What is Net Book Value?

What is Net Book Value?

Net book value is the amount at which an organization records an asset in its accounting records. Net book value is calculated as the original cost of an asset, minus any accumulated depreciation, accumulated depletion, accumulated amortization, and accumulated impairment.

Given these deductions, net book value represents an accounting methodology for the gradual reduction in the recorded cost of a fixed asset. It does not necessarily equal the market price of a fixed asset at any point in time. Nonetheless, it is one of several measures that can be used to derive a valuation for a business.

The original cost of an asset is the acquisition cost of the asset, which is the cost required to not only purchase or construct the asset, but also to bring it to the location and condition intended for it by management. Thus, the original cost of an asset may include such items as the purchase price of the asset, sales taxes, delivery charges, customs duties, and setup costs.

The depreciation, depletion, or amortization associated with an asset is the process by which the original cost of the asset is ratably charged to expense over its useful life, less any estimated salvage value. Thus, the net book value of an asset should decline at a continuous and predictable rate over its useful life. At the end of its useful life, the net book value of an asset should approximately equal its salvage value.

Impairment is a situation where the market value of an asset is less than its net book value, in which case the accountant writes down the remaining net book value of the asset to its market value. Thus, an impairment charge can have a sudden downward impact on the net book value of an asset.

Net Book Value Formula

NBV can be calculated by taking a company’s original asset value and subtracting its total depreciation or amortization expense to date.The following is the NBV formula:

NBV = Original Asset Cost – Accumulated Depreciation, Amortization, and Depletion

Where:

Accumulated Depreciation = Per Year Depreciation x Total Number of Years

Accumulated  Amortization = Per Year Amortization x Total Number of Years

Accumulated Depletion = Per Year Depletion x Total Number of Years

Why Is Net Book Value Important?

As we touched on previously, the underlying goal of financial reporting is to provide insight into certain aspects of a business. NBV plays a critical role in this as it helps to give merit to the value of the company by fairly representing the value of PPE.

Because of its relationship to depreciation, it is important to understand that NBV is typically much lower than market value in the first years of an asset’s useful life.

This is due, in part, to certain tax strategies that seek to minimize taxable income through the use of depreciation and amortization expense.

In some cases, this means the NBV is significantly lower than the market value of an asset in the early years of an asset’s useful life.

This is the result of both the use of different methodologies of depreciation and the idea that new assets still have a significant amount of value. This disparity makes understanding NBV and how certain tax strategies can have an offsetting impact on your balance sheet.

Advantages of Is Net Book Value

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 buildings, plants & machinery, or intangible assets like a trademark, copyright, etc.
2. At the time of liquidation of the company, the company’s valuation 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 ratios. These ratios, calculated using the net book value of an asset, help know the company’s market returns and stock market price.

Disadvantages of Is Net Book Value

1. The main disadvantage of the company’s net book value is that it is not the 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 for measuring the company’s growth prospects as the book value can be lower than the company’s earning potential.
3. There is a possibility that the NBV of the asset is not calculated correctly as the 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 them as a base for evaluation may lead to wrong decisions.
4. This changes over some time. Therefore relying completely on the NBV can make the asset valuation inappropriate.

Important Points

The NBV of the asset keeps on changing, and generally, in the case of the fixed asset, it keeps on declining due to the effects of depreciation or depletion. At the end of the fixed asset’s useful life, the NBV of the fixed asset is equal to its salvage value approximately.

Generally, the companies value their assets at cost or market price, whichever is lower . 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 asset is done, i.e., lowering the asset’s net book value to its market price, which leads to a sudden downfall in the asset’s value.

The asset’s market price is different from its NBV at any point in time. As per the company’s policy, the asset is depreciated quickly or slowly. Suppose the company depreciates its asset using accelerated depreciation , i.e., allowing a higher deduction in the beginning years of the asset than in the initial years. In that case, the asset’s net book value will be less than its market value.

Example of Net Book Value

Let’s assume a manufacturing company purchased a significant piece of equipment to be used in its operations. The machine cost the company \$600,000 and has an estimated useful life of 10 years. The company calculates depreciation monthly and depreciates assets using the straight-line method of depreciation. If the machine was capitalized and put into use on January 1, 2016, what is the NBV of the machine as of 12/31/2016?

Original Purchase Cost = \$600,000

Accumulated Depreciation as of 12/31/2016 = – \$60,000

Net Book Value = \$540,000

In this example, the accumulated depreciation was calculated by determining the depreciation amount per month, and multiplying it by the number of months the asset was in use as of 12/31/2016: \$5,000 per month (\$600,000 ÷ (120 months)) multiplied by the 12 months the asset was in use during 2016 (\$5,000 × 12 months).