The difference between book value and market value
/What is Book Value?
The book value of an asset is its original purchase cost, adjusted for any subsequent changes, such as for impairment or depreciation. The concept can also be applied to an evaluation of an entire business. For example, it is the stated amount of all equity listed on a company’s balance sheet, and is supposed to be indicative of the value of the business.
What is Market Value?
Market value is the price that could be obtained by selling an asset on a competitive, open market. It is essentially a function of supply and demand, since an item in high demand for which there is minimal supply will sell at a high price - and vice versa. Market value can be determined most easily when there are a large number of willing buyers and sellers that engage in purchases and sales of similar products on an ongoing basis.
Comparing Book Value and Market Value
There is nearly always a disparity between book value and market value, since the first is a recorded historical cost and the second is based on the perceived supply and demand for an asset, which can vary constantly.
For example, a company buys a machine for $100,000 and subsequently records depreciation of $20,000 for that machine, resulting in a net book value of $80,000. If the company were to then sell the machine at its current market price of $90,000, the business would record a gain on the sale of $10,000.
As indicated by the example, the disparity between book value and market value is recognized at the point of sale of an asset, since the price at which it is sold is the market price, and its net book value is essentially the cost of goods sold. Prior to a sale transaction, there is no reason to account for any differences in value between book value and market value. Thus, until the point of sale, the difference between book value and market value cannot be recognized on the books of the company that owns the machine.
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Recognition of Changes in the Value of Assets
One case in which a business can recognize changes in the value of assets is for marketable securities classified as trading securities. A business is required to continually record holding gains and holding losses on these securities for as long as they are held. In this case, market value is the same as book value on the books of the reporting entity.
When the difference between book value and market value is considerable, it can be difficult to place a value on a business, since an appraisal process must be used to adjust the book value of its assets to their market values.
There are situations when the market value of a fixed asset is much higher than book value, such as when the market value of an office building skyrockets due to increased demand. In these situations, there is no way under Generally Accepted Accounting Principles (GAAP) to recognize the gain in a company's accounting records. However, revaluation is allowed under International Financial Reporting Standards (IFRS).