Cost Approach and Depreciation Analysis
This domain tests replacement cost, depreciation, and the cost approach, especially where market evidence is thin. The examiner wants land and building treated separately and obsolescence explained.
Core rules
- Replacement cost new is the current cost to build an equivalent utility asset; reproduction cost replicates the original exactly.
- Depreciation has three parts: physical deterioration, functional obsolescence, and external obsolescence.
- Effective age and remaining economic life can estimate physical deterioration; curable items are treated separately.
- Value = land value + depreciated replacement cost of improvements, unless the asset is not land-dependent.
- Cost does not equal value: the approach must be tested against market evidence or used for special-purpose assets.
Worked example
A building has replacement cost new of 800,000 and land value of 300,000. Effective age is 15 years and total economic life 50 years, so physical deterioration is 15/50 x 800,000 = 240,000. Functional obsolescence is 50,000 and external obsolescence 30,000. Depreciated building = 800,000 - 240,000 - 50,000 - 30,000 = 480,000. Indicated value = 480,000 + 300,000 = 780,000. Land is added once and not depreciated.
Traps
- Using original cost instead of current cost.
- Applying straight-line depreciation to all assets without inspection.
- Ignoring functional or external obsolescence.
- Double-counting land.
- Reporting cost as market value without support.