Building on the framework of understanding an asset’s effective age, one can then begin to look at that asset’s physical deterioration. Physical deterioration is simply an effect of depreciation on an asset caused by physical means, not including economic or functional obsolescence. In order to find the physical deterioration, take the asset’s anticipated physical life (how long it is supposed to last) and divide it by the effective age.
For an example of this concept, assume an asset has a physical life of 10 years and an effective age of 5 years. With these assumptions, 50% would be the apparent physical deterioration. This, in the appraisal world, is what is known as the age/life ratio.
There is the possibility, however, that the asset mentioned may outlive its physical life. This is where effective age becomes an important factor of the equation. Sometimes, an asset can be taken care of to the point that its effective age outlasts the physical age, which requires the physical deterioration to be altered. In this case, instead of using merely the physical life in the denominator of the equation, the sum of the effective age and remaining physical life of the asset would be used. If the physical life were to be used when the effective age is greater than it, it would indicate more than 100% physical deterioration, giving the impression that the asset does not function.
Expanding from the first example, supposed that this same asset still has the physical life of 10 years but has now progressed to have an effective age of 12 years. This may have been due to a rebuild or overhaul on the equipment. In the process, it has been determined that the asset physically has a remaining physical life of 3 more years. As a result, the physical deterioration would be 12/12+3, indicating an 80% physical deterioration.
Putting this concept to use, an owner of an asset can use information to determine how much functionality has been used up from an asset, which may assist in its valuation.