Book value is the book value of a company and often bears little relation to the market value of an asset. It is a generally accepted accounting principle (GAAP) term that reflects the net dollar value at which the historical cost of assets is recorded on a company’s balance sheet and represents the price paid for an asset less accumulated depreciation. Book value or depreciated cost are other terms that the financial community will use to refer to book value.
Fair Market Value (FMV) is the most widely recognized and accepted standard of value for the transfer of assets in the acquisition and sale of businesses. The ASA’s definition of FMV is “the amount for which property would change hands between a willing seller and a willing buyer when neither is acting under duress and both have reasonable knowledge of the relevant facts.”* The Concept of FMV relates to the value at which a transfer of assets should be anticipated to occur under the conditions existing at the time and date of a company’s valuation.
The easiest way to describe the two values is to understand that book value represents the depreciated value of what was paid for a particular asset, while market value represents the current price at which that asset can be purchased in the future. market.
Fixed assets such as machinery, equipment, buildings and vehicles that are expected to last more than 1 year may be depreciated as an expense in the income statement based on the annualized user cost of these assets. From an accounting perspective, depreciation transfers a component of the asset’s cost from the balance sheet to the profit and loss account during each year of the asset’s expected life. There are a variety of depreciation methods that comply with GAAP standards and are generally grouped into two classes: (1) straight line (2) accelerated. The fact that many homeowners choose an accelerated method to reduce their short-term tax liability adds additional confusion when evaluating balance sheet values.
For example, let’s say a business purchased a piece of machinery or a vehicle for $50,000 that had an expected useful life of 5 years. If the owner chose to use straight-line depreciation, the book value is reduced by $10,000 for each of the 5 years. If they instead opted for an accelerated method, such as a double declining balance, the book value is reduced by $20,000 in the first year. In each of these cases, the “book” value of the asset will be different and none of them will influence the “market” value, since there is absolutely no way to calculate the market value of a commercial asset from a balance.
According to the IRS, there is no simple formula for obtaining FMV. Depending on the type of asset, there are many methods and industry resources used to value items, similar to “blue books” for automobiles. An item’s original value may also be irrelevant, especially when considering that a variety of assets have appreciated in value over the same period that the CPA has been depreciating them. This will cause certain assets to be listed on the balance sheet at a fraction of their FMV value. Replacement cost is another indicator of FMV, but even this process may not bear a direct relationship to the actual value of the assets. When FMV is in question, the recommended approach is to hire a professional firm that specializes in valuing each particular asset class.
*ASA Business Valuation Standards (Herndon, VA: American Society of Appraisers, 1997), p. twenty
