The amount of depreciation is estimated using one or more of three fundamental methods: the economic age-life method, the market extraction method, and the breakdown method
. The market extraction method has little application to custom-built commercial properties for the same reasons the sales comparison approach is not useable, i.e., the lack of similar sales.
The emphasis to date in accounting for accrued depreciation has been to estimate the difference between cost and value by referring to sales rather than to refine the breakdown method of measuring causes of accrued depreciation.
The breakdown method of measuring accrued depreciation typically lists the causes in the following order: curable physical depreciation, incurable physical depreciation, curable functional obsolescence, incurable functional obsolescence, and external obsolescence.
The reordering of the deductions adopts the breakdown method of estimating accrued depreciation, but there are changes in how some of these items are perceived and defined.
The deduction for any item of special incurable functional obsolescence is limited to the reproduction cost remaining at this stage in application of the suggested cost approach method for measuring accrued depreciation by the breakdown method.
The breakdown method of measuring accrued depreciation using engineers' elemental costs is warranted in appraisal projects involving significant, viable special-purpose buildings, like churches, schools, public buildings, and specially designed industrial or research facilities, and especially in cases where litigation is involved.
The breakdown method of estimating physical depreciation entails estimating "all items of depreciation individually"(1) then adding the individual estimates together and deducting the sum from the estimated reproduction or replacement cost.
Three steps are involved in estimating physical depreciation by the breakdown method. The first step is to estimate curable physical depreciation by calculating the cost to cure deferred maintenance items.
Max Derbes relies on the breakdown method of estimating physical depreciation to derive a residual estimate of the productive life of long-lived components of property improvements.(3) His analysis supports the then-new concept of depreciating the "bone structure" over its physical life rather than over some shorter term, economic-life estimate.
Step three consists of estimating "the depreciation that has accrued from physical, functional, and external causes."(4) He notes that the crucial difference between the use of the breakdown method of computing physical depreciation and using the simpler age-life method is that the breakdown method employs estimates of physical life to compute building component depreciation whereas the age-life method utilizes a ratio of effective age to economic life.
Because Marshall and Swift depreciation schedules only consider effective age and economic life, they are not amenable to calculating physical depreciation of the core structure by the breakdown method.
These breakdown methods
work, and they've been applied many times.