MAHATMA EDUCATION SOCIETY’S

Pillai HOC College of Architecture Rasayani

Valuation
Module – 3
Professional Practice – 2 (B. Arch, Mumbai University)
Dr. Joydeep Dutta – Fall 2020-21
Module 3: Depreciation
• What is Sinking Fund?
• What is Depreciation?
• Factors that cause Depreciation
• Physical Condition, Functional & Economic Obsolescence
• Methods of calculating depreciation:
• (1) Straight line Method
• (2) Constant percentage method
• (3) Other methods
What is Sinking Fund?
• The fund which is gradually accumulated by way of periodic annual deposit
for the replacement of the building or structure at the end of its useful life
• The object of creating sinking fund is to accumulate sufficient money to
meet the cost of construction or replacement of the building or structure
after its utility period
• The sinking fund is created by regular annual or periodic deposits in
compound interest bearing investment
• It may be created by taking a sinking fund policy with an insurance
company or by depositing in bank to collect highest compound interest.
• The calculation of sinking fund depends on the life of the building and
scrap value of the building for the cost of old materials.
• The cost of land is not taken into account in calculating Sinking fund as land
remains intact.
What is Sinking Fund?
• The sinking fund may also be required for payment of loan.
• If a property is owned or constructed by taking loan a sinking fund may be
created by setting aside a sum of money annually to accumulate with
compound interest in order to repay the debt at the end of the term of
loan.
• The amount thus set aside is also known as Annuity payment.
• The amount which will be set aside may also be paid
directly to lender by way of annual instalment.
×
• Amount of annual instalment of Sinking fund will be: =
( )
• where, S = total amount of Sinking fund to be accumulated
N = no. of years to accumulate the Sinking Fund (SF)
i = % rate of interest in decimal
I = Annual Installment required
Sinking Fund calculation
• A pumping set with a mortar has been installed in a building at a cost
of Rs. 2,500.00. Assuming the life of the pump as 15 years, work out
the amount of annual instalment of Sinking fund required to be
deposited to accumulate the whole amount of 4% compound interest

• The owner is to deposit Rs. 125/- annually in 4% compound interest carrying

investment for 15 years to accumulate Rs. 2,500/-.
Sinking Fund Example:
• An old building has been purchased by a person at a cost of
Rs.30,000/- excluding the cost of the land. Calculate the amount of
annual Sinking fund at 4% interest assuming the future life of the
building as 20 years and the scrap value of the building as 10% of the
cost of purchase

• Annual Instalment for Sinking fund required for 20 years = Rs. 907.20
What is Depreciation?
• 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 wear and tear, decay and obsolescence.
• Usually a percentage on depreciation per annum is allowed
• The general annual decrease in the value of a property is known as Annual
depreciation.
• Usually, the percentage rate of depreciation is less at the beginning and
gradually increase during later years.
• 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.
Factors that cause Depreciation
• Wear and tear
• Fall in market value
• Accidents like fall of a tree
• Obsolescence
• Decay
• Changes in demands
• Changes in Arts and fashion
• Calamity like flood, lightning etc.
• Actions of elements of Nature like heat, cold, wind etc.
• Structural deterioration.
Depreciation as Decrease in Worth
• Depreciation conveys a decline or lessening in worth (value) of a real
estate property (or asset)
• This decrease is due to the quantum of satisfying services already
rendered during the time lapsed
• The measure of decrease in value is the difference between the
Present Worth of an asset at two different times
• The main causes for Depreciation may be classified under 3 heads:
• Physical Condition
• Functional Obsolescence
• Economic Obsolescence
• These factors may either be curable or incurable
Depreciation: Physical Conditions
• Decrease in worth due to:
• General wear and tear
• Elements of nature, e.g. heat, cold, wind
• Structural deterioration
• If proper maintenance is done, the first two factors can be taken care
of, e.g. leaky roofs, cracks in plaster, service line damages, etc. by
incurring special expenses
• Hence they are curable physical depreciation
• Structural deterioration may be due to cheap construction, cheap
materials, poor workmanship, etc. and cannot be remedied easily
• Hence they are incurable physical depreciation
Depreciation: Functional Obsolescence
• The term functional means not structural or organic, but pertaining to a mode by which it
fulfills its purpose.
• Obsolete conveys the idea of being discarded – going out of use, or outdated
• These can be caused by the following causes:
• Inadequacy or over-adequacy
• Absence of bath or WC, lack of ventilation, improper flooring, insufficient sized kitchen
• Over-adequacy: Too many electrical points, huge bathroom with super specifications
• Lacking in utility
• Small floor space of rooms, bad location of rooms w.r.t. directions, improper ventilation
• Obsolete necessities
• Water drawn from a well or hand-pump, absence of lift, etc.
• Outmoded or odd design
• Roofs with tin sheets, toilet not attached, etc.; freakish architectural feature, crazy wall colour, etc.
• Such obsolescence may be curable or incurable
• Improving drainage or water connections, adding a western WC, changing colour scheme are curable
• Increasing floor heights, adding a lift may not be feasible and thus incurable
Depreciation: Economic Obsolescence
• Economic obsolescence are caused by external factors, and not by the internal
aspects of the property (or asset)
• Economic obsolescence is almost always incurable
• These can be caused by the following causes:
• Changes in character and use
• Infrastructure quality of neighbourhood declines, slums grow up, land use turns industrial
• Changes in laws
• Planning & zoning laws change – Land-use changes, FSI changes, height restrictions, etc.
• Proximity to nuisance
• Factory producing noise or noxious gases, cinema hall attracting large crowds, graveyard, etc.
• Over-supply
• When more properties are available than the demand, then land values decrease
• Social changes
• Infiltration of unsocial elements in neighbourhood, social quality declines
Methods of calculating Depreciation
( )
• (1) Straight line Method ………. =
• (2) Constant % Method ……….. = (1 − )
• (3) Sinking fund Method
• (4) Quantity survey Method
• (5) Sum of the digits Method
• (6) Unit Cost Method
Straight Line Method of Depreciation
• Here it is assumed that the property loses its value by the same
amount every year.
• A fixed amount of the original cost is deducted every year, so that at
the end of the utility period only the scrap value is left.
• The present value minus salvage value is distributed uniformly for its
service life.
( )
• Annual Depreciation =
• where, C = Original cost or Replacement Value
S = Scrap value or Salvage value
n = life of the property in years
Straight Line Method: Example
• Cost of New Building = Rs. 4,00,000
• Salvage Value 10% at the end of life = Rs. 40, 000
• Life assumed = 60 years
• Find the depreciated values after 10 years and 60 years

( )
• Annual Depreciation =
• D = (400,000 – 40,000)/60 = 360,000/60 = 6,000/-
• Depreciation value after 10 years = Rs. 60,000
• Depreciation value after 60 years = Rs. 3,60,000
• Depd. Value after 10 years = 400000 – 60000 = 340,000/-
• Depd. Value after 60 years = 400000 – 360000
• (which is the salvage value assumed) = Rs. 40,000
Constant % Method of Depreciation
• Also called Declining Balance Method
• Here the depreciation % age remains constant through the life of the building.
• But the capital sum or base goes on reducing every year by an amount equal to
the depreciation of previous year. Thus the quantum of depreciation in this
method will go on reducing every year
• This is unlike the straight line method wherein the quantum of the depreciation
remains constant.
• The depreciated value is calculated by using the formula: = (1 − )
• where, V = Depreciated value of the building
C = Replacement Cost of Building
r = rate of depreciation per year
n = age of the building in years
Constant % Method: Example
• Replacement Value = Rs. 20,00,000/-
• Age of building = 15 years
• Depreciation assumed = 2%
• Find the depreciated value after 15 years
• Depreciated value after 15 years

• Total Depreciation factor = 1 – 0.73857 = 0.26143 = 26.143%

• But how do we find the constant % of Depreciation?
Constant % Method of Depreciation
• The depreciated value is calculated by using the formula: = (1 − )
• where, V = Depreciated value of the building
C = Replacement Cost of Building
r = rate of depreciation per year
n = age of the building in years
• Derivation of the Constant % R:
• If R = r/100 = Constant %., then
• Depd Val after 1st Yr: …… V1 = C – RC = C(1-R)…….
• Thus, Depd. Val 2nd Yr = V2 = C(1-R) – C(1-R)R = C(1-R)(1-R) = C(1-R)2 ….
• so, after n years, Vn = C(1-R)n …. This is the salvage value
• SV = C(1-R)n …….. Thus, (1 − ) = ……
• Thus, % =1 −( )
Common Example: Compare the 2 methods
• A temporary shed is constructed for Rs. 12,000/-. Assuming its
Salvage value at the end of 6 years as Rs. 3000/-, determine the
amount of depreciation and book value for each year by:
• (a) Straight line method
• (b) Constant % method
Common Example: Straight line method
• A temporary shed is constructed for Rs. 12,000/-. Assuming its Salvage value at the end of 6 years
as Rs. 3000/-, determine the amount of depreciation and book value for each year
( )
• : =
• C = 12,000/- …….. S = 3,000/- ……. n = 6 years
( ) ( )
• , = = = 1,500/- (value reduces by 1500/- each year)
Book value at end
Age in years Depreciation Total Depreciation
of year
0 12000
1 1500 1500 10500
2 1500 3000 9000
3 1500 4500 7500
4 1500 6000 6000
5 1500 7500 4500
6 1500 9000 3000
Common Example: Constant % method
• A temporary shed is constructed for Rs. 12,000/-. Assuming its Salvage value at the end of 6 years
as Rs. 3000/-, determine the amount of depreciation and book value for each year

• : = (1 − ) ……. % =1 −( )

• =1 − = 1 − 0.7936 = 0.2064 = 20.64% . .

• Now, Depn after 1st yr = 12,000 x 0.2064 = 2,477/- … Depd. Value = 12000 – 2477 = 9523/-
• Depn after 2nd yr = 9523 x 0.2064 = 1965/- … Depd value = 9523 – 1965 = 7558/-
Total Book value at
Age in years Depreciation
Depreciation end of year
0 12000
1 2477 2477 9523
2 1965 4442 7558
3 1560 6002 5998
4 1238 7240 4760
5 982 8222 3778
6 778 9000 3000
 Common Example: Compare the 2 methods
• A temporary shed is constructed for Rs. 12,000/-. Assuming its Salvage value at the end of 6 years
as Rs. 3000/-, determine the amount of depreciation and book value for each year

• Straight Line Method (D = 1500/-) Constant % Method (R = 20.64%)

Total Book value at Total Book value at

Age in years Depreciation Age in years Depreciation
Depreciation end of year Depreciation end of year
0 12000 0 12000
1 1500 1500 10500 1 2477 2477 9523
2 1500 3000 9000 2 1965 4442 7558
3 1500 4500 7500 3 1560 6002 5998
4 1500 6000 6000 4 1238 7240 4760
5 1500 7500 4500 5 982 8222 3778
6 1500 9000 3000 6 778 9000 3000

• Note, the amount of depreciation decreases each year for Constant % Method
• Note, Constant % method is also referred to as Declining Balance Method
Thank you
• End of Module 3