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5. Methodological features of commercial vessel estimation based on cost approach
The systemic estimation of reproduction cost RC (or replacement cost), along with the depreciation and obsolescence is of great importance in the process of value estimation of the vessel or other asset.
Reproduction cost RC is a sum of expenses for construction of structural analogue in market prices on the date of estimation. Replacement cost is a sum of reproduction cost of a functional analogue. And the structural analogue is also a functional analogue.
The estimation of reproduction cost can be done separately as an independent subject, when there is a revaluation of the real assets, that except rules of an expert estimation is regulated in this case not only by the rules of an appraisal but also by book keeping standards.
For example, in Russia by Book Keeping Regulations PBU 6/01 (ÏÁÓ 6/01) «… the commercial company can not more often than once in a year (for the beginning of fiscal year) re-estimate groups of homogeneous objects of the real assets at present (reproduction) cost by indexation or by direct recalculation based on documentary confirmed market prices».
According to methodological instructions of book keeping the real assets (the Order # 91 n (91 í) from October, 13th, 2003 of Ministry of Finance of the Russian Federation) it is defined, that «… current (reproduction) cost of the real assets objects is understood as a sum of cash which should be paid by the company on the date of revaluation if there is a need of replacement of any object ».
The revaluation is made for groups of the same real assets. If the revaluation of the real assets has already been, subsequently, the revaluation is made annually for the beginning of the present year and presented in the tax reporting from the beginning of the year following for accounting.
It should be noted, that book keeping standards in some cases contain ambiguous definitions, and much leaves to the discretion of the expert.
For example, on the one hand, under book keeping Regulations, when making revaluation it is required to determine of reproduction cost in «market prices» with the account that in the case of replacement of any asset, it would be necessary to pay the sum of cash which corresponds to its market value on date of revaluation.
At the same time, according to the book keeping Regulations the expert determination of depreciation is not required when revaluating the assets, though it’s quite clear that the replacement of the asset whish was in operation and is subject to depreciation does not, mean acquisition of the same not new asset, which is subject to depreciation.
5.1. Economic models of commercial vessel reproduction cost
Recommended by different authors methods of determination of reproduction cost (market costs for construction) of commercial vessel are the following:
1) Estimation is done according to usual contract prices of similar vessels constructing set for the time as much as possible approached to the date of estimation;
2) Estimation is done on the basis of data of vessels construction costs, published in specialized directories, catalogues, advertizing brochures of shipyards, standard regulations of vessels estimation and revaluation, published by corresponding services;
3) Estimation is done on the basis of expenses calculations in order to get an exact replica of the commercial vessel, or a vessel of equal utility on the date of estimation.
It is possible to see, that first two methods are based on application of the comparable sales approach and differ by data sources, and the third method is close to working out of the facility dependent cost estimate.
It’s clear, that is not provided use of the income approach while determining of the reproduction cost.
Strictly speaking, it is not quite logical and probably indicates at mixing of concepts: on the one hand, the concepts of reproduction cost as the total of expenses for vessel construction in present market prices, and on the other hand, the method of expenses components summation to determine reproduction cost as under the cost estimate.
As the reproduction cost evaluated in market prices is formed not only during the vessel construction, but also while it is transferred to the shipping company which, when it makes payment is guided by expected profitableness even if terms of the contract are defined prior to the beginning of the vessel construction, it is possible to make a method of value estimation under the income approach for a new vessel, i.e. estimations of the reproduction cost which in the market conditions and the compromise interests of the new vessel seller and the buyer is closely connected with its reproduction cost, and also, with expected profitableness.
The analogy is pertinent. In spite of the fact that the displacement of a commercial vessel is equal to the total of its parts, the method of displacement determination does not necessarily consists of weights of the parts of the summation, and it is possible to determine the weight of the displaced water under the Archimedes law, that is also truly indicates the displacement of the vessel.
By the way, the application of three approaches set, if besides the use of the comparable sales approach and a method based on summation of expenses it is possible to make up and apply correctly the income approach to market value estimation of a new asset (or vessel), is methodologically more valid for expert revaluation of a fixed capital as it has to be reflected in the accounting reporting according to appraisal standards.
While determining the reproduction cost of not a new vessel it can be difficult to determine by the expert opinion the total of construction expenses in market prices on the revaluation date if the data of expenses for construction are lost or have become outdated.
At the same time, the data for not a new vessel about its profitableness in the property complex are collected. In this case the application of the income approach for determination of the market value of a new similar vessel (or another asset) and further reproduction cost on the date of its revaluation with the account necessary adjustments to the market value along with use of the comparable sales approach to determine the reproduction cost of serial vessels (or other assets of the marine company) can make a basis of the of revaluation general algorithm.
If the method of determination of the reproduction cost is based on summation the following kinds of expenses which should be taken into consideration while determining the reproduction cost of a commercial vessel (or a vessel of equal utility if the objective is to determine the replacement cost) are usually provided.
1. Direct costs.
1.1. Cost of materials, purchased machines, mechanisms, products and equipment.
1.2. Wages of the basic industrial workers.
1.3. Special expenses, including connected with use of construction and lifting facilities: a construction berth, a dock or a building slipway.
1.4. A shop overhead charges, including charges for equipment operation and shop general charges.
1.5. General manufacturing expenses.
1.6. Non–production expenses.
1.7. Shipyard profit.
2. Indirect costs.
2.1. Expenses for payment of the designing, technical supervision and control over the vessel construction.
2.2. Payment of consultations, inspection (survey), supervising, legal and auditor services.
2.3. Expenses for financing, repayment of credits and interest.
2.4. Expenses for advertising, marketing and vessel sale.
2.5. Administrative expenses, fee and profits of developer.
3. Enterprise profit (except the profit of developer and the creditor), including taxes.
The types of expenses listed above are entered in a «technological» binding that is from the point of view of a shipyard instead of an object – a vessel and can be attributed to the structure of expenses for objects of various classes, not only for commercial vessels or marine engineering and ocean technology.
To calculate he expenses besides labor input of construction it is necessary to apply scientifically proved standard of a payment, when reproduction cost of a commercial vessel will not exceed solvent demand of the future ship-owner and it will be paid back by the profit.
In frameworks of the cost approach for value estimation of marine commercial vessels or other real assets as a part of the marine company’s property complex it is rather reasonable to develop and use the models of reproduction cost.
Working out of models of cost was carried out at the branch scientific research institutes of the ship–building industry and shipping, at profile universities, etc. The model of reproduction cost can be defined as a data system (graphs, tables, databases and so forth) and rules of reproduction cost calculation (mathematical equations, algorithms, instructions, methodical manuals etc.).
Models of expenses summation don’t always provide acceptable accuracy of the reproduction cost total value estimation and would be used in addition to other methods of the reproduction cost estimation.
The use of reproduction cost models nevertheless allows solving the structural tasks, with the account the above mentioned remark including the following ones:
– To formulate signs (characteristics) of comparability and to define units of comparison;
– To define the structure of reproduction cost that is applied further for an estimation of depreciation based on method of «separation».
The use of models of reproduction cost of commercial vessel or other real asset of the marine company allows defining:
A) The structure of reproduction cost, that is specific or percentage ratio of various components as a part of reproduction cost;
B) The correlation of reproduction cost of different vessels or ranging of vessels in sequence of its decrease or increase;
C) The monetary value of reproduction cost.
Concerning the last point from the specified tasks (C) it should be noted that not any models of reproduction cost reflect the influence of market variability on cost. Some models of cost known by industrial and scientific publications consider only vessel characteristics.
The reproduction cost (or replacement cost) is an important economic concept and can be applied for the solution of some tasks:
– For definition of requirements in contracts for fleet replenishment;
– As the optimality criterion in some design subjects;
– As intermediate value in estimation of commercial vessel market value, in economic estimation of depreciation etc.
5.2. Integrated structural components as a part of the commercial vessel reproduction cost
Usually reproduction cost is determined as the total of components to which can be referred the values of either the several integrated infrastructural parts (groups) or several technological parts, and sometimes the compromise option of reproduction cost separation into components – simultaneously into structural and technological groups is applied.
Reproduction cost of a vessel RC as the total of addends RCn is determined as RC=ΣRCn.
The ranging of industrial expenses components, that is addends of reproduction cost into groups RCn is made on the basis of dependence on commercial vessel technical characteristics or their combinations uniformly influencing cost, for example as follows:
– Purpose;
– Displacement and its components;
– Displacement empty;
– Cargo capacity;
– Deadweight;
– Type and power of the main engine;
– Dimensions;
– Tonnage;
– Characteristics of used materials;
– Ice forcing class etc.
The following infrastructural parts of expenses can be referred as a part of commercial vessel reproduction cost RCn.
– Vessel hull (the hull of commercial vessel or its separate parts with framing, erecting parts, bulkheads, decks, platforms, piecks, cabins and superstructures);
– Vessel hull equipment (the equipment of general purpose used on commercial vessels of various classes, except for the special purpose equipment);
– Deck devices and general purpose systems (except for the systems concerning main engine and power–plant);
– Main engine and power–plant, mechanisms, systems and the engine room equipment;
– Special equipment – load–lifting, towing, etc.;
– Ship–building equipment.
The similar method of ranging of the integrated infrastructural parts of expenses was used in a technique of vessels economic indexes estimation [16], developed in the Central scientific research institute of a marine fleet (CNIIMF).
The advantage of the considered method of CNIIMF is the ability to take into account the influence of the vessel characteristics on reproduction cost (or replacement costs) components.
Doubtless advantage of models which are created according groups of structural separation is the possibility to make a in–depth analysis of reproduction cost of not only one vessel, but also the different projects which being constructed at one as well as at different shipyards.
It is supposed, that cost detalization within reasonable limits adds to evaluation objectivity until the error of estimation does not exceed some articles of reproduction cost. Thus, it is considered, that the error of an expert estimation of separate articles of expenses can be both positive and negative.
In reproduction cost components summation, the errors of different signs are mutually compensated, and consequently the error of reproduction cost estimation (that is costs total) is less than errors of components anyway in their relative value.
Classification of industrial reproduction costs RCn by technological signs was used in the technique of the Central scientific research institute «Rhumb» of the ship–building industry.
The following items can be referred to the costs components according to their technological attributes:
– Direct material inputs – materials, half–finished products, counter agency deliveries of details, assembles and units;
– Expenses for transport, communications, utilities etc.;
– Wages of the basic workers, auxiliary workers, engineers, scientists, management personnel, etc.;
– Profit and taxes.
The advantage of the industrial expenses RCn classification method by technological attributes is the ability to consider change of resources costs (materials, deliveries, work …), and also rates (taxes, insurance coverage, indexes of profitability and commercial risks …).
Professor L.B. Breslav [9] advised to use the so–called «matrix» models representing tabular forms where classification attributes of ship construction costs vary in the lines and columns for estimation of ship–building costs total, and double summation is made to determine the reproduction cost by components RCn,m of costs RC=ΣΣRCn,m.
For example, expenses in various columns can refer to different infrastructural parts: the vessel hull, the hull equipment, the vessel systems and devices, the vessel power–plant …, and in various lines – to different technological groups: materials, counter agency deliveries, wages, overhead charge, taxes … profit.
Using this way of calculation, the industrial costs for each infrastructural part are determined as the total of technological groups of costs and vice versa, and different concepts of costs systematization are interrelated as a whole.
The basis of value estimation in industry is the definition of expenses for salary and for purchase of material resources. The following items: materials, electric power and energy sources, counter agency deliveries, etc. can be referred to resources.
The main part of ship hull structures of vessels is made from carbon steel which is very cheap, strong and technologically suitable for welding, and also used in rolling and punching manufacture.
For most of marine commercial vessels the weight of carbon steel makes more than 97 % of the hull weight. The same is true for vessel’s power–plants, mechanisms, elements of devices and systems structures which are not made at the shipyard, but are delivered by contractors.
Besides, steel of low alloy, pig–iron, nonferrous metals and nonmetallic materials can be applied in hull structures but scarily.
For the analysis it would be reasonable to compare the cost of one tonne of steel and the cost of one tonne of ship–building metal frameworks construction.
Expenses for steel purchase as parts of commercial vessel reproduction cost, despite great total cost, are not a dominant component of costs and vary from 15 to 20 %, including cost of energy in expenses for metallurgical process and cost of steel which goes to waste.
The greatest quantity of power resources is consumed for metallurgical process of carbon steel and other metals used in shipbuilding.
Thermal or machining processing of structural materials at the ship yard consumes much less energy.
Thus, cost of the most part of energy sources spent for commercial vessel construction is finally included into cost framework of structural materials.
As energy expenses referred to one tonne for the metallurgical process much more than metal processing energy expenses it is possible to consider that the indicated specific value more completely characterizes material resources share as a part of vessel construction costs.
Thus it is necessary to underline that it is a question of the commercial vessel reproduction cost structure instead of the structure of ship yard indexes which does not carry out the metallurgical process.
The reproduction cost of a commercial vessel to a large degree includes the added value and is mainly a sum of variable components: salaries, direct material inputs, profit of the shipyard.
Reproduction cost is established with respect to the added value defined at the level to which the new vessel will be in the market demand.
That’s why to estimate the reproduction cost the forecast of commercial vessel productive operation by means of working out and use of market pricing models is also required.
The breaking up of the cost into the integrated parts (vessel hull, hull equipment, systems and devices, vessel power–plant …) makes modeling of the reproduction cost of commercial vessel or other real asset more specific and informative, since classification of expenses by technological groups (materials, counter agency deliveries, salary, overhead charge, taxes, … profit) for shipbuilding and for other industries is similar in many respects.
The breaking up of reproduction cost into the integrated infrastructural parts gives the chance to establish dependences of cost by groups and in total on characteristics of commercial vessel or other real asset of the marine company and to use the received dependences for cost determination, and also for feasibility analysis and optimization of the project characteristics by economic criteria.
Besides, the dependences of reproduction cost of the infrastructural parts on characteristics of commercial vessel or other real asset of marine company can be applied for accumulation and processing of statistical data and for approximation. It cannot be executed when reproduction cost broken into technological groups.
Nevertheless, the following methodological difficulties arise while making the analysis of the integrated groups as a part of reproduction cost of commercial vessel.
The concept of a cost of the integrated infrastructural part is defined insufficiently. It is impossible, for example, to imagine the engine room equipment as a collected operating system existing separately from the vessel as a whole.
Therefore, insufficient clearness of the methodological definition of the integrated infrastructural part can cause indeterminate of its estimation.
It is necessary to specify, that it is the correct estimation of cost as a part of reproductive cost that is of practical value rather than the concept of the integrated infrastructural part.
At this point «cost of infrastructural part» definition, which could be used for determination of commercial vessel reproduction cost or other real asset of marine company, should be introduced.
To search the answer for the question, let’s consider an example. We will represent the reproduction cost of vessel RC as a sum of two components depending on empty vessel displacement DP and on main engine power Ne, figuratively speaking, as a cost of «structures» and «power»: RC = a1×DP+a2×Ne.
Factors a1 and a2 define the degree of influence of empty vessel displacement DP and main engine power Ne on reproduction cost RC and also they are scaling as they establish correlation between displacement and power dimensionalities.
It is required, that the characteristics of the commercial vessel used in the formula as parameters were not interdependent. Strictly speaking, this rule is difficult to achieve.
So, in the given example the main engine power and displacement of the commercial vessel empty are used as parameters. Clearly, that these characteristics depend on each other. But the choice of other combination can be less successful because all characteristics of the commercial vessel are functionally interconnected.
Factors a1 and a2 in the offered formula are unknown. To determine the factors we masts do either statistical approximation with application of the accepted formula or use the given analogues – two vessels for which are such characteristics as: displacement empty DP, main engine power Ne and reproduction cost RC, as a sum of expenses in modern market prices for construction, are known.
If, the least necessary number of analogues are applied to determine of factors a1 and a2 is equal to the number of unknown factors. In the considered example it is necessary to use the data of two commercial vessels of similar purpose for which we know the following indexes: reproduction cost RC, displacement empty DP and main engine power Ne.
According to analogues the following values of the specified indexes are accepted:
– The first analogue RC1 = 3370 thousand US dollars, DP1= 1160 tonne, Ne1 = 885 kW;
– The second analogue RC2 = 9510 thousand US dollars, DP2 = 3220 tonne, Ne2 = 2888 kW.
As a result we receive the factors values:
a1 = 2.629 thousand US dollars / tonne and a2 = 0.362 thousand dollars / kW.
Accordingly the parametrical formula to determine the reproduction cost of the commercial vessel as the total of two infrastructural parts looks like
RC = 2.629 × DP + 0.362 × Ne, thousand US dollars.
The verifying substitution of values shows that the first item – the part of reproduction cost depending on commercial vessel empty displacement makes about 90 % of commercial vessel reproduction cost, and the second item – about 10 %.
Similarly, it is possible to define in what proportion to each other and to a total sum are the costs of the integrated infrastructural parts in other variants of the set separation depending on other characteristics of the commercial vessel and their combinations influencing the reproduction cost.
Apparently, the concept of the cost of integrated infrastructural part, used for estimation of the commercial vessel reproduction cost, should be introduced using a certain algorithm.
The first step is to work out parametrical, analytical or statistical (regression) dependences of reproduction cost on characteristics of commercial vessel which are important but whenever possible are least interdependent in system sense.
The second step is to study the degree of influence of every included characteristics of the commercial vessel on the reproduction cost and to define what part of the cost can be correlated with each of these characteristics.
The name of the integrated infrastructural part in the given definition corresponds to the characteristic of the commercial vessel with which the part of reproduction cost is correlated.
At every stage the cost of the integrated infrastructural part should be interpreted as the value of the vessel characteristic which justifies the expenses for the construction, and its name can be used to designate this infrastructural part.
Tab. 5 contains rough relative values of elements of reproduction cost of dry–cargo vessels and crude–oil tankers of structural breakdown groups by the published data [18].
Table 5
Relative values of elements of groups of reproduction cost structural breakdown, %
Elements |
Dry–cargo vessels |
Crude–oil tankers |
Metal hull |
From 21 to 27 |
From 35 to 42 |
Equipment parts |
From 4.5 to 9.0 |
From 1.4 to 6.4 |
Timber, coverings, severalty |
From 8.1 to 10.6 |
From 5.8 to 8.0 |
The equipment of premises |
From 2.0 to 3.7 |
From 1.1 to 1.8 |
Vessel devices |
From 4.8 to 7.0 |
From 4.8 to 5.2 |
Deck mechanisms |
From 5.2 to 8.6 |
From 2.7 to 4.0 |
Vessels systems |
From 3.6 to 5.1 |
From 4.7 to 10.0 |
Engine room pipelines |
From 0.6 to 1.3 |
From 0.9 to 2.4 |
Mechanical equipment |
From 4.5 to 8.9 |
From 4.3 to 7.6 |
Electric equipment |
From 4.1 to 8.3 |
From 3.3 to 5.3 |
Radio– and navigating equipment |
From 1.9 to 3.9 |
From 0.8 to 1.8 |
Supply |
From 0.5 to 1.1 |
From 0.3 to 0.5 |
Power plant |
From 9.3 to 15.0 |
From 6.5 to 9.7 |
General ship yard works |
From 10 to 13 |
From 9.5 to 10.5 |
The break up of reproduction cost into groups of elements opens the possibilities to estimate some kinds of depreciation and to reproduce reproduction cost value if its separate elements are known.
Test questions
1. Concepts of reproduction cost and replacement cost.
2. Definition of reproduction cost in revaluation of the real assets, periodicity of revaluation and presentation in the reporting.
3. Methods of commercial vessel reproduction cost determination.
4. Kinds of expenses as a part of commercial vessel reproduction cost.
5. Industrial binding of economic models of commercial vessel reproduction cost.
6. Assignment of commercial vessel reproduction cost models.
7. Structural tasks of commercial vessel reproduction cost models use.
8. Advantages of reproduction cost models which are created of groups of structural breakup.
9. Tasks solved using the reproduction cost.
10. Concept of systematization of expenses for vessel construction in groups depending on uniformly influencing the cost of commercial vessel technical characteristics or their combinations.
11. Example of the integrated infrastructural parts as elements of commercial vessel reproduction cost.
12. Degree of detailed elaboration of reproduction cost structure breakup into groups.
13. Advantages of reproduction cost models which are created according to the groups of technological breakup.
14. Matrix model of reproduction cost breakup into groups of expenses.
15. Influence of expenses for materials and energy sources on commercial vessel reproduction cost.
16. Methodological difficulties in defining the concept of commercial vessel integrated infrastructural part.
17. Selection of factors in the set of analogues reproduction cost total.
18. Algorithmic approach at integrated infrastructural part definition as the element of commercial vessel reproduction cost.
19. Concept of reproduction cost.
20. Distinction of methodological concepts: the reproduction cost of a commercial vessel as the total of expenses in modern market prices for construction on the one hand, and the way of expenses summation as a method of reproduction cost determination on the other hand.
21. Other methods of reproduction cost determination within the limits of the independent approaches that are not costs summation.
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