Net book value definition
/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 follows:
Add the original cost of an asset. The original cost of an asset is its acquisition cost, 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.
Subtract accumulated depreciation. This the total depreciation for a fixed asset that has been charged to expense since that asset was acquired and made available for use.
Subtract accumulated depletion. This is the amount of depletion expense that has built up over time in relation to the use of a natural resource.
Subtract accumulated amortization. This is the cumulative amount of all amortization expense that has been charged against an intangible asset.
Subtract accumulated impairment. This is the accumulated amount of all impairment charges levied against an asset.
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 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.
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Disadvantages of Net Book Value
Net book value can be mistaken for the market value of a business or an asset. It may be substantially higher or lower than market value, since it is simply an accounting measure; it is entirely unrelated to the supply and demand issues that are the basis for a business or asset valuation.
Example of Net Book Value
ABC International acquires a machine for $50,000. Management expects that it will have a salvage value of $10,000 and a useful life of ten years. The company uses the straight-line method to depreciate the machine. This means that the machine is being depreciated at a rate of $4,000 per year, which is calculated as:
($50,000 Cost - $10,000 Salvage value) / 10 Years = $4,000 Depreciation/year
Thus, after three years, ABC has recorded depreciation of $12,000 for the machine, which means that the asset now has a net book value of $38,000.
Terms Similar to Net Book Value
Net book value is also known as net carrying amount or net asset value.