Your account books don't always reflect the real-world value of your business assets. The carrying value of an asset is the figure you record in your ledger and on your company's balance sheet. The carrying amount is the original cost adjusted for factors such as depreciation or damage. These factors may not reflect what the asset would sell for. Suppose your company carries a building on its books for a decade but keeps it in excellent condition. If you sell the building you might realize much more than its book value.
The equation for calculating carrying value on most assets is simple. Take the original purchase cost. Add up the depreciation or amortization over the years you've held the asset and subtract the total from the purchase price. Then subtract any impairments on the value.
Depreciation is an accounting tool for acknowledging wear and tear on the value of tangible assets such as equipment, buildings, vehicles and furniture. The exact method for figuring depreciation each year depends on the kind of asset and the depreciation method you choose. A straight-line method, for example, subtracts the same percentage of value every year. Suppose a $40,000 asset has a 10-year useful life and will be worth $2,000 in salvage value at the end of the decade. Subtract $2,000 from $40,000 to get $38,000, then divide that by 10 years. You can take $3,800 in depreciation each year.
Other methods get you different results. The "double-declining balance" depreciation method, for instance, gives you a bigger write-off up front but slows down later. "Units of production" bases depreciation on the number of units, such as shoes or hammers, that the asset will manufacture over time. "Sum of the years" is based on the asset's remaining life; it's another method that gives you higher depreciation up front.
You can use whichever depreciation method gives you the best deal on a given asset. Once you decide which method to use, it's not easy to change, so consider the financial benefits of each. If you think it's in your interest to deduct a lot of depreciation on your taxes immediately, the double-declining balance method might be a good bet. The straight-line method might be preferable if you want a steady deduction year after year.
Amortization is depreciation applied to intangible assets such as patents and copyrights. It's always calculated by the straight-line method. Unlike tangible assets, there's no salvage value when an asset's useful life expires.
Unlike the gradual loss from depreciation, impairment represents an abrupt decrease in value. The decrease happens when something drops the asset's recoverable value below the carrying amount. The recoverable value includes any future cash flows the asset might generate and the final salvage value.
Possible impairments include physical damage, obsolescence and regulations that make it harder to use the asset. For an impairment example, assume you have an office building with a book value of $1 million. After fire damage, the remaining recoverable amount is $400,000. That's a $.6 million impairment. Your accountant will have formulas for figuring the exact impairment amount.
Calculating book value of bonds works a little differently. You start with the face value of the bond, then you add or subtract any unamortized premiums or discounts on the bond. Investors pay premiums for bonds with a high rate of interest and discounts when they think the rate is too low. If you have a 10-percent discount on a $5,000 face value bond, you will amortize that $500 discount over time until you finally cash the bond. Each year you add the unamortized amount to the previous year's carrying value to get the current book value.