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Chapter 12 ESTIMATING LOSS IN VALUE: ACCRUED DEPRECIATION CHAPTER TERMS AND CONCEPTS Accrued depreciation Curable postponed Age-life method Current-value accounting Book value Deferred maintenance Capitalized income method Depreciation in accounting Cost basis Depreciation in appraisal Cost-to-cure method Diminished utility Curable depreciation Economic life 2 CHAPTER TERMS AND CONCEPTS Economic obsolescence Physical deterioration Effective age Rental loss method Functional obsolescence Sales data method Locational obsolescence Straight-line method Loss of utility Super adequacy Misplaced improvement Under-improvement Over-improvement 3 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. 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 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. 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. TYPES OF ACCRUED DEPRECIATION Physical Deterioration Functional obsolescence External Obsolescence CURABLE DEPRECIATION Curable Cost to correct the condition or defect is less than the amount of value restored INCURABLE DEPRECIATION Incurable Cost to correct the condition or defect is greater than the amount of value restored What do you think? MEASURING ACCRUED DEPRECIATION Straight-Line or Age-Life Sales Data (Market) Method Cost-to-Cure (Observed Condition) Capitalized Income BY THE SALES DATA METHOD 14 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. 15 Physical Deterioration • Deferred maintenance—curable • Deferred maintenance—incurable • Short-lived items • Long-lived items 16 Functional Obsolescence • Curable—an addition • Curable—a replacement or substitution • Curable—super adequacy or overimprovement • Incurable—a deficiency • Incurable—a super adequacy 17 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. 18 SUMMARY OF THE COST APPROACH Cost Approach Section of the URAR and 2055 Forms SUMMARY 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/agelife method, the sales data method, the cost-tocure/observed condition method, or the capitalized income method.