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Developing the Cost Index & Depreciation Schedules. By Dave Duty Property Valuation Specialist II North Carolina Department of Revenue Local Government Division Property Tax Section 2011 Advanced Personal Property Seminar Sheraton Four Seasons Hotel, Greensboro, NC

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Developing the cost index depreciation schedules l.jpg

Developing the Cost Index & Depreciation Schedules

By Dave Duty

Property Valuation Specialist II

North Carolina Department of Revenue

Local Government Division

Property Tax Section

2011 Advanced Personal Property Seminar

Sheraton Four Seasons Hotel, Greensboro, NC

Tuesday September 13th, 2011


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Let’s talk about these things:

  • The Cost Approach to Value

  • The NCDOR Cost Index & Depreciation Schedules

  • The Producer Price Index

  • Historical Cost vs. Allocated Price

  • Mass Appraisals

  • Variations in the Trend Factors

  • Variances From the Schedules

  • Trends in the Billboard Manual


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Review of the Cost Approach to Value

What is it?

Installed cost-The Westmoreland Case

Replacement cost new

Composite resources

Depreciation

Economic life


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Cost Approach to Value

  • The 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 value

  • Must 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


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Installed Cost

  • Invoice 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


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Support from Westmoreland Case 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.”…


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RCN

  • 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


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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?


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Enter the NCDOR Cost Index & Depreciation 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


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Enter the NCDOR Cost Index & Depreciation 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


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Enter the NCDOR Cost Index & Depreciation 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


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Review of the NCDOR Cost Index and Depreciation Schedules Manual

What is it?

Memorandum

Introduction

Major Category Descriptions

Valuation Tables


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Cost Index & Dep. Schedules Manual

  • 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


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Annual Memorandum Manual

  • Summarizes changes from the previous year

  • More clarity in the category

  • New prevalent industry descriptions

  • Life year adjustments

  • Reminders

  • Example: Propane gas tanks

  • Special schedules


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Introduction Manual

  • 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


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Major Category Descriptions Manual

  • From 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


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Valuation Tables Manual

  • Provide the good factor percentages to apply to the reported costs

  • A method to arrive at Fair Market Value

  • Data 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


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Import File Manual


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Producer Price Index Data Manual

What is it?

Website tables

Migrate over to NCDOR Schedules

Examples

Facts about PPI


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Producer Price Index Manual

  • 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



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Percentage change over a 12 month period: Manual

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 = 3.80

3.80 / 224.2 = + 0.017

Multiply by 100 x 0.017 = +1.7 % overall change


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Consider the relationship between the depreciation taken and the value remaining-

A -10 means it takes 10 years to fully depreciate

the remaining value of the asset:

Yr. Depreciation Taken Remaining Value

1st 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%


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Calculate the good factor based on the trending factor x the straight-line 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!


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Facts straight-line depreciation factor-

  • 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


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Historical Costs vs. Allocated Purchase Price Value straight-line depreciation factor-

What is it?

Our goal for equitable valuation

Undesirable features of allocated purchase price

Example of higher tax liability

Questions to ask


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Historical vs. Allocated straight-line depreciation factor-

  • 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


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Our Goal for Equity straight-line depreciation factor-

  • 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


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Undesirable Allocated Purchase Price straight-line depreciation factor-

  • Short circuits the use of the CI&DS

  • Not based on cost new in the year of manufacture

  • Arbitrary number selected by a non-appraiser

  • Motive is to lower income tax liability

  • Could increase value on M & E, then decrease value on “good will” to inflate the amount of depreciation, thus less income tax on the business


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Allocation? : ( straight-line depreciation factor-

  • Requested amount could be after a write down of assets

  • Could 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?


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Allocation? straight-line depreciation factor-

  • 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?


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The Last Resort! straight-line depreciation factor-

  • 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


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Higher Tax Liability??? straight-line depreciation factor-

  • Given Data:

  • 2002 Commercial Bread Baking Oven

  • Historical Installed Cost = $100,000

  • Use A-10 Schedule

  • Sitused in Wake County = $0.534 rate

  • So…$100,000 x 25% = 25,000 divided by 100 = 250 units of value x $0.534 =

    $13.35


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Higher Tax Liability??? straight-line depreciation factor-

  • Bought asset in 2010

  • Allocated purchase price = $30,000

  • So…$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 ??????


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Questions to ask----------------- straight-line depreciation factor-

  • 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?


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Questions to ask----------------- straight-line depreciation factor-

  • 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?


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Mass Appraisals??? straight-line depreciation factor-

What is it?

How the schedules accomplish our goal

Elements to consider

Reverse Trending


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Massive Numbers straight-line depreciation factor-

  • 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 105-317.1

  • Getting a value by going backwards


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Variations in the Trend Factors straight-line depreciation factor-

The “T” Schedules

Example of the effects of a positive trend

Other impacted schedules

Residual values


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Example of a positive trend straight-line depreciation factor-

  • Yr. 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%


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Variations straight-line depreciation factor-

  • U-12 stops @ 35% for tractors

  • U-5 goes down to 10% for data processing

  • U-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


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Residual Values straight-line depreciation factor-

  • 25% is a conservative amount of value

  • Difficult to value older equipment

  • Remaining value is a “going concern” value


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Variances From the Schedules straight-line depreciation factor-

Idle and non-idle equipment

Construction in Progress

Expensed items

Leased equipment

Leasehold improvements

Inventory

Questions to ask


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Variances straight-line depreciation factor-

  • Idle 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---


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Variances straight-line depreciation factor-

  • Construction 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


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Variances straight-line depreciation factor-

  • Expensed 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


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Variances straight-line depreciation factor-

  • 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


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Variances straight-line depreciation factor-

  • Inventory

    Definition by the financial officer vs. the county definition

    Supplies

    Questions to ask?


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Questions straight-line depreciation factor-

  • 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?


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Trends in the Billboard Industry straight-line depreciation factor-

The Billboard Manual

Base costs

Percent change in building costs

Manual is always current


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Trends in the Billboard Manual straight-line depreciation factor-

  • 2009 Billboard Manual

  • A cost factor is applied to the base costs

  • This factor is the percentage increase or decrease over the previous year to construct a billboard structure

  • Fluctuates from year to year

  • No need to revise the manual


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Local Government Division---919-733-7711 straight-line depreciation factor-Dave Duty---919-715-9771

THE END


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