Book value / Accumulated depreciation / Book value per share
In financial accounting, the term book value refers to the current balance sheet value of either (a) assets, or (b) the equity value of the company.
- For most assets, book value is essentially the original purchase price less accumlated depreciation, as shown in the example below.
- The example also shows how book value for the company (Owner's Equity from the balance sheet) is composed of contributed capital and retained earnings.
Asset book value is a central concept in asset life cycle management, especially when the market value of an asset differs substantially from its book value. Book value of the company, on the other hand, is theoretically what would be left if the company's assets were liquidated and its outstanding bills were paid. Some investors pay attention to the the company's book value, when they compare book value per share of (common) stock to the stock's current market price per share, attempting to decide whether the stock is underpriced or over priced.
Note, incidently, that the term book value is also used more generally to mean the "standard," or reference book market price for a wide range of goods, including automobiles, boats, motorcycles, and other items. The "book value" for a used car of a given age, distance driven, and condition, is provided by sources such as the Kelly Blue Book.
• Book Value for Assets
• Book Value for the Company
• Balance Sheet Example
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Book Value for Assets
The balance sheet shows the book value for different categories of assets owned by the company, such as Current Assets, Property, Plant and Equipment., or Intangible Assets, for instance. Each asset category, however, is the sum of book values for individual assets.
Assets are valued first by the historical cost convention commonly used in accounting, that is, they are initially valued at the asset's price at the time it was acquired. For assets that are subject to another accounting convention, depreciation, the asset value declines through each year of the asset's depreciable life, as each year's depreciation expense is subtracted from the book value.
The decline in asset book value with increasing accumulated deprecation is determined by several factors including the asset's original cost, depreciable cost, residual value, and the depreciation schedule used. Over it's depreciable life, the asset's book value will decline from it's original value, down to it's residual value. In other words,
Original Cost of Asset = Depreciable Cost + Residual Value
Only the depreciable cost component will be claimed as depreciation expense across the years of depreciable life. The asset's residual value (sometimes called salvage value) remains at the end of depreciable life—if residual value is permitted with the depreciation schedule used. Residual value is the estimated net value of the asset that would or could be received if the asset were retired or scrapped.
The figure at left shows how an asset originally costing $100 decreases in book value to its residual value over its depreciable life, as depreciation expense is charged each year (the example shows straight line depreciation across a 5 year life). As the remaining depreciable value declines each year, the total accumulated depreciation increases. The balance sheet in fact keeps both the original acquisition value and the accumulated depreciation in view, as shown in this excerpt from the Assets page of the example balance sheet below. Grande Corporation provides three balance sheet entries for accumulated deprection as follows:
Assets |
The figures, of course, are totals representing all the assets in each category. For all the assets still within their depreciable life, accumulated depreciation will increase on the following year's balance sheet.
When the company charges a depreciation expense, incidentally, several income statement and balance sheet accounts are involved. The depreciation expense charge in fact begins with entries in the bookkeepr's journal that might look like this:
Grande Corporation Date Account Debit Credit DD-MMM-YY 770 Deprec exp, factory |
The depreciation expense is entered as a debit to an income statement account, here a depreciation expense account for this class of asset (smaller companies might record all depreciation expenses in a single account for all assets). As an income statement account, Depreciation expense, factory manufacturing equipment has a balance increase by the debit amount.
At the same time, an equal, off-setting credit entry is made in the asset account Accumulated depreciation, factory manufacturing equipment. This account, however, is also a contra asset account, so that the normal "rules" of debit/credit additions/subtractions are reversed, and a credit here also increases the account balance. (For more on debits, credits, see the encyclopedia entry Double entry system).
At the end of the accounting period, the balances in Depreciation expense accounts appear on the income statement, subtracted from Sales revenues and lower reported margins and profits. At the same time, the balances in the Accumulated depreciation accounts appear on the balance sheet, as shown in the example above, to lower the current book value of assets below their original book value.
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Book Value for the Company
The balance sheet for a company is a detailed implementation of the so-called accounting equation:
Assets = Liabilities + Owners Equity
In other words, the balance sheet shows what the company owns outright (equities), what the company owes (liabilities), and the resources the company has to work with (assets), at one point in time (usually the end of the reporting year or reporting quarter). The book value of the company is the total value shown under Owner's Equity.
In this excerpt from the more complete balance sheet (at bottom), the company book value is the value of the category Owner's Equity:
Owners Equity |
The two components of the company's book value (Owner's Equity) are Contributed capital and Retained earnings.
- Contributed capital includes funds paid by investors for the purchase of stock directly from the company. This occurs at the company's initial public offering (IPO), and when the company issues more shares again at at subsequent stock offerings (Stock shares purchased in the secondary market do not contribute to contributed capital). See the encyclopedia entry on contributed capital for more on the components of this category.
- Retained earnings are profits the company has earned and used to grow equity. the other main use for profiTts is to distribute them to shareholders as dividends..
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Balance Sheet Example
A more detailed version of the balance sheet examples from above is presented here.
Grande Corporation Assets Liabilities Owners Equity |
For more on the major balance sheet categories and balance sheet usage, see the encyclopedia entry for balance sheet. For working examples of interrelated financial statements and a full coverage of financial statement metrics, see Financial Metrics Pro.
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