Net book value is the value of an asset as recorded in the books of accounts of a company. It is the carrying value of the asset on the balance sheet of the company and is calculated as the original cost of the asset less the accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.
The value of an asset keeps declining steadily due to the effect of depreciation or amortization, as the case may be. At the same time, the number of accumulated depreciation increases in the books by the amount of depreciation expensed in that accounting period. Therefore, as the asset value decreases, the number of accumulated depreciation increases by the same amount.
If the asset is expected to have a value at the end of its useful life (salvage value), the net book value of the asset at the end of its useful life will be equal to its salvage value.
Net Book Value Formula
The original cost of the asset refers to not only the purchase price of the asset but also the costs associated with bringing the asset to the desired location and making it operational.
Therefore, the original cost of the asset is calculated as the sum of the purchase price of the asset and the cost of acquisition. The cost of acquisition includes the delivery charges, set up costs and other duties and taxes that need to be paid to acquire the asset.
Accumulated depreciation is the total amount of depreciation that has been charged as an expense in the income statement of the company from the time a fixed asset was purchased and put to use in the business operations.
If the asset in question is an intangible asset, it will be amortized as an expense in the income statement similar to depreciation expense. Accumulated amortization is the total amount of amortization expense charged to an intangible asset. This accumulated amortization amount needs to be subtracted from the original value of the intangible asset to calculate the net book value of the intangible asset.
If the asset in question is a natural resource, it will be recorded as a depletion expense in the income statement similar to depreciation expense. Accumulated depletion is the total amount of depletion expense charged against a natural resource.
This accumulated depletion amount needs to be subtracted from the original value of the natural resource to calculate the net book value of the natural resource.
When the fair value of an asset permanently reduces, it is recognized as an impairment loss in the income statement. Accumulated impairment is the total amount of impairment expense charged against an asset.
This accumulated depletion amount needs to be subtracted from the original value of the asset to calculate the net book value of the asset.
Net Book Value Example
M/S XYZ Ltd purchased a piece of machinery on Jan 1st, 2016 for $280,000. Additionally, the company had to pay $2,000 as delivery charges, $3,000 as set-up costs and taxes and duties of $15,000 on the machinery. The company uses the straight-line method of depreciation for all its assets. What is the net book value of the asset as on December 31st, 2019, if the machinery is expected to have a useful life of five years?
First, let’s calculate the total cost of the machinery. As mentioned earlier, the total cost of an asset includes the cost of acquisition. In this case, the cost of acquisition includes costs such as delivery charges, set-up costs, and taxes and duties. Therefore, the total cost of the asset would be:
Therefore, the total cost of machinery equals $300000.
Next, we calculate the accumulated depreciation to December 31st, 2019.
Since the company uses the straight-line method of depreciation and the useful life is five years, the amount of depreciation that will be expensed in the income statement each year would be:
Accumulated depreciation to December 31st, 2019 (which is 4 years) would then be:
Now, we calculate the net book value of the asset as on December 31st, 2019.
- Original cost of the asset: $300,000
- Accumulated depreciation: $240,000
The net book value of the machinery as on December 31st, 2019 is $60,000.
Net Book Value Analysis
Net book value is an important metric used to determine the fair value of a company, especially in cases of mergers and acquisitions or liquidation.
Net book value is affected by the amount of accumulated depreciation reported in the books. Therefore, companies that use an accelerated rate of depreciation model might report lower net book value for the asset in the first few years of the asset life.
Also, remember that the net book value of an asset might not represent its actual market value since assets are usually recorded at cost in the balance sheet whereas their market prices are subject to change continuously. If the market value of the asset falls substantially and the company concludes that the value of the asset has permanently reduced, then the company recognizes an impairment loss for that asset. The book value of the asset is then adjusted by the impairment loss and the resulting value would now be the new net book value of the asset.
Net Book Value Conclusion
To sum up:
- Net book value is defined as the carrying value of the asset on the balance sheet of the company and is calculated as the original cost of the asset less the accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.
- The net book value of the asset will equal its salvage value at the end of its useful life
- It is one of the most important metrics used for determining the fair value of a company.
- The net book value of the asset might, in most cases, not equal the market value of the asset, either due to fluctuation in market values, or due to the company using an accelerated depreciation model.
FAQs
1. What is Net Book Value (NBV)?
The net book value of an asset is the carrying value of the asset on the balance sheet.
2. How do you calculate the Net Book Value (NBV)?
It is calculated as the original cost of the asset less the accumulated depreciation. The formula is:
NBV = Original Cost of Asset - Accumulated Depreciation
3. Why is the Net Book Value (NBV) important?
NBV is important because it represents the amount a company would receive if it sold an asset for its book value. It is also used in the calculation of impairment losses.
4. What are the disadvantages of the Net Book Value (NBV)?
One disadvantage is that NBV may not be reflective of an asset's true market value. Additionally, companies that use an accelerated depreciation model may report a lower NBV for the asset in the first few years of its life.
5. What is the difference between the Net Book Value (NBV) and the fair market value?
The difference between net book value and fair market value is that the former is based on the carrying value of an asset as recorded in the books, while the latter may be reflective of an asset's true market value, which may be higher or lower than the carrying value.
