Cost approach

Definition

The cost approach is a method used to estimate the value of an asset by determining the cost to replace or reproduce it, minus any depreciation. It involves considering both direct and indirect costs associated with creating a similar asset.

5 Must Know Facts For Your Next Test

1. The cost approach is often used for evaluating performance in responsibility centers dealing with fixed assets.
2. It includes both historical costs and replacement costs to give a comprehensive view.
3. Depreciation plays a critical role in adjusting the value in the cost approach.
4. This method can be useful in making decisions about capital investments and budget allocations within decentralized organizations.
5. Accuracy in estimating both direct and indirect costs is vital for reliable results using this approach.

Review Questions

• What types of costs are considered in the cost approach?
• How does depreciation impact the valuation in the cost approach?
• In what scenarios within responsibility centers might the cost approach be most useful?

Related terms

Responsibility Center:

A segment of an organization for which a manager is held accountable for certain activities and financial performance.

Depreciation:

The allocation of the cost of an asset over its useful life, affecting its valuation.

Capital Investment: Funds invested in a firm or enterprise for the purpose of furthering its business objectives, particularly relevant in long-term planning.