Net Book Value is an accounting principle that helps accountants determine the value of a business’s assets. When it comes to financial reporting one of the underlying goals is to assess how much the company is worth, what it produces, and how much cash flow is available.
Each of the core financial statements serves to answer these questions, with the balance sheet representing what a company is worth.
Let’s discuss how the concept of Net Book Value (NBV) is used by accountants to determine the value of a company’s assets, how that impacts the balance sheet, why it is important, and how to calculate it.
What Is Net Book Value?
Net book value is the historical cost of an asset, less any amounts recorded for depreciation, amortization, or depletion.
It is a product of fair value reporting that requires assets be reported at their market value. The concept of fair value underscores many of the financial reporting standards that are required under US GAAP.
Fair value reporting refers to, “an asset’s sale price agreed upon by a willing buyer and seller, assuming both parties are knowledgeable and enter the transaction freely.”
Net Book Value And The Balance Sheet
NBV is often used to disclose the value of Property, Plant, and Equipment (PPE). This means that it is reduced as assets are depreciated or amortized. It derives from the idea that, over time, assets lose some of their value as they are used.
Depreciation is subtracted over the course of the asset’s useful life and is often utilized by tax professionals to help reduce the burden of income taxes.
Another factor to consider in reporting NBV is salvage value. In some cases, assets may have some value remaining at the end of their useful life, this is referred to as salvage value. Because of its relationship to depreciation and amortization, NBV should slowly and predictably decrease over time.
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.
How To Calculate Net Book Value
The formula for calculating net book value is:
NBV = Original Asset Cost – Accumulated Depreciation, Amortization, and Depletion
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
Example: How To Calculate NBV
A company purchases a new fleet vehicle at a cost of $60,000. The company will depreciate the asset by $12,000 a year for three years. The third-year net book value would be equal to the following:
Original Cost: 60,000
Less: (Depreciation) (36,000)
Net Book Value: 24,000
In this case, depreciation would be calculated as follows:
$12,000 annual depreciation expense x 3 years = $36,000 accumulated depreciation
The carrying value of the fleet vehicle might consequently become its salvage value or at some point, the asset might be fully depreciated and have no value. In these cases, salvage value acts as a fair value floor in which the asset cannot be depreciated further. Certain types of equipment fall into this category, or any asset that can be salvaged either wholly or in pieces.
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