Net Book Value

What is a Net Book Value?

Net book value refers to the net value or the carrying value of the assets of the company as per its books of account, which is reported on the company’s balance sheet, and it is calculated by subtracting the accumulated depreciation from the original purchase price of the asset of the company.

Net Book Value Formula

The formula used to calculate the net book value of the assets is as below:

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For eg:
Source: Net Book Value (wallstreetmojo.com)

1. Original Purchase cost here means the purchase price of the asset paid at the time when the company purchased the assets.
2. Accumulated depreciation here means total depreciation charged or accumulated by the company on its assets till the date of the calculation of the net book value of the asset.

Net Book Value Calculation Example

Let’s assume that the company Jack ltd purchased plant and machinery on January 1, 2011, worth $800,000 having a useful life of 10 years. The company has the policy to depreciate all assets annually using the straight-line method of depreciationStraight-line Method Of DepreciationStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more. Calculate the net book value of the asset for the financial year ending on December 1, 2018.

Answer

For the case of the company as given above, the purchase price of the asset is $800,000 on January 1, 2011. The useful life of the asset is 10 years, and the company has the policy to depreciate all assets annually using the straight-line method of depreciation. So, we calculate the depreciation, which will be charged every year, by dividing the purchase price of the asset with the useful life of the assetUseful Life Of The AssetUseful life is the estimated time period for which the asset is expected to be functional and can be put to use for the company’s core operations. It serves as an important input for calculating depreciation for assets which affects the profitability and carrying value of the assets.read more.

In order to calculate the net book valueBook ValueThe book value formula determines the net asset value receivable by the common shareholders if the company dissolves. It is calculated by deducting the preferred stocks and total liabilities from the total assets of the company.read more, accumulated depreciation charged till the financial year ending on December 1, 2018, will be calculated for the 8 years.

So, the NBV of the asset at the end of the financial year 2018 that will be reported on the balance sheet of the company comes to $16,000.

Advantages

1. The NBV of the company is the most used financial measure while valuing the companies and is measured for all the assets, whether they are tangible assets like building, plant & machinery, or intangible assetsIntangible AssetsIntangible 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. read more like a trademark, copyright, etc.
2. At the time of liquidation of the companyLiquidation Of The CompanyLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more, the valuation of the company is based on its NBV of the assets, and it is the main base for measuring assets value.
3. The net book value is used for calculating various financial ratiosCalculating Various Financial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more. These ratios, calculated using net book value of an asset, helps in knowing the company’s market returns and stock market price.

Disadvantages

1. The main disadvantage of the company’s net book value is that it is not same as the market value of the company as it is the cost of an asset less accumulated depreciation and is generally far away from the market value or maybe it can be close to the asset’s market value but generally never equals to the market value.
2. It is considered while evaluating the growth of the company. Still, it is not a correct indicator measuring the growth prospects of the company as the book value can be lower than the earning potentials of the company.
3. There is a possibility that the NBV of the asset is not calculated correctly as calculation of book value is very critical as it requires various compliances with applicable laws and standards. So deriving actual book values is sometimes difficult, and using it as a base for evaluation may lead to wrong decisions.
4. This changes over a period of time. Therefore relying completely on the NBV can make the asset valuation inappropriate.

Important Points

1. The NBV of the asset keeps on changing and generally, in case of the fixed asset it keeps on declining due to the effects of depreciation or depletion and at the end of the useful life of the fixed assetFixed AssetFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more, the NBV of the fixed asset is equal to its salvage value approximately.
2. Generally, the companies value their assets at cost or market price, whichever is lowerCost Or Market Price, Whichever Is LowerLower of cost or market (LCM) is the conservative way through which the inventories are reported in the books of accounts. It states that the inventory at the end of the reporting period is to be recorded at the original cost or the current market price, whichever is lower.read more. In case the market price of the asset is less than its cost, then the NBV of the asset has to be its market price. In such a case, the impairment of the assetImpairment Of The AssetImpaired Assets are assets on the balance sheet whose carrying value on the books exceeds the market value (recoverable amount), and the loss is recognized on the company's income statement. Asset Impairment is commonly found in Balance Sheet items such as goodwill, long-term assets, inventory, and accounts receivable.read more is done, i.e., lowering the asset net book value to its market price, which leads to sudden downfall in the value of the asset.
3. The market price of the asset is different from its NBV at any point in time. It is as per the company’s policy that how quickly or slowly the asset is depreciated. If the company depreciates its asset using accelerated depreciationUsing Accelerated DepreciationAccelerated depreciation is a way of depreciating assets at a faster rate than the straight-line method, resulting in higher depreciation expenses in the early years of the asset's useful life than in the later years. The assumption that assets are more productive in the early years than in later years is the main motivation for using this method. read more, i.e., allowing a higher deduction in the beginning years of the asset, then in the initial years, the net book value of the asset will be less than its market value.

Conclusion

Net book value is the cost of the asset at which the asset is purchased, which includes the purchase price of the asset plus all expenses that are incurred in making the asset ready to use less the accumulated depreciation or any impairment losses. It is considered to be the most used financial measure for the valuation of the company, and the net book value is most cases is different from the market value of the asset.

It is the base of reporting of the figures in the balance sheet of the companyBalance Sheet Of The CompanyA 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.read more. Primarily for the analysis of the growth potentials, the investor refers to these net book value figures only. Hence, the companies should focus on the correct calculation of such figures before reporting them in the financial statementsFinancial 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.read more.

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