Amortization and market value are the two most common methods for reporting asset valuations. Each accounting method has its advantages and disadvantages.
Amortized cost is a concept that you will likely come across when preparing or reviewing business financial statements such as the balance sheet or income statement. Market value, on the other hand, is a bit more of a broad concept that applies to different scenarios and is not always used in such a specific accounting context.
The market value of an asset, which could be a house, an investment account or a piece of manufacturing equipment, is usually determined based on the market's supply and demand for the given item. For example, the seemingly inflated price customers pay for a pair of popular basketball shoes at the mall represents the shoes' current market value.
Amortized cost, on the other hand, is the result of a formulaic process that starts with an asset's original cost and then involves adjusting it over time to accommodate for wear and tear on the asset. The remaining, adjusted value of the asset and the amortized portion of its cost is recorded in the company's financial statements.
Market Value Definition
Market value can be determined in various ways, depending on the type of asset you're considering. For a market-traded stock, for example, the most recently quoted price on the stock exchange is the current market price or value, on a per-share basis. If the asset doesn't have such an easily determined price, like a home that's just been put on the market, realtors and appraisers use the price of similar homes that have recently sold to establish a range of opinion of the home's market value.
You might hear some people use "fair value" interchangeably with market value. However, they are not the same thing. Fair value consists of the price at which an asset would change hands between a knowledgeable and willing buyer and seller. On the other hand, market value can involve other factors such as a buyer or seller who doesn't know the value of the asset, or an asset that can command a higher price from certain buyers, such as collectors.
Market value can also indicate a public company's market capitalization or value. You can find a public company's market value by multiplying its current share price by the number of shares of stock it has outstanding. For privately held businesses, however, things become more complex because there are no shares of stock trading on a public market to give an idea of value.
A business valuation expert is usually brought in to assess a private company in other ways to determine its value, such as using market comparables, sale transactions from similar businesses and a discounted cash flow analysis to provide an estimate of the company's market-value range.
Defining Amortized Cost
Amortized cost is typically used in a business setting, and you can find amortized costs detailed on a company's balance sheet and income statement. This is a separate concept from that of loan amortization, which is a schedule of loan and interest payments.
When a company buys an asset, such as a piece of equipment, it has a "useful life" period that is declared by the Internal Revenue Service. The company records the asset's purchase price, known as its book value, on its balance sheet.
Over time, as the asset gets used up during its predetermined useful life, the company periodically reduces a portion of the asset's book value and shows it as an expense on its income statement. If the asset is a tangible item, such as a building, office equipment or an automobile, the expense is recorded as depreciation. If the asset is intangible, such as goodwill, the reduction in book value is shown as amortization expense on the income statement. The asset's amortized value is its remaining book value after subtracting the amortization expense.
Relating the Two Metrics
If you're reviewing a set of company financial statements and looking at assets that have been amortized or depreciated, you won't be able just to add together the amount of amortization or depreciation expense and the remaining asset value to come up with the asset's market value.
The market value of an item will vary from its book value or the cost at which a company originally purchased the item. Supply and demand, inflation, the cost of materials and other factors may cause the current market price to differ in some cases significantly.
Additionally, the asset's book value is reduced even further by the amortization process. Companies may also use an accelerated type of depreciation or amortization calculation as a way to reduce their income tax liability in any given year. This creates a situation where no relationship exists between the book value, whether or not it's net of amortization or depreciation and the item's market value.
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