Effective Procurement Of Equipment Accounting Essay

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Effective procurement of equipment as well as the maintenance and replacement of equipment are among the many problems that confront the management of any major port of trade. It is therefore likely that GPHA, which manages the Tema port one of the busiest ports in West Africa faces the same problems. Given the volume of trade (export and imports) that GPHA has to deal with it is imperative that the machines and equipment it uses be of the right kind and be in the right working conditions all the time. The average volume of total exports/imports from the ports of Ghana, managed by GPHA is approximately 530,000 TEUs per annum as compared to 260,000 TEUs form the ports of Benin (World Bank, 2012). This study evaluated the effectiveness of procurement, replacement and maintenance practices at GPHA in order to document what is working and to recommend strategies for improving performance where necessary.

Equipment are constantly being improved and developed. However, unless managers of organizations avail themselves for the economies of modern cost-reducing equipment, their competitiveness is likely to be negatively impacted.

A business can remain competitive only as long as its plants and equipment are kept functioning and up-to-date either through extensive continuous rehabilitation or through the purchase of new modern equipment. Informal conversations I have had with many experts in the area of preventive maintenance have shown that most Ghanaian organization especially public organization like GPHA have no definite equipment replacement policy at all. According to Dr. Darah, an Engineer with Coma Oil Ghana Limited, many of those that have a policy merely employ some rule-of-thumb method that does not meet the present needs of these companies.

Conversations this researcher had with Alhaji Huseini Suleiman, General Manager, Engineering, personal communication at GPHA revealed that within the last few years, large additions have been made to plant capacity at GPHA, but comparatively little advancement has been made with regards to equipment modernization programs such as the replacement of lower vintage accessories with that of higher ones on schedule or the Maintenance of old equipment.

Preliminary investigations that motivated this research indicate that top officials at GPHA often complain that they have no money to spend on the modernization of their machinery and equipment. However, what these executives do not realize is the fact that: they may be paying for machinery and equipment modernization over and over again through breakdowns and repairs which result in both a loss of production and high cost. These complaints by themselves justify a study of the maintenance and procurement practices at GPHA. This research does just that.

It is absolutely essential that industrial executives at GPHA be in a position to recognize and determine the economic characteristics of existing equipment in their plant and also of that which they are contemplating purchasing. This will enable them to know definitely when a piece of equipment needs maintenance or if it should be replaced. It is only through adequate cost accounting records and by careful monitoring of replacement needs that can this be done. Some sound basis must also be provided to ensure the original selection of the most appropriate type of equipment for the performance of the given task or service, and later its replacement by new and up-to-date equipment to justify the disposal of the old equipment and the investment of additional capital on the new.

Before any equipment replacement study can be procured in an organization like GPHA, management must become aware of the presence of an equipment investment opportunity. Every production asset becomes a candidate for profitable replacement at some point. The difficulty lies in recognizing this point when it is reached. Current practice provides for this recognition in a number of ways.

One procedure (The MAPI procedure) calls for reviewing available records and classifying equipment according to its past service life in the company's plant. Categories of equipment are then established, and an expected service life, based on historical data, is assigned to each category (Orenstein, 1956). Any asset, which attains the expected service life associated with it, is analyzed annually until it is replaced. For example, one company makes an annual study of all machine tools of a given class which have reached an age of ten years, because this has been the average service life for this type of equipment in its plant.

This procedure is often supplemented by records of certain operating costs which are maintained for each piece of equipment. The costs selected are those which are expected to reflect the presence of deterioration. These may include special repairs, scrap and rework. Periodic reviews of these records often reveal that these charges are becoming excessive for a given unit, and the asset is then studied for possible replacement. Next, most firms rely on their shop superintendents, foremen, and machine operators to notify concerned individuals when a machine is incapable of maintaining tolerances or meeting established production schedules.

In addition, most firms expect their equipment analysts to learn about new developments in the design and construction of machine tools through contacts with representatives of equipment manufacturers, reading current technical publications, and attending machine tool exhibitions. Often knowledge of the availability of a newly-designed machine suggests a possible use for it in the shop with the result that one or more existing units are studied for replacement.

In theory, all these measures for recognizing an equipment investment opportunity are inadequate according to Alhaji Huseini Suleiman, General Manager, Engineering, personal communication at GPHA. Using attained age of the equipment as a criterion by which machines most likely requiring replacement can be preselected is unsatisfactory for a number of reasons. First, it is possible that the company has been replacing equipment too late in the past, and actual service lives, therefore, do not necessarily coincide with economic lives.

Second, since the life of any one asset might be less than the average life of a group of such assets, the company might be overlooking many attractive investment opportunities by working with average service lives.

In so far as records of selected operating costs are concerned, at best they will indicate only the presence of deterioration and will not yield any information on the obsolescence which the respective assets may have accumulated. This is a serious deficiency, because the factor of obsolescence is often more important than that of deterioration. While it is true that reports from shop personnel, coupled with information obtained by the equipment analysts from external sources, will reveal the presence of obsolescence, this procedure is associated with it a large element of chance and, hence, cannot be relied upon.

In order, to insure the recognition of every equipment investment opportunity, an organization like GPHA should periodically make a study of every piece of equipment in the plant with a view towards possible re-placement. If this were done, say once a year, delayed replacements would be kept to a minimum. This, however, is not done. The reason for not doing it is not because industry is unaware of the deficiencies of prevalent procedures or because it believes that the theory is incorrect but because the cost of such comprehensive surveys would ordinarily is prohibitive. Once a decision has been made to study a production facility with a view towards possible replacement, the next step is to select the available alternatives. Here there is no gap between theory and practice. One of the alternatives is to retain the existing unit. Another is to rebuild or overhaul the present machine.

GPHA has a choice of a number of new machines which are available on the market. In selecting the new machines, the equipment analyst relies to some degree on his knowledge of the various sources of a particular type of equipment. This is supplemented by directories in which manufacturers of various kinds of equipment are listed. A list of possible suppliers is then compiled and information is obtained from these firms on the specific machines they have available to perform the operation involved.

1.1 Tema Port Infrastructure

Tema city and port lie in southeastern Ghana along the Gulf of Guinea (Atlantic Ocean), 18 miles (29 km) east of Accra. Tema Port is the biggest of the two sea ports in Ghana. The other one is the Takoradi Port. It has water enclosed area of 1.7 million square meters and a total land area of 3.9 million square (http//www.ghanaport.gov.gh)

The Port of Tema is more than a mere loading or unloading place for goods. It is also a traffic junction, where goods are trans-shipped and transit cargo destined for the hinterlands/landlocked countries of Burkina Faso, Mali and Niger are handled. It is equally a port with a wide range of industrial and commercial companies, producing or handling among others petroleum products, cement, food items, iron and steel, aluminum products and textiles.

Opened formally in 1962, Tema harbor encloses 410 acres (166 hectares) of sea and is Africa's largest man-made (http//www.ghanaports.gov.gh). There are 3 miles (5 km) of breakwaters, 12 deepwater berths, an oil-tanker berth, and a dockyard, warehouses, and transit sheds (see www.ghanaports.gov.gh). The port's container yard is capable of holding over 8,000 Twenty foot Equivalent Units (TEUs) at any given time. There are 290 reefer points available. A separate fishing harbor with cold-storage and marketing facilities is situated east of the lee breakwater http// www.ghanaports.gov.gh).

The harbor is a monumental legacy of the late Osagyefo Dr. Kwame Nkrumah, President of the First Republic, who was anxious to see rapid industrialization of the country. Most of the country's chief export, cocoa, is shipped from Tema. Tema port handled 6.3 million tons of cargo in 2000, nearly three quarters of total sea-borne trade for Ghana, whilst the export was little over half of sea-borne exports. In 2001, this figure dropped slightly to 6.14 million tones. Of this, 5.07 million tons were imports and 783,000 tone exports and 283,000 tone was transit cargo.

1.2 Statement of the Problem

Capital equipment is a major investment for most firms and the management of such capital is a problem that modern management regularly faces. It is therefore essential for decision makers to be careful in making decision regarding selection and procurement of these major assets. Many companies especially ports and harbors are faced with the problems of getting the best value for their investments in the capital equipment.

Capital equipment is of long term nature and therefore it is important for a thorough cost-benefit-analysis to be carried out before such investments are made. When proper mechanism of selection, maintenance and replacement of equipment for an organization is not put in place, any mishap will impede on the smooth operation of the business. The losses that arise from the breakdown of equipment may be harmful to the existence of the organization. In as much as management of a business may be willing to choose the cost-effective ways of managing their equipment, they are often faced with the choice of the type of method to use so as not to incur unnecessary cost to the business. Ghana Ports and Harbors Authority appears not to be free of such challenges in managing their equipments making it a good candidate for a case study.

1.3 Research Question

What are the differential economic impacts of procurement, maintenance and replacement of equipment on the performance of a major port focusing on GPHA as a case study?

1.3.2 Objectives

The specific objectives of this study are:

To assess the economic impact of effective selection, maintenance and replacement of equipment in organisations such as ports of trade.

To show how systematic data recording impact on decision making in equipment selection and replacement at a major port of trade

To investigate the economic advantages in implementing an appropriate replacement process of equipments at a major port of trade.

To recommend strategies to improve the efficiency of procurement, maintenance and replacement procedures at GPHA

1.5 Significance of Study

The study will offer solutions to the scheduling of equipment maintenance and the design of system-reliability problems. It will also provide the organization with means for controlling expenditure of capital by controlling better operating rate and cost. The study will shed light on how much attention is given to the equipment, when and why owners tend to replace it and the method of replacement used.

This study will equip the management of the Tema Port with information as to what methods to adopt when they are to replace existing equipment in the organization. Such a road-map will reduce the use of "trial and error" during the selection process. The results of the study will serve as a reference point for analyzing the benefits that the organization will reap when it pays more attention to the how the equipments in the organization are monitored.

The study will also add to existing literature on the topic of equipment replacement in big organizations such as ports. Hence, researchers interested in further studies will find this study as a point of reference for their literature review. The findings of the study will also help educate policymakers with regards to the enactment of policies and laws to ensure the smooth importation and exportation of goods in and out of the country.

1.6 Scope and Limitations of the Study

The study is of the equipment pool of Ghana Ports and Harbors Authority - Tema. This pool includes: all assigned automobiles, trucks, tractors, cranes, reach stackers, trailers, generator sets, heavy duty compressors, and other equipment of various categories. To find the most appropriate technology or system one will have to employ a series of varying data over a period of time for various comparisons.

Due to limitation of time and money the study will be limited to Ghana Ports and Harbors Authority -Tema. The study is done within a specific time frame, an academic year; hence, it will not be possible to extend the study to cover the Takoradi Port. However, the methods could be replicated in future research and this will ensure external validity. Also, the financial constraints that the student faces will not permit a detailed study of the two ports in Ghana. The study is financed entirely from the meager resources of the researcher. One critical challenge the study suffered was that due to the security nature of the Tema Port, I was only allowed to sample very few equipments and machinery, a situation that obviously impacted on the output of this study negatively. It would appear, therefore, that the sample surveyed may not be totally representative.

1.7 Delimitation

The delimitations of a study are those characteristics that limit the scope (define the boundaries) of the inquiry as determined by the conscious exclusionary and inclusionary decisions that the researcher makes. Among these are the choice of objectives and questions, variables of interest, alternative theoretical perspectives that could have been adopted.

This research was conducted within a given parameter. It deals with issues that confront the Tema harbor in their quest to ensure an effective running of the port. It does not include the role of government in the selection, replacement and maintenance of the equipment. It only assesses the responses of managers and all employees who are involved when it comes to taking decisions on the selection and replacement of equipment at the harbor. The study seeks to understand the economic benefits that will accrue to the company, when it puts in place the necessary checks for selecting, procuring and replacing equipment.

On the inception of the structural adjustment program (SAP) during the late 80s, the government of Ghana had either outsourced or completely sold many of the functional units of GHPHA. This resulted in GHPHA losing ownership of most of its functional units as well as numerous assets. Many of these assets (e.g. plants and equipments) and functional units were sold our outsourced to foreign interests/investors. In the course of this study, many of these outsourcers/investors were reluctant to allow me access to plants and equipments at the port; resulting in my inability to sample a lot of relevant equipment. 

1.8 Organization of the Study

The study is divided into five chapters; the first chapter is the introduction. It gives a background to the study, the scope and limitations, the objectives of the study, the research problem and the research questions. The next chapter reviews existing literature with regards to the topic of the study. This is followed by chapter three; this chapter presents the research methodology. It includes the research design, data collection methods and the methods for analyzing data collected. The findings, results and data analysis are found in chapter four. The last chapter, chapter five will include conclusions and recommendations, limitations and direction for future research.



2.0 Introduction

This chapter indicates brief historical development of equipment replacement systems and some of the attempts and models of replacement problems that have been formulated for equipment that are subjected to degradation or deterioration through operation. Further, the application of principles of replacement, assumptions made on equipment replacement tools and methods employed on equipment selection and replacement, equipment management policy and some definitions of terms are covered.


Historical Development of Equipment Replacement

Before the industrial revolution, man relied upon tools to do his work. After the industrial revolution tools and animals were replaced by machines that could work faster and consume fewer resources. In short, machines were more productive. This change was felt in every field of engineering. Machines were made that could do all sorts of work related to construction, manufacturing, operations ranging from digging and trenching to filling and lifting. As technology progressed, a profound effect on pieces of capital equipment took place. They became faster, more powerful, more productive, and lasted longer. Now there are many types of machines on the market, and they are used for various jobs in the field. The most popular pieces of equipment are those that are used in excavating and moving earth (such as cranes, mechanical lifts), and concrete equipment (such as mixing drum trucks, concrete pumps among others). There are also other specialized equipment used for tunneling, driving piles, and pumping water and compressed air. All of these are pieces of equipment that are often used in ports and harbors.

2.2 Assumptions of Replacement Models of Items that Deteriorate

Deterministic models have been developed for problems related to replacement and maintenance of equipment-An analytic and a mathematical form is established following Grant (1950)

Which relates the system's performances as measured by E to the values of the control variables Xi and the uncontrollable variables Yj. The Yj are usually expressed in terms of the time parameter t. Where Yi (t) is assumed to be a known function of t. The major assumptions made for measuring of system performance and developing a model were generally based on one of the following objective functions in quantitative terms.

The cost or return during a specified period of time.

The average cost of return per time period.

The present value of the discounted future costs or returns.

The average number of items produced or used per maintenance.

The control variables are specified as one or more of the following

The life of an item.

The selection of alternative items to acquire.

The methods or procedures for replacement or maintenance.

In some cases, the solutions have been developed in policy form. That is, the solution is expressed as criteria for replacement or as procedures to be employed in solving a class of similar problems in most cases. The data required to solve replacement problems can be found in the history of the system's previous performance supplemented by estimates of its future performance (Grant, 1950).

2.3 Grant's Method

Grant (1950) discusses in quantitative terms the problem of when existing equipment should be replaced on the basis of inadequacy, obsolescence, excessive maintenance, and declining efficiency. He summarizes the qualitative formations to date. He also presents procedures for analyzing and reaching solutions to the economic-replacement problem where:

More efficient equipment is introduced before replacement,

The value of money is constant over the life of the equipment, and

The annual operating cost is non-decreasing.

2.4 Dean's Model

Joel Dean (1951) was the first to state explicitly that capital investment for replacement purposes ought to compete with other investment the firm is capable of making. He argues that the return on investment should be used to evaluate alternative possibilities on capital investment. The combined cost for current equipment (the sum of relevant operating cost and the capital-wastage cost) is expressed as a function of equipment age. Replacement occurs when the combined costs equal the average cost per year of the new equipment plus the annual return on the capital outlay for the new equipment less the salvage value of the new equipment. The point of replacement occurs after the annual cost of the old equipment exceeds the average cost per year of the new equipment.

2.5 Orenstein's Model

An interesting result developed by Orenstein (1956) in the event of equal depreciation payments is that the economic life is independent of rate of return for an annual-cost-minimization model. Orenstein considers three costs:

Acquisition cost, A.

Annual rate of return on return, r.

Linear operating cost,s

He defines the economic life as one that minimizes the average annual sum of the above,

The economic life is then the value of such that

d = increase in operating cost or the average increase in operating cost is equal to the annual depreciation value of the equipment. The selection of alternative equipment would depend on minimum values of the total average cost over the life of each. Obsolescence is considered to be introduced by increasing the interest rate, decreasing the life expectancy, or decreasing the salvage value.

2.6 Sandiford, Bernholtz, and Shelson Model

The models considered so far have assumed analytic forms for the cost functions. Sandiford, Bernholtz, and Shelson (1956) considered arbitrary values for the annual costs and developed numerical, iterative procedures for determining the economic life of vehicles. The measure of performance chosen was the average annual cost over the replacement interval. The optimal policy was use of that replacement interval which minimized the average annual cost, to be determined for each group of equipment.

The total average cost C was considered to be sum of capital wastage (acquisition cost less salvage), interest, repair costs, and un-serviceability cost. Values of C were calculated from historical data for each equipment class by taking the cumulative averages and the minimum obtained by inspection. The authors used historical data to obtain optimum replacement intervals.

2.7 Comparing The Alternatives

A number of theoretical approaches have been developed for use in making the required cost comparison. However, all are an outgrowth of three basic methods. The first of these calls for describing each alternative in terms of a uniform annual cost; the most economical alternative is the one with the lowest annual cost. The second basic method consists of describing each alternative in terms of the present worth of all revenues and expenditures associated with it; the alternative represented by the lowest present worth is considered to be the most economical one.

In the third method, the rate of return to be realized on the extra investment in the new facility is computed; if this rate equals or exceeds the company's return requirement for that classification of investment, replacement is indicated. The factors entering the analysis are independent of the method employed. The difference lies in the manner in which these factors are handled. In theory, the equipment analyst must always begin by describing the alternatives in the following terms:

The investment required

the equipment's service life

its terminal salvage value

the rate-of-return requirement

The annual revenues and operating costs associated with each alternative.

However, if revenues or certain operating costs are not affected by the choice of alternatives, they become irrelevant and can be ignored (Sandiford, Bernholtz, & Shelson, 1956). For reasons that will become apparent later, the simplest although most unusual case is the one in which the service lives of the two alternatives are equal. As a rule, very straight techniques can be employed to find the uniform annual costs, present worth, or the rate of return on the extra investment. This, however, can be done only after the respective units of equipment have been described. Unfortunately, in practice, this requirement creates tremendous problems of estimation even in the simple case under consideration.

While the present value of the old equipment and the required investment in the new equipment can be determined with little difficulty, the same cannot be said of the other factors. Service lives will be affected by the rate at which the respective alternatives accumulate deterioration and obsolescence (Sandiford, Bernholtz, & Shelson, 1956).

Terminal salvage values will also be affected by these elements and by the nature of the future market for used equipment (Sandiford, Bernholtz, & Shelson, 1956). The character of these elements is extremely difficult to predict. As a result, many companies "play it safe" by selecting unjustifiably short service lives and ignoring salvage values completely.

The difficulties encountered by firms are even greater for the factors of revenues and operating costs. As far as revenues are concerned, if there is reason to believe that they are relevant, management must predict such non-predictable things as the nature of the products to be produced on the equipment during its service life, the demand for these various products, and unit selling prices. It is not surprising; therefore, that so many firms choose to assume that revenues will not be affected by the choice of alternatives even when there is reason to believe that they will be. Instead, this factor is treated as an irreducible. Predicting the magnitude of operating costs presents similar problems. Theory requires that these costs be estimated for each year of the equipment's life. The level of such costs as direct labor and direct materials will be affected by the nature of the products to be processed on the equipment, the annual rate of production of each of these items, hourly wage rates, unit material costs, labor efficiency, the amount of scrap produced, and the condition of the machine at various points in its life.

Most managers believe it impossible to forecast the nature of these factors with any appreciable degree of accuracy. An even more difficult situation prevails in regard to overhead expenses, such as indirect labor, maintenance, rework, supervision, and the like. At the present time, no practical means exists that would permit determining the portion of most of these overhead charges which can be attributed to a particular machine already in operation. All of these obstacles confront the analyst in his attempt to estimate future operating costs. They contribute to the fairly common practice of ignoring overhead expenses in equipment replacement analyses and considering only direct labor and material costs based on current products, rates of production, wage rates, unit material costs, labor efficiency, scrap, and machine condition. Any anticipated changes in these factors are treated as irreducible.

In addition to requiring estimates of initial investments, service lives, salvage values, revenues and operating costs, theory requires that management establishes a minimum attractive rate of return (Sandiford, Bernholtz, & Shelson, 1956). The rate-of-return requirement should be that interest rate which will permit the firm to allocate its available capital in the most efficient manner. Selection of this rate requires that management determine its supply and demand schedules for capital. At various interest rates, different amounts of capital will be both made available to and required by the company for investment.

In general, as management is willing to pay higher interest rates for the use of borrowed money, it will have more opportunities to obtain money, and its supply of capital will increase. On the other hand, as management demands higher rates of return from its investments, it will have fewer opportunities to invest money, and its demand for capital will decrease. At some interest rate the capital supply and demand will be equal. If all available investment opportunities are of comparable risk and tax status, this is the interest rate which should be used as the minimum rate-of-return requirement. Actually, the determination of this rate is much more difficult in practice than in theory. To begin with, it is almost impossible for a given firm to ascertain what amounts of money are available at various rates of interest. In fact, difficulties are many times encountered in determining what the cost of money actually is, as in the case of equity financing.

The supply schedule of capital exists but cannot be accurately described. The same is true for the demand schedule. Its determination necessitates investigating all internal and external opportunities for investing funds and making accurate estimates in order to compute probable rates of return. For all practical purposes this is impossible to do or, if possible, would involve a prohibitive expense. Even if all these obstacles to the determination of capital supply and demand schedules were overcome, the resultant interest rate would have a number of deficiencies.

First, it would represent a state of equilibrium only at a given point in time; this means that it would neither reflect future changes in investment opportunities nor future changes in capital availability. Next, the resultant interest rate would have to be modified to provide for both the different levels of risk inherent in various investment opportunities. For the possible differences in the tax status of these investment opportunities; no completely satisfactory methods for doing so exist at this time.

The combined effect of all these problems encountered in any attempt to apply the theory underlying the selection of the interest rate is that many organizations resort to the use of the pay-off period as a capital rationing device in spite of their awareness of the deficiencies of this device. The entire problem of estimation grows in complexity in the more realistic situation in which the old equipment is expected to have a shorter life than the new equipment.

In any comparison of two alternatives, it is mandatory that equal time periods be considered. Therefore, if the existing machine has a shorter expected life than the proposed machine, the analyst must predict the characteristics of the existing facility's future successor, which is the equipment that will eventually replace the existing machine if the latter is retained. These characteristics consist of the future successor's first cost, service life, salvage value, revenues, and operating costs. If the combined lives of the old equipment and its future replacement equal the life of the proposed present replacement, the required computations can then be made. The one alternative becomes the proposed present replacement and the other, the existing machine followed by some future machine.

If the combined lives of the old equipment and its future successor exceed that of the presently available new equipment, it is then necessary to forecast the nature of the equipment that will be procured in the future to replace the proposed present replacement. These predictions must be continued until each alternative represents equal time periods. This means that each alternative will consist of a series of machines-one headed by the old unit, the other by the proposed new unit. There is no need to elaborate upon the problem of estimation created by a situation such as this. It provides many managements with an additional incentive to adopt rule-of-thumb methods of analysis.

The theorists, of course, recognize the presence of this difficulty and, for that reason, usually make some simplifying assumptions with regard to the nature of future equipment. They are simplifying in the sense that they eliminate the need for the analyst's considering these future replacements when making his estimates and computations.

2.8 Equipment Management Policy

Equipment management is crucial to the profitable utilization of equipment (Suskie, 1996). Firms who have large equipment fleets should have a strategic plan for successful management of these fleets. Planning fleet strategy with decision-makers from throughout the company keeps equipment ownership on track with the firm's goals (Suskie, 1996). Strategic management requires the cooperation between the different management teams of estimating, project management, accounting and the firm owners (Suskie, 1996). . The written equipment policy goes a long way to ensure the cooperation between different divisions of management (Suskie, 1996). The equipment policy has a great impact on the profitability of the firm by governing the ways to utilize equipment to its full potential and hence increase the profits accrued by them. The policy provides decision-making guidance regarding equipment to the management, operation, and maintenance divisions of the firm. The following section presents the issues relevant to this topic.

2.9 Equipment Selection

Equipment selection is a critical factor when trying to complete a project within budget and on schedule. Without proper working equipment, productivity decreases, delays increase, possible injuries occur and unnecessary costs are incurred. It is important to all the parties in a firm that a project begins with appropriate selection of the equipment needed to perform the work (Amirkhanian & Baker, 1992). Proper selection of equipment contributes to project efficiency, reduced equipment downtime and increased profits. Selection of the correct plant for the job ideally forms part of the planning process, and equipment should be chosen for a particular task only after analysis of many interrelated factors.

The important considerations for selecting equipment include the following:

The function to be carried out,

The capacity of the machine,

The method of operation,

The limitations of the method,

The cost of the method, and

The cost comparison with other methods (Amirkhanian & Baker, 1992).

Lowest overall cost is the prime consideration in buying a piece of equipment. There are four factors to be considered:

Machine productivity: In equipment operations, the production requirement is a known quantity. The best size of equipment is chosen to deliver that production at the lowest cost. It is also important to distinguish between primary and secondary usage of the equipment. Operating conditions have substantial effect on equipment productivity.

Product features and attachments: Cargo handling equipment is available with a wide variety of features and attachments. These attachments offer greater productivity, broader applications, versatility, increased operating safety and improved operator convenience. These features should be evaluated with complete objectivity.

Dealer support: From the moment of purchase to the final resale, the equipment dealer plays an important part in determining the efficiency of the equipment. For instance, the dealer/manufacturer organizes technical training for technicians and operators of the buyer. The dealer also supports the buyer with spare parts suppliers for the efficient maintenance of the equipment. They also carry out regular inspection and certification of the equipment.

Price: The total cost of owning and operating a machine and not the price alone should be the basis for decision making when purchasing equipment. In that the initial cost of some equipment is lower than others but its maintenance and operating cost is higher than equipment which has a relatively higher initial cost (Puerifouy & Ledbetter, 1985).

2.10 Equipment Acquisition

Engineers and other users of equipment are concerned with a decision as to whether to purchase, rent or lease equipment. Under certain conditions it is financially advantageous to purchase, whereas under other conditions it is more economical and satisfactory to rent. Following are three methods by which engineers may secure the use of equipment (Clapp, Shuler, Nobe, DeMiranda & Nobe, 2007):




The method selected should be the one that will provide the use of the equipment at the lowest total cost, consistent with the use that will make of the equipment.

The decision to acquire an asset should be made for both technical and economic reasons. The profitability of the proposal should be evaluated by calculating the expected rate of return and, comparing it with the cost of capital. The decision as to how to acquire the asset can then be considered as a financial decision. The major factors that influence the decision as to which is the most advantageous are as follows (Harris & McCaffer, 1991):

Tax savings from the purchase of the equipment or plant,

The profit flows of the acquiring company,

The acquiring company's cash flows, which determine what money is available for plant acquisition; and

The acquiring company's gearing ratio (borrowed capital/equity capital) which influences the amount of further borrowing possible.

2.11 Purchase

Outright purchase is simply payment of buying price by the acquiring company to the supplier (Harris & McCaffer, 1991). This involves the acquiring company in a large cash payment very early, before the equipment has acquired any revenue. However, outright purchase provides acquiring company with capital allowances written down of the purchase price of the equipment (Harris & McCaffer, 1991). If cash is available from within the company's own resources or even from an overdraft. This form of acquisition is the cheapest. Outright purchase places the tide of the equipment immediately with the acquiring company. This means that the equipment becomes an asset over which the company has full control which it can use to negotiate finance, which it can use anywhere as well as dispose off to produce cash from its resale value.

2.12 Advantage of Purchasing

Direct ownership of equipment has the following advantages (Douglas, 1975):

It allows the owner to utilize depreciation and interest on the equipment loans as tax deductible business expenses.

It improves the psychology of maintenance and pride of operation through direct ownership.

It gives the owner complete freedom to use his equipment as he wishes and to dispose of it whenever and wherever he finds advantage.

It assures the owner of any investment credit, which may be acquired, with the purchase of the machine.

The owner benefits directly from wise disposal and salvage value.

Buying equipment summarized from work by (Levis, 1914) has the following advantages:

It builds assets on the books of the owner.

Equipment is always available when needed.

Equipment can be bought to fit needs.

Gives pride and privilege of ownership.

2.13 Credit Sale and Hire Purchase

A credit sale is a sale in which the acquiring company takes the ownership or title of the equipment immediately but the purchase price is paid in installments. These installments include the purchase price plus any financing charges of the supplier.Hire purchase is a contract where by the acquiring company pays a regular hire charge and, at some predetermined point after payment of a proportion of the agreed hire charges. The acquiring company buys the equipment for a nominal sum. This facility to purchase distinguished the hire purchase contract firm leasing, which does not permit the acquiring company to purchase the leased equipment.

Both hiring purchase and credit sales require cash deposits. But these deposits are much less than the whole purchase price and therefore in cash considerations these form of acquisitions are less demanding than outright purchase. However, the interest charges included in the hire purchase contracts are likely to be greater than those the acquiring company would pay on an overdraft.

2.14 Leasing

The difference between leasing and purchasing is that the ownership of the equipment remains the property of the leasing company (the lessor) and the acquiring company (the lessee) never becomes the owner (Douglas, 1975).

The acquiring company (the lessee) only acquires the use of the equipment, in return for payments or rentals. There are two categories of lease; the finance lease and the operating lease. The finance lease is normally arranged through leasing companies who have no particular interest in the equipment and offer no technical support but merely arrange the lease.

The lessee pays the lessor payments or rentals for the use of the equipment acquired. The equipment is usually supplied by a third party the equipment manufacturer or dealer from whom the equipment is bought by the leasing company. The operating lease is normally arranged with manufacturer or suppliers who offer such a service as part of marketing their products. Here the leasing company is the equipment manufacturer.

2.15 Advantages of Leasing

The advantages to the user from leasing are (Douglas, 1975):

The lease provides another source of credit; it enlarges the credit pool.

It releases working capital by providing up to 100% financing for new or used equipment.

By its tax advantages, it reduces the contractors' tax obligations.

It creates a favourable cash flow by paying equipment expenses as they accrue rather than in advance.

It improves the contractor's financial ratios.

It gives the small contactors more leverage in getting warranties and other obligations of the manufacturer fulfilled.

It enables the contractor to utilize the expertise of the engineering staff of the lessor for guidance in the selection of the equipment and its maintenance and management.

It provides the opportunity for the small contactor to take advantage of the large volume use of the lesser in obtaining lower prices for fuel, tyres and other supplies.Unlike other means of acquiring the use of equipment, leasing can provide benefits to the lessee (user) that may not be available through purchasing and financing alternatives. The lessee's consideration of leasing is based on the concept that it's the use of equipment rather than ownership that determines a profit to be made (Thurow, 2008).

The obvious advantage to leasing is acquiring the use of an asset without making a large initial cash outlay (Lerman, 1984). The advantages of leasing compared to a loan arrangement to purchase equipment, according to Lerman are:

A lease requires no down payment while a loan usually requires one.

A lease requires no restrictions on a company's financial operations, but loans often do.

A lease spreads payments over a longer period than loans, and

A lease provides protections against the risk of equipment obsolescence, since the lessee can get of the equipment at the end of the lease.

2.16 Hiring (Renting)

The difference between hiring (renting) and leasing is that leasing is regarded as a long term hiring (Anon, 1987). Hiring is the use of equipment by the lessee for short terms such as daily, weekly or monthly periods. When equipment is hired the lessor provides the required repair and maintenance. In a leasing arrangement the repair and maintenance of the equipment is the lessee's responsibility. The individual renting a piece of equipment would only have to pay for the equipment as it is needed (Anon, 1987).

Some of the advantages of renting are (Anon, 1987):

No maintenance cost.

Newer equipment.

No disposal problems.

Cost accounting simplified.

Flexibility on job planning.

Labor downtime is less.

Use for seasonal purposes. E.g. Christmas seasons.

Fixed rate cost (No hidden cost of ownership).

Line of credit not tied up as it would be on a purchase.

2.17 Equipment Maintenance

Maintenance is the general upkeep of the equipment. Equipment like any other will breakdown during its life (Douglas, 1975). This is due to normal wear and tear or to sudden failure of a component part. The primary purpose of providing maintenance is to reduce the incidence of failure. This is done by replacement, Repair or servicing in order to achieve an economical level of uti1ization during the working life of the machine. The reduction of downtime minimizes costly stoppages on the field and the disruptive effect on the labor and schedule of work. The cost of maintenance has to be balanced against the benefits. And at some stage a piece of equipment will require replacement. Maintenance involves labor (both direct and indirect), material, plant, and overhead required to sustain equipment in good, serviceable condition. It includes periodic inspection, lubrication, servicing, repairs and overhauls. A maintenance system should include the following provisions for all degrees of maintenance (Douglas, 1975):

Preventive maintenance

Corrective maintenance (Repairs)

Minor or field,

Major or shop,


All owners of equipment must keep cost, time, and production records of their equipment. This is not only necessary from an accounting standpoint but also from a control viewpoint. The extent of these records will vary with the type of work. Cost, time, and production records are kept for several reasons (Douglas, 1975).

For cost control of the job in progress,

To assess the financial condition of the firm,

To assess progress on the job,

To set standards of cost, time, and production,

To be used as a basis of litigation,

To establish tax liability,

To collect data for economic analysis.

2.18 Equipment Replacement

The problem of replacements arises after an industrial enterprise or project has been in operation. The rate of replacing of equipment may vary due to internal factors such as, sensitivity of the working area, and external factors such as competition. Depending on the internal and external factors replacement problem can be due to the following reasons (Douglas, 1975).

The main reason for equipment replacement can be divided into three broad categories:

Wear out (equipment that deteriorate with time ),

Sudden failures,

Obsolescence (Douglas, 1975).

The problem of replacing various worn out spare parts of equipment is one, which arises in every organization. In some cases, instead of changing spare parts of an equipment, it may be more economical to replace the equipment altogether especially if it has deteriorated with constant use. To know whether it is feasible or not, economic analysis is very important. As equipment gets worn out with time and usage, it functions with decreasing efficiency. Failure of equipment that is subjected to wear and tear (deterioration) is easily predictable. On this type of failure, maintenance or upkeep of equipment is usually practiced. Due to the predictability of failure, behaviour changes on operation and maintenance cost or both can easily be guessed.

Likewise replacement policy should be on analyzing the operating and maintenance cost. Based on the analysis two conditions may be anticipated:

Policy is never to replace the item. This condition is hardly met in real situation.

If the costs fluctuate with time, the equipment should be replaced only when the cost is in increasing trend (Douglas, 1975).

Generally, costs of industrial equipment increase with time or age. Even though the increase in cost necessitates replacement of the equipment, the rate of increase in cost may vary from item to item. Due to varying rate in cost increase during operation, there is no clear and defined time, which indicates the replacement of the equipment. Replacement of equipment requires calculating the increase in operating costs, maintenance cost, forced idle time costs and costs for replacing by new equipment (Douglas, 1975).

Thus, at some stage it may be more economical to discard the old equipment and replace it with a new one.

Replacement Because of Inadequacy

Equipment that is inadequate in capacity to perform the required service is a logical candidate for replacement. The inadequacy in the amount and type of service requirements can be due to;

An increase or decrease in the amount of service required from the asset,

An increase or decrease in the demand for its product or service,

Changes that may arise from competitive situations either from competition among producers on a single industry or competition, which may arise with substitute products,

Act of public authority etc (Douglas, 1975).

Replacement Because of Excessive Maintenance (wear and tear).

A machine rarely has all of its elements worn out at one time. Due to this, it is economical to repair many types of parts in order to maintain and extend the life of the equipment and its usefulness. Some of the repairs are minor in extent, while some are periodic and extensive. The sum of these maintenance costs may be big enough to demand replacing the equipment.

Replacement Due to Obsolescence

Obsolescence can materialize economically or functionally. A new and improved design can render existing equipment obsolete economically. A decrease/increase in demand might result in the present equipment (having higher/ lower capacity) being obsolete functionally since new equipment having higher /lower capacity it is available to accommodate the new demand level. On the other side the availability of improved machines performing the same service with more economical ways and methods will pay to replace old assets with new ones or to relegate them to stand-by purposes or other inferior uses for better economical advantage. Further equipment can be obsolete if it is no more under manufacturing.

Physical Impairment

Equipment may be out of operation or perform less than expected due to damage or improper handling. For instance, if a machine falls into the sea while working it will have to be replaced.

Change in Public Requirements Regarding the Machine or The Product.

This is mainly due to the fact that the equipment has become obsolete. Sometimes it is as a result of a higher legal requirement or the inability of the equipment to meet the ever increasing demands of the public. This happens when the client base of the organization increases at alarming rate. When this happens the existing equipment may not be able to operate effectively, hence a call for replacement.

Sudden Failing Equipment

When equipment performs at about full capacity and they are over-stretched, they may eventually break down and there will be a need for replacement.

Factors to Consider in Calculating the Replacement of Equipment

The following factors should be taken into consideration while formulating an appropriate system for replacing equipment.

Rate of Inflation

The price of equipment does not remain steady with time. Thus, while formulating a replacement policy, this factor should be taken into consideration. It can be considered by assuming a certain rate of inflation. Thus, if the inflation is [i] percent, then the price of the equipment cn after n years given that the present price C is

Cn =C [1=I]N

Discount Factor

As the money value changes with time the calculation of equipment replacement should include the interest rate (rate of inflation to have the present value of the money to be spent in the future).

Operating Cost

Equipment incurs certain costs while in operation. It may be due to the application of some ingredients like lubricant or fuel or due to maintenance etc. There are empirical evidences that such operating costs increase with increasing age. These are due to variety of reasons such as deterioration of components or wear and tear. Basic data on operating costs are necessary to ascertain whether it is too high compared to acquisition cost or not.


Depending on its use depreciation has different meanings. Some of them are

Decrease in Value: This concept implies that the value (market value or value to the owner) of one asset is computed at two different dates (Orenstein, 1956). The difference is the depreciation regardless of what combination of causes may have been responsible for the value change. This is the meaning generally implied on every day speech.

Amortized Cost: It is an accounting concept of depreciation where the cost of an asset is a prepaid operating expense to be apportioned among the years of its life by some more or less systematic procedure. (Orenstein, 1956). It should be emphasized that it is the cost not the value that is allocated.

"Depreciation accounting is a the system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit(which may be a group of assets) in a systematic and rational manner.

Differences in value between an existing old asset and a hypothetical new asset taken a standard of comparison. This is an appraisal concept of depreciation and money appraisals of old assets. Appraisal depreciation means the value of inferiority at some particular date (date of appraisal) of one asset, the existing old one being appraised to another asset, a hypothetical new one used as basis of valuation (Orenstein, 1956).

Impaired Serviceableness. As machines become older they are often unable to hold a close tolerance as when they were new. Similarly, the strength of structures may be impaired by the decay of the corrosion of metal members. This is sometimes called as depreciation to refer impaired functional efficiency. It is not commonly used.