Business, Legal & Accounting Glossary
In accounting and finance, the carrying value or carry value of an asset is the amount reported as the asset’s current nominal “worth” for accounting purposes. It is also called the book value of an asset (although book value may also be used to refer to the shareholders’ equity in the balance sheet).
In accounting, every asset and liability attributable to a company must have a balance sheet value. The value of many assets and liabilities, however, may only be estimated. Carrying value formally refers to the value that appears on the balance sheet for each asset, although the term is used less frequently for assets whose market price is readily determined (such as a quoted security).
Book or carrying value may be used in particular to describe assets whose actual value may differ from the balance sheet estimate, or whose market value may be indeterminate (or irrelevant, if the likelihood of a “market” transaction involving the asset is minimal).
Accounting treatment for any asset acquired involves attributing the cost of the asset at acquisition to the price of the asset, and subsequently adjusting the value of that asset. The most common convention used to estimate the value of many assets (for reporting purposes) is to estimate the “useful life” of that asset, and subsequently to allocate a portion of the acquisition price to each year using depreciation. At certain times, management may “adjust” the carrying value of an asset to reflect its actual value, particularly on refurbishment. Any asset that is disposed of will also cause an adjustment (reported as a gain or loss upon disposal) if the disposition price differs from the carrying value.
Accounting has traditionally used historical acquisition cost, minus depreciation (and as adjusted) as the primary determinant of carrying value. This can lead to large differentials between the “book value” of an asset (or the company itself) if assets have appreciated in value and over long periods of time. For example, under historical cost accounting, a company may carry land purchased at any point in the past at acquisition value (land usually does not depreciate). Simply due to inflation, the value of the land may have substantially increased, but the carrying value may not have changed unless management specifically chose to adjust the carrying value.
Increasingly, accounting standards are requiring that more assets be reported at estimated market value, particularly where a market price can easily be determined. For many assets, however, there may still be substantial differences between carrying value and actual value. In addition, any decisions to dispose of or revalue an asset will have an impact if the carrying value differs from actual value.
In cases where substantial adjustments are made to carrying value, financial results will be affected; if such asset revaluations are large in relation to operational results, it may be an indication that financial results should be interpreted carefully.
As a simple example, consider an asset that is purchased for $100, which the company decides to depreciate linearly over 10 years (every year, the asset loses $10 of its total worth). At year 0, the asset is worth $100. At year 1, the asset has depreciated by $10, so its book value (carrying value) is $90. At year 2, the asset has depreciated by $20, so its carrying value is $80, and so on.
At the end of the tenth year, the asset is sold for scrap for $10, while management had estimated that it would have no value. The company reports a gain on disposal of $10 as income.
Any change to the value of assets and liabilities is generally reflected in the profit and loss statement (some exceptions do exist, particularly under different accounting systems). A revaluation of an asset could, therefore, create the appearance of a change in profitability that may not be repeatable. In addition, such revaluations may not result in cash returns to the company in the near future. For this reason, such revaluations may be referred to as “extraordinary events.” Asset revaluations have figured prominently in certain accounting scandals, with accusations that assets were revalued to manipulate results.
As an extreme example, a company sells widgets and consistently makes $1000 pre-tax profit per year, with no change in the sales or profits foreseen. Its only asset or liability is a building (with land) acquired 100 years ago for $1000, and it has no liabilities. The company has never adjusted or depreciated the cost of this building (with regular repairs treated as expenses). The value of the building is now $100,000. The shareholders of the company have just hired a new management team. As with previous management teams, management is paid $100 per year, plus a guaranteed bonus of 10% of accounting profits ($100 per year).
At the end of the first year, management revalues the building to reflect its true worth or $100,000. Profit on the asset revaluation is $99,000, and total profits are $100,000. Management receives $10,000 and retires.
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This glossary post was last updated: 18th April, 2020 | 21 Views.