Replacement of Assets that Deteriorate with Time

Assets that deteriorate with time, such as machinery, equipment, or vehicles, will eventually require replacement to maintain the efficiency and effectiveness of the organization’s operations. Replacement decisions are crucial for an organization because they involve significant costs and can affect the organization’s performance, competitiveness, and profitability.

There are several approaches to asset replacement decisions, including the following:

Age replacement policy: Under this policy, the asset is replaced after a certain number of years or operating hours. The replacement decision is based on the age or usage of the asset and assumes that the asset deteriorates at a constant rate over time. The replacement decision is made by comparing the cost of continuing to operate the asset with the cost of replacing it.

Condition-based replacement policy: Under this policy, the asset is replaced when it reaches a certain level of deterioration or condition. The replacement decision is based on the condition of the asset, such as the level of wear and tear, and assumes that the asset deteriorates at a variable rate over time. The replacement decision is made by comparing the cost of continuing to operate the asset with the cost of replacing it.

Economic life-based replacement policy: Under this policy, the asset is replaced when its economic life is reached. The economic life is the period during which the total cost of owning and operating the asset is minimum. The replacement decision is made by comparing the total cost of owning and operating the asset with the cost of replacing it.

Benefit-cost analysis: This approach involves comparing the benefits and costs of replacing the asset. The benefits may include improved efficiency, increased productivity, reduced maintenance costs, and improved safety, while the costs may include the cost of the new asset, installation costs, and disposal costs of the old asset. The replacement decision is made by selecting the option that provides the highest net benefits.

In practice, organizations may use a combination of these approaches, depending on the specific context and the nature of the asset. Effective asset replacement decisions can help organizations maintain their competitiveness, reduce costs, and improve their operational efficiency.