The fair market value of an asset tends to determine the price of an asset that is based on its current value. However, book value also known as the carrying value or depreciated cost is a term which is determined by the Generally Accepted Accounting Principles that states the value of an asset should be depreciated over its useful life. It is the amount that should be recorded on the balance sheet and later this depreciation can then be transferred to the profit and loss account as an expense. It is essential to differentiate between the two terms as both of having certain benefits and costs associated with them. Yet the advantages of recording assets in the statements at the fair market value overweigh the benefits of book value since it shows a more transparent picture of the value of an asset.
Fair Market Value GAAP and Book Value
According to the principles of GAAP, assets should be recorded at the book value in the balance sheet, as the assets should be depreciated since the value of the asset tends to decline over its useful life. This depreciation is then transferred to the income statement as an expense to arrive at the actual profit or loss
Advantages and Disadvantages of Fair Market Value
Using the fair market value of an asset in the financial statements of a business tends to show an improvement in its financial performance. If the value of the asset appreciates in the market over time, in result it would increase the total economic value added from business operations and will also improve the financial ratios. However, evaluating the fair market value of an asset is quite subjective as certain circumstances are to be taken into consideration. For instance time, comparable precedents, and so on. Fair market value is yet an accurate measure to determine the actual worth of an asset in the market at which both the buyer and the seller agree to make the transaction.
Book Value V/s Fair Market Value
It can be concluded by analyzing the valuation of an asset using both the book value method and the fair market value method that using the fair market value method is preferable. Since fair market value also accounts for the appreciation in the prices of an asset in the market which book value tends to ignore and this has an impact on the performance of financial health of a business as the book value keeps on declining over the years due to deduction of accumulated depreciation expense, however, an increase will only be recorded under the fair market value that will improve the financial statements.
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