Functional obsolescence is the impaired usage of an asset because its design is outdated and it can no longer be updated to handle current requirements. For example, a computer becomes functionally obsolete when it no longer has sufficient RAM to handle video processing applications in a timely manner. When functional obsolescence occurs, an asset is disposed of and its remaining book value is written off. 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.
The 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.