ESTIMATING LOSS IN VALUE: ACCRUED DEPRECIATION

Chapter 12

Accrued depreciation

Age-life method

Book value

Capitalized income method

Cost basis

Cost-to-cure method

Curable depreciation

Curable postponed

Current-value accounting

Deferred maintenance

Depreciation in accounting

Depreciation in appraisal

Diminished utility

Economic life

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CHAPTER TERMS AND CONCEPTS

Economic obsolescence

Effective age

Functional obsolescence

Locational obsolescence

Loss of utility

Misplaced improvement

Over-improvement

Physical deterioration

Rental loss method

Sales data method

Straight-line method

Super adequacy

Under-improvement

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CHAPTER TERMS AND CONCEPTS

LEARNING OUTCOMES

1. Distinguish the concept of depreciation as it is used in accounting from that used in appraisal.

2. Name and give the causes of three types of depreciation.

3. Name four methods of estimating accrued depreciation and describe how they may be applied to an appraisal problem.

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DEPRECIATION

Definition: In accounting practice, all capital assets except

land are considered to be wasting assets, assets that decline in value over time.

The estimate of accrued depreciation in appraisal, first, a dollar or percentage amount is deducted from the estimated cost of the improvements as if new on the date of value, rather than from their historical cost basis. Second, the amount of depreciation represents the appraiser’s best estimate of the actual market loss in value as compared to a new building, whereas accounting depreciation is a theoretical loss.

Appraisal Depreciation

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DEPRECIATION: BOOK

Book Depreciation Definition: Deduction from cost

Purpose: Accounting, income tax reporting, etc.

How Determined: Company policy, IRS Regulations

How Applied: Deduction from book or historic costs.

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DEPRECIATION: ACTUAL

Actual Depreciation Definition: Loss in value

Purpose: Used in Appraisals (cost approach primarily)

How determined: Cost to cure, age-life, sales data, rental loss…..

How applied: Deduction from current replacement cost.

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TYPES OF ACCRUED DEPRECIATION

Physical Deterioration

Functional obsolescence

External Obsolescence

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CURABLE DEPRECIATION

Curable Cost to correct the condition or defect is less than the amount of value restored

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INCURABLE DEPRECIATION

Incurable Cost to correct the condition or defect is greater than the amount of value restored

What do you think?

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MEASURING ACCRUED DEPRECIATION

Straight-Line or Age-Life Sales Data (Market) Method Cost-to-Cure (Observed Condition) Capitalized Income

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BY THE SALES DATA METHOD

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Cost-to-Cure Method

It measures the accrued depreciation by the cost to cure or repair any observed building defects. After inspecting the premises, the appraiser tries to identify each building defect, feature, or condition that reduces value. Each is then classified as either physical, functional, or economic.

In addition, each defect must be studied to estimate whether it is economically curable or incurable. However, economic obsolescence is rarely economically curable, so the cost-to-cure method is of little use.

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Physical Deterioration

• Deferred maintenance—curable

• Deferred maintenance—incurable

• Short-lived items• Long-lived items

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Functional Obsolescence

• Curable—an addition• Curable—a replacement or substitution• Curable—super adequacy or over-

improvement• Incurable—a deficiency• Incurable—a super adequacy

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Capitalized Income Method

or rental loss method can be used to estimate either the total loss in value from all causes, or simply the loss in value from a single cause.

To estimate loss in value from all causes, a comparison is made between the rent of the subject building on the date of value and the rent of a new or modern building that could take its place.

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SUMMARY OF THE COST APPROACH

Cost Approach Section of the URAR and 2055 Forms

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SUMMARY

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Accrued depreciation for appraisal purposes is the estimated loss in market value of the improvements, when compared to their replacement or reproduction cost on the date of value. This value loss can be caused by physical deterioration, functional obsolescence, and/or economic obsolescence. Many types of physical deterioration, such as deferred maintenance, are curable by painting, fixing up, or doing repair work. Accrued depreciation may be estimated by the straight-line/age-life method, the sales data method, the cost-to-cure/observed condition method, or the capitalized income method.