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  #1  
Old 10-12-2010, 07:29 AM
Abester's Avatar
Abester Abester is offline
 
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Default Order of Depreciation Deduction

A friend of mine called to ask for a source of the proper order to deduct depreciation as a percentage. For example, on a $100,000 improvement cost new, physical of 10%, functional of 9% and external of 8%.

I was taught that the order is 100,000 x .90 x .91 x .92 so there is no double dipping. If that is correct (as I was taught), I don't find a straightforward source that shows the sequence of percentage adjustments (or the lump sum adjustments reflected as percentages). I've looked through the 11th, 12th and 13th Editions but didn't really see it.

Anyone???
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Old 10-12-2010, 07:44 AM
Randolph Kinney Randolph Kinney is offline
 
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Quote:
Originally Posted by Abester View Post
A friend of mine called to ask for a source of the proper order to deduct depreciation as a percentage. For example, on a $100,000 improvement cost new, physical of 10%, functional of 9% and external of 8%.

I was taught that the order is 100,000 x .90 x .91 x .92 so there is no double dipping. If that is correct (as I was taught), I don't find a straightforward source that shows the sequence of percentage adjustments (or the lump sum adjustments reflected as percentages). I've looked through the 11th, 12th and 13th Editions but didn't really see it.

Anyone???
Algebraically speaking, there is no difference in the order and the end result since you are multiplying.

a X b X c = c X b X a
  #3  
Old 10-12-2010, 10:23 AM
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Terrel L. Shields Terrel L. Shields is offline
 
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As a practical matter it would rarely mean much. Your estimate of EX OB and FUN OB are likely to be less precise than the mathematical variation of adding all 3 together vs doing one at a time...

Say I have a house that is 10 years old (EA) and 40 years remaining life. It has a screwy layout say... And it has a cell tower on the adjacent property where a strobe light blinks all night and you lay within the fall distance of the tower..

You find a sale (or sales) where a new house (no physical deterioration) suffers a 5% price deduction for having a similar layout.

You find a sale (or sales) where a house sold for 20% less because it lay within the fall distance of a cell tower.

You have a RCN of $100,000. Since 20% of the house is "used up", we assume the DCN (sans EX and FUN) is $80,000. So...do we knock off 5% off the RCN? or 5% off the DCN? It is the difference between $76,000 and $75,000...let's go with $75,000.
Again, the EX OB is 20%...so is that 20% off $100,000 or off $75,000? That's the difference between $60,000 and $55,000...but wait!

External obsolescence CAN (and in this case likely would) affect the LAND as well... So if the typical lot around is worth $40,000...(i.e. 75k + 40k = $115,000), then the EX OB could be $23,000....and would need to be taken from the total property amount rather than the improvements alone. ....or, you could argue the defect is in the location (land) and ALL the EX OB should come out of the land price.

The issue is hopelessly complex and you probably should be careful how you ANALYZE the comparables to make sure that you REPLICATE (reverse engineer) the method you used to estimate obsolescences in the first place.

And, imho, such obsolescences are the reason why the cost approach is generally weak when Ex Ob and Fun Ob are encountered....happy trails to you...
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  #4  
Old 10-12-2010, 10:28 AM
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Deduct external and functional prior to physical to avoid depreciating items (double dipping) that are already deducted as external and/or functional items. Ya can't depreciate something that doesn't contribute to value.
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  #5  
Old 10-12-2010, 11:25 AM
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Deduct external and functional prior to physical to avoid depreciating items (double dipping) that are already deducted as external and/or functional items. Ya can't depreciate something that doesn't contribute to value.
Funny, I was taught to deduct physical first and then the other two for the same reason. I remember we had a long discussion on this a few years back and my mentor said there were two "camps" on this subject.

One camp said do them all at once and the other said no it was double dipping.
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  #6  
Old 10-12-2010, 11:42 AM
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Quote:
Algebraically speaking, there is no difference in the order and the end result since you are multiplying.

a X b X c = c X b X a
Of course the algebra is correct for the final answer. In this case, however, the dollar amount of each component is at issue. So, the order is relevent.
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  #7  
Old 10-12-2010, 01:05 PM
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Originally Posted by Michigan CG View Post
Funny, I was taught to deduct physical first and then the other two for the same reason. I remember we had a long discussion on this a few years back and my mentor said there were two "camps" on this subject.

One camp said do them all at once and the other said no it was double dipping.
It seems very clear that to "do" them all at once will lead to double dipping. Physical depreciating an over improvement clearly double dips. Assuming a $100,000 superadequacy that is physically depreciated before being deducted as functional obsolescence is simply wrong--unless of course you acknowledge the deduction for physical depreciation as lowering the deduction for functional--depreciate the over improvement 20% and deduct $80,000 for functional vs. deducting $100,000 for functional and not deducting for physical.

Bottom line, you just have to know what you're doing! I sense that many do not.
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  #8  
Old 10-12-2010, 01:09 PM
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Using Abe's original numbers: $100,000 - 17% (functional and external) = $83,000 x .90 (physical) = $74,700 VS. $100,000 X .27 (all three) = $73,000.


Clearly there is a difference!
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