Book Value and Market Value

An accounting-based valuation of an asset—its "book" value—can be identical to its market value. However, such an event is more a coincidence than anything else. Theoretically, on the actual date of a transaction, the book value and market value are the same.209 At all other times, however, the market value is likely to be different. Indeed, because market value is based on the expectations of future events, the market value of assets will typically fluctuate.210 Indeed, one of the advantages of historical-cost accounting is that it creates some stability in the financial marketplace because companies can prepare fairly stable balance sheets periodically without "marking to market" all their assets.211

Thus, accounting statements can never be relied upon as the indicator of value in the marketplace.212 Accounting statements have an essential, important role, but that role is not to predict market value.

fluctuate. See The Columbia History of the World, Chapter 1. Thus, the notions of investment capital, risk, reward, market value, and toil were well established in ancient times.

209 Even this observation requires some simplifying assumptions, such as assuming that the decision to buy and the purchase transaction are made at the same moment; that there are no distorting eff fects of sales or other taxes; that the purchase price was the same as the market price on that day; and there was no compulsion to buy nor were there undisclosed material facts about the asset.

210 The most visible example of this is the stock market, where security prices will change minute to minute.

211 For large companies with significant pension obligations, real estate, and foreign-exchange risks, the swing in apparent value from marking some of these assets to market every quarter—but not others—can mask more important business conditions. Certainly some parts of the balance sheet benefit from such treatment (such as financial derivatives), but a frequent mark-to-market of the entire balance sheet would be prohibitively expensive and confusing in many instances.

212 That is not to say that book value has no usefulness. Without it, it would probably be impossible to account for a firm. Furthermore, among very similar assets, the ratio between book and market value can provide an insight into how the market is pricing certain assets.

TABLE 11-1 Concepts of Value in Accounting and Economics


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