Corporations maintain fixed asset records for property tax and financial reporting purposes. The value of all company assets (including real estate, equipment, and vehicles) is calculated using standard accounting procedures. However, this value – known as net book value – typically has no relation to the market value of those same assets. Business owners are often shocked to find that the net book value and market value of their assets are nowhere near each other.
What is Net Book Value?
When a company acquires an asset – such as a piece of real estate, a machine, or a vehicle – the purchase is recorded on the company’s fixed asset record. This record (which may have alternate names such as depreciation schedule or tax asset detail) captures the date and purchase price of each acquisition.
Corporations will then depreciate the purchase price over time, typically according to standard accounting procedures such as GAAP, or Generally Accepted Accounting Principles. The acquisition value minus the accumulated depreciation is the asset’s net book value.
There are multiple methods and timeframes for calculating depreciation. However, in all cases, after the entire accounting life of the asset has passed, the net book value is recorded at either a nominal salvage value, or simply and most commonly taken all the way down to $0.
In many jurisdictions, business personal property taxes are based on the depreciated asset values reported by the owner. Corporate accountants will therefore often select the shortest asset lives defensible in order to depreciate equipment purchases as quickly as possible.
How is Market Value Different from Net Book Value?
While the net book value of equipment is calculated according to common accounting procedures, market value is determined by real buyers and sellers in the equipment marketplace. Another way to think of the difference is this: net book value says, “How much is this asset worth for tax calculations?”, whereas market value says, “How much would somebody actually pay for this item?”
Market value is therefore not a mathematical calculation like net book value. Instead it is an opinion or estimate of potential transaction value. Net book value is determined by accountants, while market value is estimated by professional equipment appraisers.
Unlike net book value, market value cannot be calculated from a formula or depreciation schedule. It requires professional judgment supported by market evidence, comparable sales, cost analysis, and other valuation methodologies depending on the type of equipment.
Net book value is used primarily for tax accounting and financial reporting purposes. Market value estimates may be used for a wide range of purposes including collateral valuation, purchase price allocation for financial reporting, acquisition due diligence, insurance, and litigation.
Do Fair Market Value and Market Value Have the Same Meaning?
A market value is an estimate of what an asset may sell for in a specific circumstance. But there are many different types of market values, depending on the situation being considered. An equipment appraisal may include multiple types of market value, including fair market value, orderly liquidation value, forced liquidation value, or several other types.
The most common type of market value is “fair market value,” which is the price a willing buyer would pay a willing seller with neither party under any compulsion to make the transaction.
For example, when you buy a used car from a dealer, you are not compelled to buy the car – after all, there are many other car lots in town. Also, the dealer is not compelled to lower their price to entice you – they can wait for another interested buyer.
When you and the dealer have agreed to a price for the car which satisfies both of you, you may consider that a “fair” price, and that price would be a good indicator of fair market value.
However, there are other situations which result in market values which may not be considered “fair.” For example, in a bankruptcy auction, the seller is typically compelled to sell to the highest bidder by the court.
Besides the compulsion to transact, other circumstances such as marketing timeframes, buying terms, and relationships between the parties can also result in transactions which are not deemed to be “fair” in the sense of representing fair market value.
Appraisal organizations, such as the American Society of Appraisers, provide equipment in alternative situations.
Is Market Value Always Higher than Net Book Value?
An equipment appraisal estimates market value based on actual marketplace conditions rather than accounting depreciation, which is the basis of net book value. Because of this foundational difference, market value and net book value are rarely equal. For older equipment in particular, market value is typically higher than net book value.
It is not uncommon for companies in equipment-heavy industries, such as agriculture, construction, manufacturing, packaging, and processing, to own many long-lived equipment assets which have net book values of $0. But when these items are sold in the open marketplace, they often have positive market value.
A common example would be a semi tractor. Large trucks such as semi tractors are often assigned a 5-year accounting depreciation life on fixed asset records. A 10-year-old semi tractor with 1,000,000 miles would therefore often be assigned a net book value of $0. However, the actual resale value of such a tractor may be between $5,000-$25,000, depending on the model, condition, and configuration. In this case, market value is clearly higher than net book value.
However, market value is not always higher than net book value. For newer equipment in particular, market value may be lower than net book value.
A common example of this may be restaurant equipment. Food service furniture, fixtures, and equipment (FF&E) are often assigned a 7-year accounting depreciation life. If the restaurant owner’s accountant decides to use a simple straight-line depreciation method over 7 years of accounting life, the net book value of a 1-year-old fully-furnished commercial kitchen would have been depreciated about 15%.
However, the actual resale value of commercial restaurant equipment tends to fall very quickly, often as much as 25%-35% in the first year of service. Dining furniture, store fixtures, and point of sale systems may lose value even more quickly. In this case, market value is clearly lower than net book value.
Certified equipment appraisers can help business owners and accountants determine whether market value is expected to be higher or lower than net book value. Only rarely, and only by chance, would the two values be equal to one another.
Understanding the distinction between book value and market value is essential when financing equipment, preparing financial statements, negotiating an acquisition, settling litigation, or obtaining appropriate insurance coverage. An equipment appraisal helps ensure those decisions are based on actual market conditions rather than accounting conventions.