal Government DivisionProperty Tax Section

2011 Advanced Personal Property SeminarSheraton Four Seasons Hotel, Greensboro, NCTuesday September 13th, 2011

Let’s talk about these things:Let’s talk about these things:

The Cost Approach to ValueThe NCDOR Cost Index &

Depreciation SchedulesThe Producer Price IndexHistorical Cost vs. Allocated PriceMass AppraisalsVariations in the Trend FactorsVariances From the SchedulesTrends in the Billboard Manual

Review of the Cost Approach to Review of the Cost Approach to ValueValueWhat is it?

Installed cost-The Westmoreland Case

Replacement cost new

Composite resources

Depreciation

Economic life

Cost Approach to ValueCost Approach to ValueThe cost approach estimates market value on

the premise that the cost new of an asset is reduced by an amount equivalent to the total loss in value that has occurred through all forms of depreciation

Considered to be the best or most effective way to value machinery and equipment

Proven methodology, data is readily available, taxpayers tend to understand the concept fairly well

Most closely approximates the fair market valueMust determine the original historical installed

cost, the current replacement cost new, the loss in value due to depreciation, & obtain the useful economic life of the asset

Installed CostInstalled CostInvoice cost and all other costs

necessary to achieve normal utility of an asset

Bringing asset into production includes freight, taxes, installation, warranties, training, etc.

These costs are normally capitalized by the owner for accounting purposes

These costs offset income which lowers federal income tax liability

Support from Westmoreland Support from Westmoreland Case in Halifax CountyCase in Halifax County

NC Court of Appeals case page 8 & 9…the Department of Revenue has the

power to “prescribe the forms, books, and records to be used in the listing, appraisal, and assessment of property…

…guidelines provide that the acquisition cost of property includes “installation, sales tax, freight, and all other costs incurred with obtaining the property and making it ready for its intended use.”…

RCNRCN

The cost to replace property with assets which are comparable and have equivalent utility and functionality

Not reproduction cost which is the cost to construct an exact replica of the asset

Data comes from vendor catalogs, internet searches, dealer quotes, cost manuals

Ouch!Ouch!Wouldn’t it be nice if we could go to

one source of information that tracks increases and decreases in the costs of machinery and equipment?

Enter the NCDOR Cost Index Enter the NCDOR Cost Index & Depreciation & Depreciation Schedules !!!!!!!!!!Schedules !!!!!!!!!!We use index factors to

represent the overall price level changes for certain classes of property

The trending process applies the proper percentage of adjustment either positive or negative to historical cost data to find the replacement cost of an asset

Enter the NCDOR Cost Index Enter the NCDOR Cost Index & Depreciation & Depreciation Schedules !!!!!!!!!!Schedules !!!!!!!!!!Normally, it costs more to make a

product so the index factor increases

After depreciation is then applied, that remaining number is the good factor

So, higher costs to produce with pre-determined amounts of depreciation = lower good factors and lower values as the asset ages

Enter the NCDOR Cost Index Enter the NCDOR Cost Index & Depreciation & Depreciation Schedules !!!!!!!!!!Schedules !!!!!!!!!!

Depreciation is the loss in value from all causes of property having a limited economic life

RCN less Depreciation = Remaining good factors

Economic Life is the time period over which an asset may reasonably be expected to maintain utility or functionality

Review of the NCDOR Cost Index Review of the NCDOR Cost Index and Depreciation Schedules and Depreciation Schedules ManualManual

What is it?

Memorandum

Introduction

Major Category Descriptions

Valuation Tables

Cost Index & Dep. Cost Index & Dep. SchedulesSchedules

An effective & efficient method for determining current replacement cost new less depreciation to value property

Utilizes the cost approach to valuation

Widely accepted, but not required to be used by county appraisers

Annual MemorandumAnnual Memorandum

Summarizes changes from the previous year

More clarity in the categoryNew prevalent industry

descriptionsLife year adjustmentsRemindersExample: Propane gas tanksSpecial schedules

IntroductionIntroduction

A great description of what the schedules are and how the factors are determined

Example of how the good factors are calculated

Good factors-the product of the trending factor and straight-line depreciation over the economic life of the asset groupings

Major Category Major Category DescriptionsDescriptionsFrom aerospace to woodworking

equipment and industry categorization

Reference to the page number, schedule to use, and life years

Helps focus on the primary function of the business and the dominate type of equipment used

NAICS Code/Principle business in the county-captured on listing form

Valuation TablesValuation TablesProvide the good factor percentages

to apply to the reported costsA method to arrive at Fair Market

ValueData provided on the tables: The

year acquired, the age of the asset, the trend factor, the economic life in years, and the good factors

Good factors represent the remaining amount of replacement value new after depreciation-Import File

Yrs 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

A3 67 33 25

A5 80 61 42 25

A6 83 68 53 36 25

A8 87 76 67 55 41 29 25

A8T 78 64 53 41 29 19 9 5

A9 89 80 71 61 49 39 27 25

A10 90 81 74 65 56 47 36 25

A10T 81 69 59 49 39 30 22 14 6 5

A11 91 83 77 70 60 51 44 33 25

A12 92 84 80 73 65 59 51 41 31 25

A14 93 87 84 77 72 67 61 53 44 36 26 25

A15 93 88 85 80 75 70 64 58 49 41 34 25 25

A16 94 88 86 82 77 74 68 62 54 46 39 32 25

A17 94 89 87 83 80 76 71 65 58 51 44 37 30 25

A18 94 90 88 85 81 78 74 69 62 55 49 42 36 29 25

A20 95 91 90 87 84 82 79 74 68 62 56 50 45 39 33 28 25

B3 67 33 10

B5 80 61 42 25

B6 83 68 53 35 25

B7 86 72 60 46 32 25

B8 87 76 66 54 40 28 25

B10 90 81 74 64 55 44 34 25

B11 91 83 77 68 59 49 41 31 25

B12 92 84 79 72 63 56 48 38 29 25

B20 95 91 89 86 82 78 74 69 63 58 52 46 40 35 30 25 25

B25 96 93 92 90 87 84 82 78 73 69 64 60 55 51 47 43 39 35 30 26 25 25

C3 67 34 25

C6 83 68 53 36 25

Import FileImport File

Producer Price Index DataProducer Price Index Data

What is it?

Website tables

Migrate over to NCDOR Schedules

Examples

Facts about PPI

Producer Price IndexProducer Price Index

Comes from Bureau of Labor Statistics Data

Family of indexes that measures the average change over time in selling prices of goods & services

Makes use of NAICS codes!Data is from a sampling of

producers in manufacturing, mining, and service industries

Series Id:  PCU333294333294Industry:   Food product machinery manufacturingProduct:    Food product machinery manufacturingBase Date:  198312 Download:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual

2001 171.1 170.9 170.8 171.0 171.0 171.0 171.3 171.3 172.6 171.7 172.3 172.3 171.4

2002 172.4 172.6 172.9 172.9 172.8 172.4 172.7 172.8 172.8 172.7 172.2 172.5 172.6

2003 173.5 173.6 174.0 174.2 174.9 174.9 175.1 175.1 175.1 175.4 176.1 175.2 174.8

2004 175.8 176.4 179.7 180.9 181.4 181.5 181.7 182.1 183.3 183.4 183.4 184.9 181.2

2005 186.8 186.9 187.2 187.7 189.0 189.0 189.2 189.5 189.7 190.4 191.8 191.8 189.1

2006 192.5 193.2 194.5 194.7 195.2 196.0 197.4 206.2 207.2 207.7 207.8 208.0 200.0

2007 210.6 211.3 211.9 212.2 212.3 213.5 213.9 215.0 215.3 216.5 217.0 217.1 213.9

2008 219.2 219.4 220.7 222.0 222.3 222.4 223.6 224.0 224.1 224.5 224.1 223.6 222.5

2009 224.2 224.3 224.0 224.4 224.6 224.6 224.3 224.1 224.2 224.2 224.3 224.2 224.3

2010 225.2 225.5 226.6 226.8 227.0 227.0 227.9 227.9 228.0 227.9 228.6 229.9 227.3

2011 230.4 231.3 232.3(P) 233.1(P) 233.2(P) 233.6(P)              

P : Preliminary. All indexes are subject to revision four months after original publication.

Producer Price Index Industry Data

Percentage change over a Percentage change over a 12 month period:12 month period:

Select the month of September

Take 2010 figure, subtract 2009 figure and divide product by 2009 figure to arrive at percentage change

228.0 – 224.2 = 3.803.80 / 224.2 = + 0.017

Multiply by 100 x 0.017 = +1.7 % overall change

Consider the relationship between the Consider the relationship between the depreciation taken and the value depreciation taken and the value remaining-remaining-A -10 means it takes 10 years to fully

depreciatethe remaining value of the asset:Yr. Depreciation Taken Remaining Value1st 10% 90%2nd 20% 80%3rd 30% 70%4th 40% 60%5th 50% 50%6th 60% 40%7th 70% 30%8th 80% 20%9th 90% 10%10th 100% 0%

Calculate the good factor based on the Calculate the good factor based on the trending factor x the straight-line trending factor x the straight-line depreciation factor-depreciation factor-Yr. Acq’d Age Trend R-Value Good Factor Good Factor %

2010 1 1.00 0.90 0.900 90%

2009 2 1.01 0.80 0.808 81%

2008 3 1.02 0.70 0.714 71%

2007 4 1.07 0.60 0.642 64%

2006 5 1.10 0.50 0.550 55%

2005 6 1.13 0.40 0.452 45%

2004 7 1.18 0.30 0.354 35%

2003 8 1.22 0.20 0.240 24%***

2002 9 1.24 0.10 0.124 12%

2001 10 1.24 0.00 0.000 0%

***BUT-we stop at a 25% residual value!

Facts Facts

Targets US producers so imports are excluded

Price collected is revenue received by producers-not sales tax, excise tax, etc.-these are not revenue to producer

Used to deflate revenue streams to measure real growth

One of the oldest economic time series compiled by the Fed. Gov.-1891

Historical Costs vs. Allocated Historical Costs vs. Allocated Purchase Price ValuePurchase Price Value

What is it?

Our goal for equitable valuation

Undesirable features of allocated purchase price

Example of higher tax liability

Questions to ask

Historical vs. AllocatedHistorical vs. Allocated

Historical cost is the cost of the property when it was first placed into service by its original owner

Allocated cost or Acquisition cost is the price paid for an asset when acquired by the present owner

Our Goal for EquityOur Goal for Equity

Historical cost works well with the trend tables-value is gradually reduced over time

A full installed cost approach to disclosing reportable costs

The audit is an examination of the accounting records of the business owner

Undesirable Allocated Undesirable Allocated Purchase PricePurchase PriceShort circuits the use of the CI&DSNot based on cost new in the year of

manufactureArbitrary number selected by a non-

appraiserMotive is to lower income tax liabilityCould increase value on M & E, then

decrease value on “good will” to inflate the amount of depreciation, thus less income tax on the business

Allocation? : ( Allocation? : ( Requested amount could be after a

write down of assetsCould be a distressed sale or not

an arm’s length transaction-may I have a copy of your sales contract?

This may be an assigned value that fails to capture installed costs

What portion of the allocated cost do you remove when the asset is disposed of?

Allocation? Allocation? Using the allocated price is a

disservice to all other taxpayers-not uniform & equitable

Why can’t the new owner get the old records from the seller?

Why can’t the new owner get permission from the seller to allow the county to release the old records so the new owner can complete the listing properly?

The Last Resort!The Last Resort!Westmoreland case supports both

the inclusion of all costs and the methodology that the NCDOR has adopted and recommended

DO NOT DEPRECIATE the allocated purchase price-that price IS THE VALUE!!!

Leave good records in the file about why you accepted this methodology

Higher Tax Liability???Higher Tax Liability???

Given Data:2002 Commercial Bread Baking OvenHistorical Installed Cost = $100,000Use A-10 ScheduleSitused in Wake County = $0.534 rateSo…$100,000 x 25% = 25,000

divided by 100 = 250 units of value x $0.534 =

$13.35

Higher Tax Liability???Higher Tax Liability???Bought asset in 2010Allocated purchase price = $30,000So…$30,000 reported in current

year divided by 100 = 300 units of value x $0.534 = $160.20

Dear Mr. Business owner, Would you rather pay $13.35 or

$160.20 ??????

Questions to Questions to ask-----------------ask-----------------Does the price paid represent fair

market value?Were all of the assets purchased

from the prior owner?Have any of the assets been sold by

the new owner since the purchase?Were the reported costs of the prior

owner ever audited?What is the purchase price

allocation based on?

Questions to Questions to ask-----------------ask-----------------Was an appraisal made of the

property prior to the sale?Was an appraisal made of the

property after the sale?How many business locations

were involved in the purchase?May I read the sales contract?Are you sure you can’t get me

the historical installed costs?

Mass Appraisals???Mass Appraisals???

What is it?

How the schedules accomplish our goal

Elements to consider

Reverse Trending

Massive NumbersMassive Numbers

Appraising mass numbers of groups of assets vs. mass numbers of individual pieces of equipment

M & E, F & F, Computers, etc.Consider all elements in 105-317.1Getting a value by going backwards

Variations in the Trend FactorsVariations in the Trend Factors

The “T” Schedules

Example of the effects of a positive trend

Other impacted schedules

Residual values

Example of a positive trendExample of a positive trendYr. Acq’d Age Trend R-Value Good Factor Good %2010 1 1.00 0.98 0.980 98%2009 2 1.01 0.96 0.970

97%2008 3 1.06 0.94 0.996 99%2007 4 1.17 0.92 1.076 108%2006 5 1.21 0.90 1.089 109%2005 6 1.29 0.88 1.135 113%2004 7 1.32 0.86 1.135 114%2003 8 1.35 0.84 1.134 113%2002 9 1.36 0.82 1.115 111%2001 10 1.35 0.80 1.080 108%2000 11 1.38 0.78 1.076

107%1999 12 1.39 0.76 1.056 106%

VariationsVariationsU-12 stops @ 35% for tractorsU-5 goes down to 10% for data

processingU-6 & U-8 goes to 15% for semi-

conductors, digital & switching equip.B-5 goes to 10% for analog TV equip.D-6 goes to 15 % for POS, hand held

data, & electronic cash register equip.

M- does not drop below 40%-vaults

Residual ValuesResidual Values

25% is a conservative amount of value

Difficult to value older equipmentRemaining value is a “going

concern” value

Variances From the SchedulesVariances From the SchedulesIdle and non-idle equipment

Construction in Progress

Expensed items

Leased equipment

Leasehold improvements

Inventory

Questions to ask

VariancesVariancesIdle equipment Equipment that has been taken

off production status on a permanent basis---

Non-idle equipment Stand-by & seasonal equipment

that is waiting to be used at the proper time---

VariancesVariancesConstruction in Progress – CIP The investment in production

equipment which has not been placed into operation

Listed with the county @ 100%

Validation costs and physical wear & tear

VariancesVariancesExpensed Items The cost is expensed depending on the threshold amount IRS Section 179 items• Leased Equipment Generally valued at the same amount as owned

property Manufacturer/Lessor should report retail selling price

VariancesVariances

Leasehold Improvements Real estate improvements to

leased property contracted for, installed, and paid for by the lessee which may remain with the real estate

10 or 20 year life? Use the “N” schedule

VariancesVariancesInventory

Definition by the financial officer vs. the county definition

Supplies

Questions to ask?

QuestionsQuestions

Why is the equipment idle?Is the equipment permanently idle?What is the age of the equipment?Is there a market for the equipment?What are the future uses of the

equipment?What is the condition of the equipment?What is the remaining life of the

equipment?

Trends in the Billboard IndustryTrends in the Billboard Industry

The Billboard Manual

Base costs

Percent change in building costs

Manual is always current

Trends in the Billboard Trends in the Billboard ManualManual

2009 Billboard ManualA cost factor is applied to the base

costsThis factor is the percentage

increase or decrease over the previous year to construct a billboard structure

Fluctuates from year to yearNo need to revise the manual

Local Government Division---919-733-Local Government Division---919-733-77117711

Dave Duty---919-715-9771Dave Duty---919-715-9771

THE END