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Historical Cost Net Income Statement

+ Capital
Historical Cost Net

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Assets Transactions Assets
Beginning of the + during the Period
Contributions = End of the
Period - Withdrawals
Period

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 Book Value in Finance
Why Book Value is Not Really “Value”

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 Book Value represent the value of an asset as recorded on
the financial statements (books)
 Book value is just reflection of accounting procedures and

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accountant tracking an asset ……

Book Value

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Assets

Equity
Liabilities
 Book Value of Physical Assets
Book Value = Purchase Price - Accumulated

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Depreciation
Life = 15 years Cost = 10,000 Salvage Value = 1,000
Annual Depreciation = (10,000 – 1,000)/15

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Annual Depreciation = 600

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 Book Value of a Physical Asset

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End of Deprec- Accumulated Book Value
Year t iation Depreciation

1 600 600 10,000 - 600 = 9,400

3 UR
600

600
1,200

1,800
10,000-1,200=8,800

10,000-1,800=8,200

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4 600 2,400 10,000-2,400=7,600

15 600 9,000 10,000-9,000=1,000

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Book Value depend on :
1. The original cost of the asset

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2. The depreciation method employed
3. The expected life of the asset (strictly, the depreciable life)

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4. The estimated salvage value
5. The depreciated life (t) that has lapsed
 Any of these change the BV

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 Depreciation method is management decision
 Depreciable life and salvage also management decisions as
per FBR guidelines
 Thus, more relevant to company and regulators, rather than
investors

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 Book Value of Financial Asset (Common Stock)

Balance Sheet of Briloff Inc, Dec. 31, 1988

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Assets

Total Debt
Claims

80

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Stockholders’ Equity
Common Stock (5 million shares, 1 par) 5
Additional paid-in capital 10
Retained earnings 73
Total net worth (Stockholders’ equity) 88

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Total Assets 168 Total Claims on assets 168

BV/share=Stockholders’ equity/number of shares

=88,000,000/5,000,000
=17.60

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 Book Value reflect the past
 Finding BV of physical & financial assets is a mechanical

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process
 BV reflects history and how accountants determine the cost

 BV do not satisfy two requirements of Market Value:

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1. Cash flow stream from the asset
2. Sacrifice

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 MV reflect the future income stream, while MV reflect the
past
 Opportunities are in future
 BV reflect past and not useful in decision making
 BV has little to do with what one will pay for asset, thus MV
are used
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 The Role of Book Value in Financial Decision Making

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Question: If book value really reflect the past, how are they of
use to anyone?
what use is accounting information to the financial
executives?

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According to the Accounting Principles Board:
Financial accounting information is produced for certain purposes by the
use of conventional principles. The information they contain describes the

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past, while decision making is oriented toward the future. A record of past
events and a knowledge of past position and changes in position,
however, help users evaluate prior decisions and the information is also a
starting point for users in predicting the future. Decision makers should
not assume, however, that the conditions that produced past results will
necessarily continue in the future