Book Value (Assets) - Explained
What is the Book Value of an Asset?
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Table of ContentsWhat is Book Value of an Asset?How is the Book Value of an Asset Used? Academic Research on Book Value
What is Book Value of an Asset?
The book value of an asset is the value equivalent to the assets carrying value in the balance sheet. It is calculated through netting the asset against its accumulated depreciation. The book value is also calculated through the total assets less the intangible assets and liabilities to obtain the net asset value which is similar to the book value. The book value of an initial outlay of an investment can be the gross of expenses such as sale taxes and service charges.
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How is the Book Value of an Asset Used?
This is also called the net book value or net asset value. The book value has two main functions.
- It acts as the total value of a company's assets that shareholders would get if the company were to be liquidated.
- It can be used to indicate whether a stock is under or overpriced when compared to the market value of a company.
In finance, the book value of an investment is described as the price paid in acquiring a security and debt investment. When a stock is being sold, the selling price less the book value gives rise to capital gains or losses on the investment. The book value is derived from the accounting practice of recording the asset value in the books at the original cost. By accounting measurements, the book value of an asset may stay constant over time.
However, the book value of a company can grow as a result of the accumulation of earnings generated through asset use. Comparing a company's book value with the market value of its shares serves as a valuation technique when deciding if the shares are priced moderately. This is because the book value of the company represents the shareholding wealth. However, a limitation to the accuracy of the book value serving as a proxy to the market worth of the shares can be realized if the valuation is not applied to assets whose market values may increase or decrease. For example, a real estate property which is owned by a particular company may gain market value at times while its old machinery's market value decreases as a result of advances in technology.
In such a situation, the book value at the historical cost would change the company's real value because of its fair market price. The price-to-book ratio is used as a valuation multiple to compare the values between two similar companies in the same industry when they follow the same accounting method in asset valuation. This ratio, however, may not be a valid valuation basis in the comparison of the values of companies from different industries and which don't use a similar method in valuing their assets. Because of this, a high ratio would not automatically mean a premium valuation, and a low ratio would not necessarily mean a discount valuation.
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