What is a Net Book Value?

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

Net Book Value Formula

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

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  • Original Purchase cost here means the purchase price of the asset paid at the time when the company purchased the assets.Accumulated depreciation here means total depreciation charged or accumulated by the company on its assets till the date of calculating 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 asset’s net book value for the financial year ending on December 1, 2018.

Answer

For the company’s case, as given above, the asset’s purchase price was $800,000 on January 1, 2011. The asset’s useful life is ten 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 asset’s purchase price by 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 company’s balance sheet comes to $16,000.

Advantages

  • 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 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.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 company’s valuation is based on its NBV of the assets, and it is the main base for measuring assets value.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 the net book value of an asset, help know the company’s market returns and stock market price.

Disadvantages

  • 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.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.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.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 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’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 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 than in the initial years. In that case, the asset’s net book value will be less than its market value.

Conclusion

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

It is the base of reporting the figures on 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. However, the investor primarily refers to these netbook value figures only for analyzing the growth potential. 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.

This article has been a guide to What is a NetBook Value & its Meaning. Here we discuss the formula to calculate the netbook value example and its advantages and disadvantages. You can learn more about it from the following articles –

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