Fixed Asset Disposals (#122)
/In this podcast episode, we discuss several reasons for keeping older fixed assets around a bit longer. Key points made are noted below.
This episode is about disposing of fixed assets – not the accounting for the disposal, but the issues you should consider before you actually do dispose of an asset. Anyway, this discussion is only about really expensive fixed assets where it’s worth your time to analyze the issues, not something cheap like a desktop computer that you’re going to swap out every few years.
When to Retain an Asset
Now, my first point is about the process you go through to buy a fixed asset. There may be a capital budgeting procedure, where someone has to formally apply to buy an asset; and you do a discounted cash flow analysis or a throughput analysis to see if it’s worth buying. But did you ever do an analysis that also includes the cost of just keeping what you already have, rather than buying a new asset at all?
In a lot of situations, there’s pressure inside a company to replace assets – maybe because there’s a bit more demand than the existing equipment can handle, or because the equipment is getting old and cranky, and the maintenance department is sick and tired of repairing it. Or maybe because it’s exceeded the recommended life span of the manufacturer.
Well, when any of these factors come into play, and the equipment doesn’t cost that much, chances are that management will just say fine – throw out the old gear and bring in the new. But what about cases where the old machinery is really expensive – or maybe it’s a whole facility that you’re thinking about replacing.
If you have a situation like this, then you need to start thinking about conducting an analysis maybe every year – and it’s mainly about what’s the cost of keeping this old clunker running just one more year? And if you’re a little short on capacity with that old asset, what’s the cost of turning away some business or outsourcing some production? This is a worthwhile discussion, because the cost of prolonging what you already have is usually way less than the cost of buying all new gear.
And if you think the risk of an old machine failing is all that great, you might want to measure the failure rate to see if it’s really as bad as you think. In a lot of situations, an old machine is really just very well broken in, and it doesn’t fail very much. In fact, you may find that the break in period for a new machine makes it less reliable than the old machine, at least for a few months.
Why Not to Throw Out Replaced Equipment
Now let’s say you’ve gone ahead and ignored my advice and bought new equipment. Even now, do you really want to sell off that old machine? After all, it may have some utility left, and chances are, you won’t be able to sell it for much. In a case like this, you may want to keep some reserve capacity on hand, just in case the new equipment breaks down. And if the new equipment is more automated than the old equipment that it’s replacing, there’s a pretty good chance that all that extra complexity is going to cause a failure.
In particular, if you like to focus on throughput, it makes a lot of sense to keep some excess capacity lying around, especially if it’s upstream from your bottleneck operation. If you want to learn more about throughput, go back to my episodes 43 through 47.
And here’s another thought. You may have to incur more cost to eliminate an asset than you would if you keep it. In particular, what if there’s a fair amount of environmental remediation cost involved? In cases like this, it may be more economical just to delay incurring those extra expenses a bit longer by hanging on to the asset.
Who Questions Fixed Asset Acquisitions?
So there’s a few things to consider. Now, who should be doing all of this questioning? The CFO should. In fact, the CFO is probably the only one who can. You see, the problem with capital budgeting is that an asset purchase builds its own bureaucratic momentum after a while, where there’s a pile of paperwork that everyone reviews and signs off on – and it has a sponsor somewhere who’s pushing it along. And here you are, trying to slow down the process and make people really think about whether it makes sense to keep using what you have, rather than buying that really neat, high-speed whatchamacallit. It takes a CFO with some clout to do this.
Of course, since the CFO needs to be involved and the CFO is busy with other things, this means that he or she can’t get involved very frequently – so you have to make those few times count.
Therefore, to be efficient, the budget analyst or cost accountant needs to spot those situations where an asset is going to be disposed of, and where there may be a good reason to keep it. They notify the CFO and supply a complete set of backup information, and then the CFO goes into battle.
So why am I spending time beating on this topic so much? The reason is that if you can avoid a really large capital expenditure even once every year or two, that could mean a savings of millions of dollars.
Parting Thoughts
And by the way, what I’m talking about here is not black and white, like you proceed with a project or you kill it. What might very well come out of the discussion is a decision to scale back on a purchase to something less expensive, while also keeping the existing machine. And this outcome can still save a pile of money.
And that last point is worth chewing on a bit. The outcome is that you keep an existing asset and also make a reduced capital expenditure. What this does is give you two assets capable to doing the same thing, which gives you greater total capacity, but which has the added benefit of still giving you some capacity even if one of the machines breaks down. And means you’re averting the risk of a production stoppage by keeping the old machine.