Replacement Costs Definition
In accounting, the replacement costs of an asset is the current market price a company would have to pay to replace an existing asset. This is in contrast to book value. Book value is the historic purchase price of the asset, less accumulated depreciation.
Replacement Costs Example
For example, if a company bought a machine for $1,000 five years ago, and the value of the asset today, less depreciation, is $300 dollars, then the book value of the asset is $300. However, the cost to replace that machine at current market prices may be $1,500. Therefore, the replacement cost would be significantly higher than the book value.
Similarly, if the company bought a quantity of steel for $10,000 a year ago, and the price of steel subsequently sky-rocketed, then the replacement cost for that same amount of steel could be $15,000, or whatever the current market price of steel dictates for the given quantity.
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