What’s wrong with using the cost approach to value intellectual property?

There are many problems with using the cost the cost approach to value IP. Probably the most significant is that the cost approach fails to reflect the IP’s earnings potential, and the value of intellectual property is derived from its earning potential.

In effect, the cost approach assumes that the fair value of the asset will be the same as its cost. However, cost does not equate to value. One invention might make it big; another with a similar investment might find little market acceptance. Clearly they do not have the same value.

If the IP has significant income upside in a growing market, the cost method will likely understate its value by quite a bit. If research and development has been inefficient or lengthy, or if the market potential is lacking, the cost method may well overstate the IP value.