Replacement cost and market value

Abstract

Purpose Several problems arise from the current valuation standards and guidance in relation to the replacement cost method and they can be classified as definitional and methodological. Definitional problems include confusion over the precise meaning of the terms cost, price and value and clarification of the economic concepts of substitution and “highest and best use” in the cases of market‐based and replacement cost methods. Methodological problems include the difficulty in finding market‐derived inputs, particularly when estimating depreciation, and the need to make end adjustments. These matters raise the question as to whether a replacement cost method is compatible with a market basis of value. This paper aims to address this issue. Design/methodology/approach The paper reviews academic literature and professional practice guidance in relation to the replacement cost method of valuation and the market value basis of valuation. Findings Defining replacement cost as a method of estimating market value rather than a separate basis of value blurs the distinction between cost and value. This paper argues that market value assumptions do not hold in the case of the replacement cost method. Originality/value The paper seeks to stimulate debate on the current professional guidance for the use of the replacement cost method of valuation.

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