What Is the Appraisal Method of Depreciation?
The appraisal method of depreciation is a simplified method used to evaluate the economic loss in value of an asset from the beginning to the end of a reporting period. The difference between the appraised values constitutes the amount of depreciation that can be recorded. It is most often used in business valuation.
- The appraisal method of depreciation is a subjective calculation of the decline in value of an asset from the beginning to the end of a reporting period based on its value at the beginning and end of a reporting period.
- This method is typically employed to value a business and the sell-on value of its assets, but can sometimes also be used for insurance or taxation purposes.
- It's not usually considered an acceptable way to record depreciation in financial statements, though, partly because it's based on a judgmental derivation.
How the Appraisal Method of Depreciation Works
Depreciation in economics is a measure of the amount of value an item loses over time. Say a company buys an important piece of machinery for $500,000. As soon as the order arrives and is unboxed it immediately becomes worth a bit less, and then increasingly more so once it starts getting used and accumulates wear and tear over time.
How can companies and individuals determine how much an asset has fallen in value over a specific period of time? One way is to invite an appraiser over. These qualified experts should be able to give the owner a concrete estimate of what the asset could fetch in today’s open market. With that information at hand, the disclosed figure can then be compared to the original purchase price to establish how much it has depreciated.
The appraisal method of depreciation can be used by a business owner to understand the current value of his or her company. For example, a bakery owner may have an appraiser review a number of factors to determine the current worth of the bakery and other business equipment by considering physical deterioration, economic obsolescence, and functional obsolescence.
The appraiser will also look at the normal useful life of machinery and equipment, and not the accounting depreciable life, since these are often not the same. In this case, the appraiser can also adjust for the current replacement cost or reproduction cost, unlike standard accounting depreciation, which only takes the original cost in its calculation.
The appraisal method of depreciation calculation is generally not recognized by GAAP, due to its subjective use of personal judgment.
Appraisal Method of Depreciation vs. Accounting Deprecation
When companies talk about depreciation, it is often in reference to the accounting version. Accounting depreciation is the process of allocating the cost of an asset over the course of its useful life so as to align its expenses with revenue generation. This can serve several useful purposes, including reducing taxable income and boosting profit.
The appraised method, on the other hand, is primarily employed to establish what a company could fetch if it chose to sell an asset on the free market. It could potentially be used for other reasons, too, such as for collateral on a loan or insurance purposes.
The appraisal method of depreciation assumes that the value of the asset being depreciated is decreasing over the term. If this is not the case, then no depreciation will be reported.
Furthermore, this method of depreciation calculation is generally not recognized by generally accepted accounting principles (GAAP). That’s partly because the appraisal approach is based on a judgmental derivation, as opposed to an objective valuation based on published market prices, such as for stocks, bonds, or equipment.
In other words, a business could avoid charging depreciation by inflating the ending appraised value of an asset.