Book value

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Book value is the recorded cost on the books for the purchase of an asset. This recorded cost is known as the historical cost. Companies in the United States, in conjunction with Generally Accepted Accounting Principles (GAAP), record all assets at their historical cost. It is essential to understand book value in contrast to market value. According to the textbook (Essentials of Corporate Finance), market value is the "true value of an asset" or in other words "the amount of cash we would get if we actually sold it." The book value of an asset does not necessarily, and in fact, rarely coincides with an assets worth from a market value standpoint. Current assets can often show an exception to this because of their quick turnover. Current assets may have similar book and market values because these assets are turned into cash in a very short period of time. Due to the speed of this turnover, there is not much time for the market value to fluctuate greatly from the book value. Fixed assets are much more likely to have a market value with greater deviation from the book value. This is because fixed assets have much more time to fluctuate in value according to changing market conditions. An example of the disparity between book and market value could be seen in the purchase of a piece of land in New York City one hundred years ago. Company XYZ may have bought a piece of land in 1908 for five thousand dollars. That same piece of land may currently be worth five million dollars. Company XYZ would still have that land recorded on their books at historical cost, or five thousand dollars. This example shows the contrast of market and book valuation. While the actual value of Company XYZ's land is five million dollars, it will continue to show up on their balance sheet at the book value of five thousand dollars. This example also illustrates that book value is simply an accepted accounting convention and not an accurate and efficient way to interpret the current value of an asset.