The current price on the open market rises and falls depending on several factors that have nothing to do with the book value of your asset. It can increase or decrease after you buy the asset. Fair value is used to figure replacement cost. Book value isn't used when replacing assets or figuring the amount of insurance needed on your current assets, as replacing an asset involves buying it at market price.
Fair value indicates whether your asset is priced too high or too low. Personal Finance Investing. This means that the book value is determined with reference to balance sheet values on any given date. In case of fixed assets, the book value would be reflected as the above amount s , net of any accumulated depreciation or amortization arisen out of normal wear and tear and impairment.
For example, Robert Inc. The book value of the machinery will change each year as follows:. As demonstrated above, the book value of assets that are subject to depreciation or amortization charge changes over time due to continuous yearly charge. Book value concept is of relevance in businesses that follow historical cost method of accounting. It is more important for asset heavy businesses than service companies which do not rely too much on fixed assets for carrying out their revenue generation activities.
The fair market value or fair value for short of an asset is the monetary amount that the asset can be reasonably expected to fetch in the open market at the prevalent prices. Fair value effectively indicates the true worth of an asset at a given time.
There are several approaches which can be applied for the determination of fair market value of assets:. Fair market value of assets is important when businesses apply fair value accounting. It is also important in the determination of true net worth of a business for which fair value of assets would be relevant.
A practical implication of the fair value concept can be found while accounting for the short term stock investments which are generally valued at their fair market values FMVs or net asset values NAVs as on the date of balance sheet.
The eight key points of difference between book value and fair market value of assets have been detailed below:. Both the values are used to determine net worth of a business. Which one of the two is more useful depends on the information needs of each individual user. Investors can compare the net worth resulting under these two methods to gauge whether a business is correctly valued or not. The carrying value of an asset is based on the figures from a company's balance sheet.
When a company initially acquires an asset, its carrying value is the same as its original cost. However, this changes over time. To calculate the carrying value or book value of an asset at any point in time, you must subtract any accumulated depreciation , amortization, or impairment expenses from its original cost.
Let's say company ABC bought a 3D printing machine to design prototypes of its product. Straight line basis is a simple way to calculate the loss of an asset's value over time. This calculation is particularly useful for physical assets—such as a piece of equipment—that a company might sell in whole or in parts at the end of its useful life.
Different from the carrying value, the fair value of assets and liabilities is calculated on a mark-to-market accounting basis. In other words, the fair value of an asset is the amount paid in a transaction between participants if it's sold in the open market.
A willing buyer and seller have agreed upon this value. Due to the changing nature of open markets, however, the fair value of an asset can fluctuate greatly over time. Let's say an investment company has long positions in stocks in its portfolio.
By having long positions, the company anticipates favorable market conditions, also known as a "bull market. However, after two negative gross domestic product GDP rates, the market experiences a significant downturn. Determining the fair value of an asset can be difficult if a competitive, open market for it doesn't exist—an unusual piece of equipment in a manufacturing plant, for example.
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