What Are the Two Main Types of Physical Depreciation

Physical depreciation is a natural process that occurs over time, and it's essential to understand its two main types to make informed decisions about assets and investments.

One type of physical depreciation is Wear and Tear, which refers to the gradual loss of an asset's value due to normal use and maintenance.

Wear and tear can be caused by a variety of factors, including weathering, erosion, and mechanical stress.

It's a common phenomenon that affects many types of assets, from buildings and vehicles to machinery and equipment.

The other type of physical depreciation is Obsolescence, which occurs when an asset becomes outdated or no longer meets the needs of its owner.

Obsolescence can be caused by technological advancements, changes in market demand, or shifts in societal values.

As assets become outdated, their value decreases, and they may eventually become worthless.

Physical deterioration in real estate is a natural process that occurs over time. It's a loss of value from all causes of age and action of the elements.

There are two types of physical depreciation: curable and incurable. Curable depreciation refers to the physical deterioration that can be fixed or cured economically, such as painting, repairing broken fixtures, or replacing old carpets. The cost of curing these issues is typically less than the increase in property value once the repairs are made.

Examples of curable depreciation include paint jobs, roof repairs, deferred maintenance, and repairs to the heating or cooling system. These issues can be fixed without breaking the bank.

Incurable depreciation, on the other hand, refers to physical deterioration that is not economically feasible to correct. These are generally major issues that would cost more to fix than the value they would add to the property. Examples include an outdated layout, poor architectural design, or extensive structural damage.

Here's a breakdown of the two types of physical depreciation:

It's worth noting that some appraisers include a third category called short-lived incurable physical deterioration, which refers to provisions for items that wear out faster than the improvements themselves. However, this is a matter of debate among appraisers.

Physical depreciation can be caused by a variety of factors, including normal wear and tear. This can include things like paint jobs, roof repairs, and deferred maintenance.

Some common causes of physical deterioration include broken fixtures, old carpets, and dated construction materials. These issues can be easily fixed and are often associated with curable depreciation.

Here are some examples of physical deterioration:

In some cases, physical deterioration can be more serious and incurable, such as when bearing walls have to be replaced or the foundation of a property is faulty.

Incurable deterioration is a significant concern for property owners and investors. It refers to physical deterioration that is not economically feasible to correct.

Examples of incurable deterioration include outdated layouts, poor architectural design, and extensive structural damage. These issues can be costly to fix and may not increase the property's value.

The cost of repairs often exceeds the potential increase in property value, making it a losing proposition for the owner. This is why incurable deterioration is often abandoned.

Here are some examples of incurable deterioration:

Incurable deterioration can be a major setback for property owners, as it can significantly reduce the asset's value. It's essential to assess the economic feasibility of repairs before deciding on a course of action.

The age of a property is a significant factor that contributes to physical depreciation. A property that's 50 years old may have outdated electrical wiring, plumbing, and HVAC systems, reducing its overall value.

A property's level of maintenance and upkeep can also impact its physical depreciation. A well-maintained property with a new roof, updated plumbing, and modern appliances will likely experience less physical depreciation than one that's been neglected.

Environmental factors can contribute to physical depreciation, with properties in areas with high levels of pollution or natural disaster risks experiencing more wear and tear.

The quality of materials used to construct a property is another key factor in physical depreciation. A property built with low-quality materials may experience more wear and tear than one constructed with high-quality materials.

A property's age, maintenance level, environmental factors, and material quality all impact its physical depreciation, making them essential factors to consider when evaluating a property's value.

Depreciation methods are used to calculate the decrease in value of an asset over time. The straight-line method is the most basic way to record depreciation, where an equal depreciation expense is reported each year throughout the entire useful life of the asset.

To calculate the annual depreciation amount using the straight-line method, you divide the total depreciable amount by the total number of years of an asset's useful life. For example, if a machine has a useful life of five years and a salvage value of $1,000, the annual depreciation amount would be $800 per year.

The straight-line method results in an annual depreciation rate of 20% ($800 / $4,000).

The straight-line method is the most basic way to record depreciation, reporting an equal depreciation expense each year throughout the entire useful life of the asset until the asset is depreciated down to its salvage value.

This method is calculated by dividing the total depreciable amount by the total number of years of an asset's useful life. For example, a company buys a machine for $5,000 with a useful life of five years and a salvage value of $1,000, resulting in a depreciable amount of $4,000.

The annual depreciation amount using the straight-line method is $800 per year, which is 20% of the total depreciable amount. This means that each year, the company will expense $800 as depreciation, until the machine is depreciated down to its salvage value of $1,000.

To calculate the annual depreciation rate, you simply divide the annual depreciation amount by the total depreciable amount, which in this case is $800 / $4,000 = 20%.

The declining balance method is an accelerated depreciation method that begins with the asset's book value instead of its salvage value. This means that the same percentage causes a larger depreciation expense amount in earlier years, then declines each year thereafter.

Depreciation is calculated using the formula: (Asset Cost - Accumulated Depreciation) x (1 / Useful Life). For example, a machine costing $5,000 with a useful life of five years would have a depreciation of $1,000 in the first year ($5,000 x (1 / 5) = $1,000).

In the declining balance method, the depreciation amount decreases each year, but at a slower rate than the double-declining balance method. For instance, in the second year, the depreciation would be ($5,000 - $1,000) x (1 / 5), or $800.

The declining balance method is often preferred over the straight-line method because it reflects the asset's decreasing value more accurately. As the asset gets older, its value decreases, and the declining balance method takes this into account by reducing the depreciation amount each year.

Depreciation in the declining balance method is calculated based on the asset's book value, not its salvage value. This is in contrast to the straight-line method, where depreciation is calculated based on the asset's salvage value.