Depreciation of Buildings in Valuation
Three methods, one building, three different answers, and why the report must say which you used.
In valuation, depreciation is the loss in a building's value compared with a new one, from wear, age and loss of usefulness. It is a market measure, not an accounting entry: the rates in a company's books or a tax return say nothing about what a buyer would deduct for a 20-year-old building.
The exam wants three things: the lives of a building, the arithmetic of each depreciation method, and the kinds of obsolescence. The methods give very different answers for the same building, which is why questions often ask you to compute more than one.
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The Lives of a Building
- Physical life
- How long the structure can stand and be used safely with normal maintenance.
- Economic life
- How long it earns more than the return that the cleared site would earn. Usually shorter than physical life, especially in cities where redevelopment pressure is high.
- Legal life
- A limit set by law or contract, such as the unexpired term of a ground lease or a demolition order.
- Effective age
- Age judged from condition rather than the calendar. A well-repaired 30-year-old building can have the effective age of a 20-year-old one.
Worked Example: Three Methods, One Building
Illustration only. Replacement cost ₹1 crore, total life 60 years, salvage value 10% (₹10 lakh), age 20 years.
Straight line
Working
Annual = (100 less 10) ÷ 60 = ₹1.5 lakh. 20 years = ₹30 lakh
Depreciated value
₹70.0 lakh
Constant percentage (reducing balance)
Working
Rate r where (1 minus r)^60 = 0.10, so r = 3.765%. Value = 100 × (0.96235)^20
Depreciated value
₹46.4 lakh
Sinking fund at 5%
Working
Annual instalment = 90 × 0.05 ÷ (1.05^60 minus 1) = ₹0.255 lakh. Accumulated after 20 years = 0.255 × (1.05^20 minus 1) ÷ 0.05 = ₹8.4 lakh
Depreciated value
₹91.6 lakh
| Method | Working | Depreciated value |
|---|---|---|
| Straight line | Annual = (100 less 10) ÷ 60 = ₹1.5 lakh. 20 years = ₹30 lakh | ₹70.0 lakh |
| Constant percentage (reducing balance) | Rate r where (1 minus r)^60 = 0.10, so r = 3.765%. Value = 100 × (0.96235)^20 | ₹46.4 lakh |
| Sinking fund at 5% | Annual instalment = 90 × 0.05 ÷ (1.05^60 minus 1) = ₹0.255 lakh. Accumulated after 20 years = 0.255 × (1.05^20 minus 1) ÷ 0.05 = ₹8.4 lakh | ₹91.6 lakh |
Why the Answers Differ
Straight line spreads the loss evenly. Constant percentage front-loads it, which matches how buyers view machinery but is harsh on a well-built structure. The sinking fund method back-loads it, treating depreciation as the money that must be set aside each year, growing at interest, to replace the building at the end of its life.
Indian valuation practice for buildings commonly uses straight line on an age-life basis, with judgement on salvage and remaining life. Whichever method you adopt, the report must state it and the inputs, because the choice moves the value by tens of lakhs.
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Obsolescence: Loss That Age Does Not Explain
- check_circleFunctional: a design that no longer suits users, such as an office floor with too many columns or a warehouse with low eaves.
- check_circleTechnological: outdated services that a new building would not have, such as no fire sprinklers or an old lift system.
- check_circleEconomic or external: a cause outside the property, such as a flyover that blocks a shopfront or a fall in demand in the area. It cannot be cured by spending on the building.
- check_circleCurable obsolescence is deducted at the cost to cure; incurable obsolescence at the loss of value it causes, often measured from the loss of rent.
How the Valuation Examination Tests This
Expect a numerical on straight line or sinking fund depreciation, and a classification question on obsolescence. The traps: depreciating the full cost when a salvage value is given, using calendar age when the question gives effective age, and calling an external cause functional obsolescence. Check the method the question names before computing.
FAQs
Which depreciation method is used for building valuation in India?expand_more
Straight line on an age-life basis is the most common in reports, with the remaining life and salvage set by the valuer. The sinking fund and constant percentage methods are also in the syllabus and appear in exam questions.
Is valuation depreciation the same as depreciation in accounts?expand_more
No. Book depreciation allocates cost under accounting or tax rules. Valuation depreciation estimates the loss in market value compared with a new building.
What is the difference between physical and economic life of a building?expand_more
Physical life ends when the building can no longer be used safely. Economic life ends when the site would be worth more cleared or redeveloped, which usually comes first.
Can depreciation be applied to land?expand_more
No. Only the building depreciates. Land can lose value for external reasons, but that is reflected in the land rate, not as depreciation.
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