Chapter Two Fair value measurement and Impairment

2.1.4.1. The Market Approach
Where active markets exist in appropriate assets (commodities, equipment, real estate, or securities), their prices should be taken into account through applying various methods under the Market Approach. Market Approach directly provides fair value, since it is based on transactions that are normally consummated between willing buyers and willing sellers in an open market.
There are two primary methods to be considered when utilizing the Market Approach:

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   Completed transaction method (CTM): is based on the principle of substitution, which states that the economic value of any asset or “thing” tends to be determined by the cost of acquiring an equally desirable item, with similar utility and functionality; therefore, no reasonable person would pay more than the amount required for such a reasonable alternative.
   
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   Guideline company method (GCM): uses prices for ordinary shares of comparable quoted firms in stock markets to establish valuation multiples that may be applied to the subject.
   

2.1.4.2. The Cost Approach
The Cost Approach to value is one of the three generally accepted approaches to estimate the fair value of an asset; its theoretical basis is reproduction cost. In practice, it may be either duplicate (reproduction) or replacement costs². The Cost Approach is especially suited for recently constructed properties because they suffer only minor depreciation and the reproduction cost is likely to be similar to the actual incurred expenditures. It is also applicable to older properties when reliable data are available to measure depreciation and estimate reproduction costs.
From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. Obsolescence is broader than depreciation, whether for financial reporting or tax purposes. According to the standard, obsolescence encompasses:

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  physical deterioration;
  
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  functional (technological) obsolescence; and
  
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  economic (external) obsolescence: consider a subject property that, due to external factors, operates at 60% of rated capacity with no increase in utilization anticipated in the foreseeable future. In this case, the 40% underutilization represents external obsolescence, sometimes referred to as inutility.
  

The duplicate cost new (DCN) reflects the cost to replace the property at its current size; hence, a reduction due to inutility would be necessary to determine fair value. Conversely, the replacement cost new (RCN) reflects the cost to build a substitute with 40% less capacity; hence, no inutility adjustment is necessary because the cost basis has already been reduced specifically to reflect this form of external obsolescence.
The basis used normally in the Cost Approach is current cost new (CCN). The figure for current cost new must include all expenditures necessary to construct the substitute property and render it ready for use. Construction costs are typically classified into two broad categories: direct and indirect. Various techniques are available to estimate current costs new.

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