Explain cost approach in mergers and acquisition

Cost approach has natural appeal. If merger/acquisition of two or more companies takes place then, new company value is the difference between asset and liabilities of its combined value.

This analysis has similarities to the balance sheet. In this, the cost basis balance sheet is converted to required value. This approach in breakdown of components of value, facilitate structure deal and post-sale purchase price.

Specialists identify all assets and liabilities including those which are not included in the balance sheet. After identification, they assign value for each, based on fair value.

Contingent liabilities, pending litigations etc. are not included in the balance sheet.

Another challenge comes, when companies' uses cash/tax basis accounting. In this, financial statements are converted into accrual basis.

Accounts receivable and payables are excluded in the balance sheet and depend on accelerated depreciation methods to understand the fixed asset market value. With this process, a market based balance sheet is created.

Separate appraisals are required for machinery, equipment etc. and are prepared by specialists.


The advantages of cost approach in mergers and acquisition are as follows −

  • Simplicity.
  • More useful to small manufacturers.
  • Conflicting appraisal evidence.
  • Provides the company's ground value.
  • Business worth is calculated.
  • Negotiations.
  • Bridging gaps between sellers and buyers.
  • Purchase price is allocated.


The disadvantages of cost approach in mergers and acquisition are as follows −

  • Lot of time is required.
  • Each item is revalued separately.
  • It is a complicated approach.

Updated on: 19-Jul-2021


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