When do I use market, cost, and income approaches for fair value?

Question

AcadiFi · Accepted Answer

IFRS 13 and ASC 820 identify three primary valuation techniques: market approach, cost approach, and income approach. The selection depends on the asset's characteristics and available inputs, with a preference for techniques that maximize observable inputs. Market approach uses prices from market transactions involving identical or comparable assets. It's ideal for Ferncroft's listed stock (Level 1 quoted price) and for liquid bonds, commodities, and comparable-company multiples. When direct quotes are available, market approach yields Level 1; when adjustments to comparables are needed, Level 2 or Level 3. Cost approach reflects the amount required to replace service capacity (replacement cost), adjusted for physical deterioration, functional obsolescence, and economic obsolescence. Best for Ferncroft's specialized manufacturing machine where no active market exists and the asset's value ties to reproduction/replacement. Typically yields Level 3 measurements. Income approach converts future cash flows or earnings to a single present value, using DCF, option pricing, or multi-period excess earnings. Applies to Ferncroft's royalty patent portfolio: project royalty streams, discount at risk-adjusted rate, adjust for obsolescence. Level 2 if inputs are observable; Level 3 if heavy unobservable assumptions. ```mermaid flowchart LR A[Asset] --> B{Observable
market?} B -->|Yes| C[Market] B -->|No| D{Cash flows?} D -->|Yes| E[Income] D -->|No| F[Cost] ``` Entities can use multiple techniques; if values diverge, weight them or disclose the range.

When do I use market, cost, and income approaches for fair value?

Master Level II with our CFA Course

Related Questions

Practice Questions