The Cost Approach1
The Cost Approach is one of the three valuation approaches used to measure fair value in financial reporting. The cost approach is often referred to as the asset approach, and the terms are used interchangeably. For instance, the American Society of Appraisers (ASA) Business Valuation Standards say that “in business valuation, the asset-based approach may be analogous to the cost approach of other appraisal disciplines.”2
However, the International Glossary of Business Valuation Terms has separate definitions for the cost approach and asset approach. The glossary defines the cost approach as “a general way of estimating a value indication of an individual asset by quantifying the amount of money that would be required to replace the future service capability of that asset.” Conversely, the glossary defines the asset approach as “a general way of determining a value indication of a business, business ownership interest or security by using one or more methods based on the value of the assets of that business net of liabilities.”3
The difference between the two definitions is that the cost approach is more often used to describe the measurement of fair value of an individual asset while the asset approach is used to measure the fair value of a business, ownership interest, or security. Under the definition of the cost approach, fair value is measured as the cost to replace the service capacity of the asset. Under the definition of asset approach, fair ...