Whole life cost calculation

An essential element of whole life costing is defining the life-cycle period to be adopted. An assessment must therefore be made of the life of the investment (the 'asset life').

Typically, the relevant asset life will be the period over which the organisation for which the study is being conducted is expected to hold an interest in the asset, and will take into account any residual value or cost of disposal.

Residual value

At the end of the life of an asset, the asset and the land will often have a residual value. In the case of relatively short life cycles, or high value land, residual values can be significant factors in determining the optimum life cycle cost options. Either:

• the asset will have reached the end of its life, and will not have an alternative use; or
• the asset will have reached the end of its life for its planned purpose, but will have an alternative use.

In either of these situations, the residual value may be significant, and will need to be assessed with care, as it may have a substantial effect on life-cycle costing calculations. Residual values will be of particular significance if the time horizon used for the purposes of the life-cycle costing calculations is relatively short.

In considering residual values, an allowance should be made for the cost of disposing of plant and equipment and for any demolition as appropriate. In considering demolition costs, allowance should be made for the value of any reusable materials.

When the asset life is assessed at over 40 years, the precise life is not critical for the purposes of whole life costing (as discounting, explained below, minimises the effect of future payments). In cases where calculations are based on a relatively short life, say 20 years or less, the assessment of time horizons must be carried out with special care.

Obsolescence

Asset life is influenced by obsolescence which can be categorised as:

• physical;
• economic;
• functional;
• technological;
• social; and
• legal.

Assets usually end their 'life' before the end of their physical life. The most common reasons for obsolescence are economic and functional considerations. Assets designed for a specific specialised use, with little or no flexibility for changing their use, are therefore likely to have shorter lives than those offering flexibility for a change of function.

The table below gives definitions and examples of each form of building obsolescence:

Notwithstanding the difficulty of the task, the surveyor, in consultation with the client, must make an informed assessment of the asset life to be used in any particular study. In making that assessment, the surveyor will need to take account of a number of factors that may influence the final assessment of asset life in any particular case.

While the examples relate to the whole asset, the obsolescence of elements or components is also relevant. For example, major refurbishment of retail buildings may be required at, say, 15-year intervals, for the buildings to remain attractive.

Owners also need to be aware of taxation issues and consider whether these affect their property or building decisions.

There are strict guidelines regarding taxation adjustments that arise upon disposal. If the plant and machinery is 'scrapped', the remaining value is written off and a balancing allowance brought into account. Alternatively, if the building (and the plant and machinery contained therein) is sold, the vendor should declare whether allowances have been claimed. An adjustment to the after-tax cost will arise, according to whether the disposal value is greater or less than the written-down value remaining on the vendor's accounts.

This is an area of tax advice that is experiencing increasing scrutiny from the HMRC and the District Valuer's Department, as parties to property transactions sometimes elect or contract the disposal values of tax-relievable components, with specific tax planning objectives.