Book value is an asset's original cost, less any accumulated depreciation and impairment charges that have been subsequently incurred. The book values of assets are routinely compared to market values as part of various financial analyses. For example, if you bought a machine for $50,000 and its associated depreciation was $10,000 per year, then at the end of the second year, the machine would have a book value of $30,000. If an impairment charge of $5,000 were to be applied at the end of the second year, the book value of the asset would decline further, to $25,000.
Book value is not necessarily the same as an asset's market value, since market value is based on supply and demand and perceived value, while book value is simply an accounting calculation. However, the book value of an investment is marked to market periodically in an organization's balance sheet, so that book value will match its market value on the balance sheet date.
Book value can also refer to the amount that investors would theoretically receive if an entity liquidated, which could be approximately the shareholders' equity portion of the balance sheet if the entity liquidated all of its assets and liabilities at the values stated on the balance sheet. The concept can also be applied to an investment in a security, where the book value is the purchase price of the security, less any expenditures for trading costs and service charges.
You can also determine the book value per share by dividing the number of common shares outstanding into total stockholders' equity. For example, if the shareholders' equity section of the balance sheet contained a total of $1,000,000 and there were 200,000 shares outstanding, then the book value per share would be $5.
You can compare the market value of the total number of an entity's outstanding shares to its book value to see if the shares are theoretically undervalued (if they sell at less than book value) or overvalued (if they sell at more than book value).
The book value concept is overrated, since there is no direct relationship between the market value of an asset and its book value. At best, book value can only be considered a weak replacement for market value, if no other valuation information is available about an asset.
How to Calculate Book Value (the book value formula)
The calculation of book value includes the following factors:
+ Original purchase price
+ Subsequent additional expenditures charged to the item
- Accumulated depreciation
- Impairment charges
= Book value
For example, a company spends $100,000 to buy a machine and subsequently spends an additional $20,000 for additions that expand the production capacity of the machine. A total of $50,000 of accumulated depreciation has since been charged against the machine, as well as a $25,000 impairment charge. The book value of the machine therefore $45,000.