Cost Approach

The cost approach indicates an intangible asset’s value by considering its replacement or reproduction cost, relying on the economic premise that a prudent investor would pay no more for an asset than the cost to acquire an asset of equal utility. As one of three generally accepted and commonly applied approaches for the valuation of intangible assets (Chartered Global Management Accountant [CGMA], Three Approaches to Valuing Intangible Assets, 2012), the cost approach is applied the least frequently—because it is considered the least representative of an asset’s future economic benefits. In common practice, the cost approach is typically applied as a method of last resort, when other methods are not feasible, when market participants could reproduce an asset of substantially similar use without restrictions or significant time delay (IVSC, Valuation Approaches and Methods. London, 2016), or as a means of validating the plausibility of valuation estimates that are generated by other valuation approaches. The cost approach is typically applied for the valuation of a workforce—a key component of a firm’s goodwill and a crucial input for the income approach to valuing intangibles. The most commonly applied cost approach methods for the valuation of intangible assets are the reproduction cost method and the replacement cost method, both of which have special characteristics with respect to tax treatment and the treatment of obsolescence charges.