BCA Depreciation & Obsolescence Analysis 1 — Questions and Answers
Question 1: What are the three main types of depreciation recognized in business appraisal?
- Physical deterioration, functional obsolescence, and external obsolescence (Correct answer)
- Straight-line, declining balance, and sum-of-years digits
- Economic, technical, and legal depreciation
- Book depreciation, tax depreciation, and market depreciation
Correct answer: Physical deterioration, functional obsolescence, and external obsolescence
In appraisal practice, the three recognized forms of depreciation are physical deterioration, functional obsolescence, and external (economic) obsolescence.
Question 2: Which type of depreciation results primarily from wear, tear, and physical damage to a business asset?
- Functional obsolescence
- External obsolescence
- Physical deterioration (Correct answer)
- Economic obsolescence
Correct answer: Physical deterioration
Physical deterioration refers to the loss in value due to wear, age, or physical damage that accumulates through normal use of the asset.
Question 3: In the cost approach to business valuation, depreciation is best defined as:
- The reduction in net income attributable to an aging asset
- The total loss in value from any cause, measured from the asset's reproduction or replacement cost new (Correct answer)
- The annual tax deduction an owner claims for an asset
- The difference between an asset's book value and its market value
Correct answer: The total loss in value from any cause, measured from the asset's reproduction or replacement cost new
In the cost approach, accrued depreciation represents the total loss in value from all causes measured against the cost to reproduce or replace the asset as new.
Question 4: What is 'curable' depreciation in the context of business appraisal?
- Depreciation that can be recovered through future inflation
- Depreciation where the cost to remedy the deficiency is justified by the resulting increase in value (Correct answer)
- Depreciation caused by external market forces beyond the owner's control
- Depreciation recognized under GAAP that can be reversed in future periods
Correct answer: Depreciation where the cost to remedy the deficiency is justified by the resulting increase in value
Curable depreciation exists when repairing or correcting the deficiency is economically feasible because the cost to cure is offset by the resulting gain in value.
Question 5: An appraiser estimating the 'effective age' of a business asset is determining:
- The actual number of years since the asset was manufactured
- The remaining useful life of the asset going forward
- The age the asset appears to be based on its condition, regardless of its actual chronological age (Correct answer)
- The age at which the asset was last overhauled or refurbished
Correct answer: The age the asset appears to be based on its condition, regardless of its actual chronological age
Effective age reflects how old an asset appears to be based on its physical condition and utility, which may be greater or less than its actual chronological age.
Question 6: The age-life method of estimating depreciation uses which formula?
- Depreciation = Replacement Cost × (Market Rate ÷ Useful Life)
- Depreciation = (Effective Age ÷ Total Economic Life) × Reproduction Cost New (Correct answer)
- Depreciation = Original Cost − Salvage Value
- Depreciation = Annual Decline Rate × Current Book Value
Correct answer: Depreciation = (Effective Age ÷ Total Economic Life) × Reproduction Cost New
The age-life method calculates depreciation as the ratio of effective age to total economic life multiplied by the reproduction cost new of the asset.
Question 7: 'Total economic life' in depreciation analysis refers to:
- The number of years the asset has already been in service
- The IRS-mandated depreciation schedule for the applicable asset class
- The total estimated period from new through the point at which the asset no longer contributes value (Correct answer)
- The remaining term of any financing secured by the asset
Correct answer: The total estimated period from new through the point at which the asset no longer contributes value
Total economic life spans from the time the asset is new to the point it is no longer expected to contribute economic value, serving as the denominator in the age-life formula.
BCA Depreciation & Obsolescence Analysis 1
What are the three main types of depreciation recognized in business appraisal?