Professional Practice & Valuation

Prepared by:Ghanashyam Prajapati

DEPRECIATION & OBSOLESCENCE

Depreciation

Types of Depreciation

Obsolescence

Types of Obsolescence

Methods of calculating Depreciation

Content

Straight line method constant percentage method inking fund method Quantity survey method

DepreciationDepreciation is the gradual loss in the value of the property due to its tear of life wear, tear and decay. This is an assessment of the physical wear and tear the building or property and is naturally dependent on its original condition, quality of maintenance and mode of use.

Thus, the value of a building or property(but not land) decreases gradually up to the utility period due to depreciation.

Usually a percentage on depreciation per annum is allowed.

The general annual decrease in the value of a property is known as annual depreciation.

Present value of a property = Initial cost – Total amount of depreciation

Types of depreciation The types of depreciation are

Physical depreciation

1.wear and tear from operation

2.Decrepitude i.e. Action of time and other elements

Functional depreciation

1.Inadequacy or suppression

2.Obsolescence

obsolescenceobsolescence may be defined as the loss in the value of the property due to change in fashions, in designs. in structures, etc.

An old dated building with massive walls, arrangements of rooms not suited in present days and for similar reasons becomes obsolete even if it is maintained in a very good condition, and its value becomes less due to obsolescence.

The obsolescence may be due to the reasons such as progress in arts changes in fashions, changes in planning ideas, new inventions, improvements in design technique etc.

Thus. though the Property is Physically sound it may become functionally inadequate and its economical returns become less.

Types of obsolescence(aInternal obsolescence

1.Poor or old design

2.Change in type of construction

3.Change in kind of construction

4.Change in utility demand

External obsolescence

1.Poor original location

2.Change in the character of the district

3.Specific detrimental influences such as construction of factories

4.Zoning laws

Methods of calculating Depreciation

The various methods of calculating depreciation are as follows

1.Straight line method

2.constant percentage method

3.sinking fund method

4.Quantity survey method

straight line methodIn this method it is assumed that the property loses its value by the same year. A fixed amount of the original cost is deducted every year. so that at the end of the utility period only the scrap value is left.

A manual depreciation = Annual decrease in value of a property

D = Annual depreciation

C = Original cost

S = Scrap value

n = life in years

Cont.Depreciation of the property after m years

Books value after m years

constant percentage methodIn this method it is assumed that the property will lose its value by a constant percentage of its value at the beginning of every year.

By this method, decrease in the value of property in the beginning years is at this faster rates, while decrease in value in the later years is at slower rate.

This method is more suitable for calculating depreciation of machines. Percentage rate of annual depreciation.

Cont.Where,

P = Percentage rate of annual depreciation

S = scrap value

C = original cost

If age of property is m years, value of property after m years after depreciation,

Sinking fund methodIn this method the depreciation of the property is assumed to be equal to the annual sinking fund plus the interest on the sinking fund for that year.

Depreciation = Annual sinking fund + Interest on the sinking fund for that year.

If,

A. Annual sinking fund

b. c. d etc. = Interest on the sinking fund for the subsequent years.

C = Original cost.

Cont.

Cont.If i Is the rate of interest, annual sinking fund installment (p) to accumulate 1 Rs. in n years

If i is the rate or interest and 1 Rs. is deposited every year. total sinking fund accumulated at the end of n years is,

Rate of depreciation in n years,