Meaning of Net Book Value
The term ‘Net Book Value’ or NBV refers to the net value of assets reported by the company in its balance sheet. It is the carrying value of assets after deducting accumulated depreciation, accumulated depletion, accumulated amortization and impairments from the original cost of the asset. The NBV shows the worth of asset as on the balance sheet date of the company.
Depreciation vs Depletion vs Amortization
These are different terminologies used for cost allocation to the various class of assets of the company. Depreciation applies to a fixed asset such as building and machinery etc. Depletion to wasting assets such as oil and mineral deposits and amortization to the intangible assets such as patent and leaseholds.
Calculation of Net Book Value
The formula for calculation of NetBook value(NBV) :
NBV = Original cost of the asset – Accumulated depreciation
Accumulated depreciation = depreciation per year x total no of years.
Depreciation = (Original cost – salvage value)/ estimated useful life.
The original cost of the asset refers to the acquisition cost. The acquisition cost includes the cost of purchasing asset plus the necessary expense incurred to bring it to location, installation and for putting it to use. Hence, apart from the purchase price, the original cost includes sales tax, customs duties, delivery charge and installation cost if any.
The deduction by way of depreciation or amortization or depletion is a process by which a company depreciates the original cost of the asset to the expenses at ratable charge over the estimated useful life of an asset. It is after deducting the estimated salvage value. Thus, the NBV declines at a predictable rate with each passing balance sheet date. Moreover, at the end of the useful life of an asset, the NBV approximately equals the residual or salvage value.
The deduction as impairment from the original cost of the asset occurs when the market value of the asset is less than the net book value of the asset. In such cases, the accountants write down the excess net book value of the asset. Hence impairment charge may further reduce the NBV of the asset.
Suppose a manufacturing company purchases a piece of machinery for $ 400,000 on 1 January 2018 for use in its operation. The expected useful life of that machinery is ten years, and the salvage value is $20,000. Calculate the net book value of the machinery as on 31/12/2019. Calculate depreciation using the straight-line method.
Original cost of the asset = $400,000
Annual Depreciation = $(400,000-$20,000)/10 = $ 3800
Accumulated depreciation for 2 years (01/01/18- 31/12/19) = $3800 x 2 = $7600
Net Book value as on 31/ 12/2019
= $400,000 – $7,600
Importance of Net Book Value
The netbook value of the asset is one of the financial measures to determine the valuation of the company. It can either used for valuing particular assets or all the assets of the company. It is calculated for tangible assets such as land, building and machinery etc. And also for intangible assets such as goodwill, patent etc.
It also helps in calculating the different financial ratio. The ratios use the net book value of an asset to determine the market return of the company and the market price of the stock.
The company valuation is based on the net book value of its assets at the time of the liquidation.
There are certain drawbacks of Net Book Value.
The NBV of the assets is not the same as the market value of the asset. The assets are recorded at cost on the balance sheet and gradually depreciated. Thus, these are not updated ones with changes in the price. So, if a company acquires a lot of real estates listed on the balance sheet, it may report net book value far less than its current market value.
From the growth perspective of a company, it is not a good indicator. As the NBV used for valuation of a company can be lower than the earning potential of the company.
There can be a miscalculation of the NBV of the asset. There are several compliances with laws and standards applicable to determine the book value. So, sometimes it is difficult to derive the book value, and using it for base calculation may lead to a wrong decision.
Net asset value or NBV is the written down value of the asset, i.e. the original cost of the asset less cumulative depreciation for the same. In other words, it is the net asset value or net carrying amount of the asset. The investor primarily refers to the net book value of the assets of the company for valuation purpose.