How to calculate building depreciation

Calculation of building depreciation is very important in valuation of a building. Depreciation is the gradual exhaustion of the usefulness of a property. This may be defined as the decrease or loss in the value of a property due to structural deterioration, use, life, decay and obsolescence. The value of a building or structure will be gradually reduced and a certain percentage of the total cost may be allowed as depreciation to determine its present value. Usually a percentage on depreciation per annum is allowed. The general annual decrease in the value of a property is known as annual depreciation. As a result percentage rate of depreciation is less at the beginning and gradually increased during later years.

how to calculate building depreciation
how to calculate building depreciation

The amount of depreciation being known, the present value of a property can be calculated. After deducting the total amount of depreciation from the original cost.

Methods of calculating building depreciation

The various methods of calculating depreciation are as follows

Straight line method

In this method it is assumed that the property loses its value by the same amount every year and a fixed amount of the original cost is deducted every year. Therefore at the end of the utility period only the scrap value is left.

Annual depreciation, D = (original cost – scrap value)/ life in years = (C-S)/n

Book value after the number of years, say N years= original cost- NxD

Constant percentage method

It is assumed that the property will lose its value by a constant percentage at the beginning of every year.

Annual depreciation d is equal to 1 – (S/C)1/n

Where C, S, n and D have the same meaning as above,

The value of the property of the depreciated cost at the end of the first year.

= C -DC = C1

Property at the end of second year,

= C1-DC2 and so on.

The depreciated cost at the end of m years = C x (S/C)m/n

The formula will fail when S equals to zero because when the ratio (S/C) is very small and the depreciation for the first year will be considerable.

Sinking fund method

Depreciation of property is assumed to be equal to the annual sinking fund plus the interest on refund for that year. Which is supposed to be invested on interest bearing investment. If A is the annual sinking fund and b, c, d represent interest on sinking fund. For subsequent years and C equals total original cost.

At the end ofDepreciation for yearTotal depreciationBook value
1st yearAAC-A
2nd yearA+b2 A+bC-(2 A+b)
3rd yearA+c3 A +b+cC-(3 A+b+c)
4th yearA+d4 A+b+c+dC-(4 A+b+c+d)

Quantity survey method

The property is studied in detail and loss in value due to wear and tear are worked out. Therefore each and every step is based on some logical ground without any fixed percentage of the cost of the property. Only experienced valuer can work out the amount of depreciation and present value of a property by this method.

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For further reading https://www.indiafilings.com/learn/depreciation-rate-building/

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