Carrying Amount Definition
Carrying amount, also known as book value of asset, is the cost of tangible assets, intangible assets or liability recorded in the financial statements which is net of accumulated depreciation/amortization or any impairments or repayments and this carrying cost may be different from current market value of such asset or liability as the market value of any asset or liability depend upon the demand and supply market conditions
It can also be defined as the value that the shareholders will get in the event of liquidation of the company. This value is generally determined by keeping in mind the GAAP or IFRS accounting principles when accounted for.
Carrying Amount Formula
- If the company has purchased some patent or any other intangible assetIntangible AssetIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. on its balance sheet, the formula to calculate the carrying amount of the asset will be (Original purchase cost – Amortization Expense).
- On the other hand, the formula for physical assets calculation, such as machinery or building, will be (Original purchase cost- depreciation).
Below is the overall formula
How to Calculate Carrying Amount?
Company XYZ purchases machinery for $20,000 on Oct-18. It uses Straight-line depreciation on the asset @ 10%. Accounting for the asset will be done as follows.
For the year ending Dec-18. The asset depreciation amount will be $20,000*10/100*3/12 = $500.
Since the asset was purchased in the month of October, the depreciation amount on the asset will only be charged for 3 months, i.e., $500 for that year. Hence on the balance sheet for the yearBalance Sheet For The YearA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. ending 31-Dec-18, the asset’s carrying amount will be $20,000- $500 = $15,000.
For the next year, full depreciation will be charged on the asset till the scrap value becomes zero.
Carrying Amount vs. Fair Value
The market value of the asset, which is also often referred to as the fair value of an asset, means for how much an asset can sell for in the market. It is the value for which an asset can be sold in the open market. For example, Company XYZ has total assets of $10,000 with a total liabilities of $80,000 the book value of the company will be $20,000 which is the value of the assets less the value of liabilities.
The market value often differs due to the following factors: –
- A difference in the depreciation methods which is used by the company and other evaluators
- The forces of supply and demand factors which makes the market value of asset vary over time depending upon the availability of the asset which can result in substantial variance in the values
- Market Value is very subjective in nature, whereas this value is based on accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts. and can be traced back to the purchase receipt of an asset.
- The market value of an asset is not related to the company’s financial statements Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.. In contrast, this value of an asset is related to the profit and loss and balance sheet item.
For example, the company purchase equipment for $200,000 each month. The company depreciates the asset for $5,000 for 4 months and then decides to sell the asset. The asset is sold for $150,000. Since the asset is sold for only $150,000 the market value of the asset is $150,000 but the carrying amount of the asset will be ($200,000 – $20,000) = $180,000. Hence the company will book a loss of $30,000 in the profit and loss statement.
When Fair Value is lower than the Carrying Value
When the company’s market value of the shares and it’s share is lower than the carrying amount, it indicates that the market and the shareholders have lost confidence in the company’s fundamentals. The future earnings are not enough to pay its debt and liabilities. There are many cases, especially with the start-up companies that their book value and market value differ significantly, and the assets are worth much less in the market than it is shown in the books of accounts. Ideally, the company should be sold off when it’s market value becomes less than the book value of the company.
When a Fair Value is greater than the Carrying Value
When the market value of the company exceeds the book value of the company, the market is positive about the future earnings prospects, increased investments. It increases profits, which will increase the market value of the company and, in turn, higher returns on the stock. A company that has consistently higher profits and increased profits will have a market value greater than the book values of the company.
However, sometimes significantly higher market values indicate overvalued stocksIndicate Overvalued StocksOvervalued Stocks refer to stocks having more current market value than their real earning potential or the P/E Ratio. Overvaluation of stocks might occur due to illogical decision making or deterioration in a Company’s financial health. and are most likely to experience a steep fall in the market prices of the stocks as investors have been too positive about the stock, and the market needs to be corrected.
When a Fair Value is equal to the Carrying Value
It is seldom that the investor will think and of the opinion that the company’s carrying amount is equal to that of the market. However, in that case, the company can be called a perfectly valued company.
Carrying Amount for an Investor
It is also the fundamental value of the company, which can be easily defined as how much the net assetsNet AssetsThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW). of the company are worth. For fundamental and value growth investors, this value is important because, for a company having a high market value from its book value is a good opportunity for investing. The price to book value ratioPrice To Book Value RatioPrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share is a good indicative ratio to measure the carrying amount of the company. The ratio indicates whether you’re paying too much for what would remain if the company is approaching bankruptcy.
This article has been a guide to Carrying Amount and its definition. Here we discuss the formula to calculate carrying amount along with examples and its differences from fair value, etc. You can learn more about accounting from the following articles –