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Historical Cost Net
Assets
Beginning of the
Period
+
Income Statement
Transactions
during the Period
+
-
Capital
Contributions
Withdrawals=
Historical Cost Net
Assets
End of the
Period
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Book Value in Finance
Book Value represent the value of an asset as recorded onthe financial statements (books)
Why Book Value is Not Really Value
Book value is just reflection of accounting procedures and
accountant tracking an asset
Book Value
LiabilitiesAssets
Equity
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Book Value of Physical Assets
Book Value = Purchase Price - Accumulated
Depreciation
Life = 15 years Cost = 10,000 Salvage Value = 1,000
Annual Depreciation = (10,000 1,000)/15
Annual Depreciation = 600
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Book Value of a Physical Asset
End of
Year t
Deprec-
iation
Accumulated
Depreciation Book Value
1 600 600 10,000 - 600 = 9,400
2 600 1,200 10,000-1,200=8,800
3 600 1,800 10,000-1,800=8,200
4 600 2,400 10,000-2,400=7,600
15 600 9,000 10,000-9,000=1,000
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1. The original cost of the asset
2. The depreciation method employed
Book Value depend on :
3. The expected life of the asset (strictly, the depreciable life)
4. The estimated salvage value
5. The depreciated life (t) that has lapsed Any of these change the BV
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
Assets Claims
Total Assets 168
Total Debt
Stockholders Equity
Common Stock (5 million shares, 1 par)
Additional paid-in capitalRetained earnings
Total net worth (Stockholders equity)
Total Claims on assets
80
5
1073
88
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
process
BV reflects history and how accountants determine the cost
BV do not satisfy two requirements ofMarket Value:
1. Cash flow stream from the asset2. Sacrifice
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
Question: If book value really reflect the past, how are they of
use to anyone?what use is accounting information to the financial
executives?
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
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 astarting 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