What is Functional Obsolescence?

Functional obsolescence is the impaired usage of an asset because its design is outdated and it can no longer be updated to handle current requirements. This condition is most likely to arise in markets where product updates are continual, or when assets have extremely long lives.

Accounting for Functional Obsolescence

When functional obsolescence occurs, an asset is disposed of and its remaining book value is written off. This can result in a significant loss, if an asset is judged to be functionally obsolescent before it has been fully depreciated. Auditors may inquire about this issue as part of an annual audit.

Budgeting for Functional Obsolescence

A business needs to review its assets on a regular basis in order to determine when they may be approaching the point of functional obsolescence, so that it can budget for replacement purchases.

Functional Obsolescence in Real Estate

The functional obsolescence term is commonly applied to real estate to describe the reason for a drop in value. For example, if an older home only has one bathroom and no basement in a neighborhood where other homes are better-equipped, this can be considered functional obsolescence.

Examples of Functional Obsolescence

As an example of functional obsolescence, a computer becomes functionally obsolete when it no longer has sufficient RAM to handle video processing applications in a timely manner. Or, a production machine becomes functionally obsolescent when it is too old to be tied into a company’s automated equipment monitoring system.