Replacement cost

What it means

Replacement cost is the price at which an asset would be acquired at the time it is recorded. It is one of the valuation bases in the Accounting Act, alongside acquisition cost and production cost.

It is used when the company paid nothing for the asset or the actual costs cannot be established. Typical cases are assets received as a gift, assets newly found at a stock-take that were never recorded, or self-constructed assets whose production cost cannot be determined.

Replacement cost is set by reference to market prices for comparable assets, price lists, quotes or an expert valuation. For used assets their condition and wear are taken into account, meaning the price at which they could be bought in that condition.

How it works in practice

When a stock-take turns up an asset missing from the books, such as an older machine that was never put into use, we determine its replacement cost and record it. We keep the evidence for the price, as the auditor or tax office may ask for it.

For gifted assets, measurement at replacement cost also affects income and the tax base. We therefore assess with the client how the gift affects tax and how the asset will be depreciated in the accounts and for tax.

For higher values we recommend an expert valuation, which is hard to challenge in an audit. For ordinary items a comparison with sellers’ offers is enough, provided it is documented and reflects the asset’s condition.

What to watch out for

Replacement cost cannot be used to revalue an asset the company bought merely because its market value has risen. The carrying value of an asset does not move upwards after acquisition, except where the law permits fair value.

An inflated replacement cost increases the company’s assets and equity without real basis. With loans or a sale of the company such a gap will surface and undermine confidence in the whole set of accounts.