Why is there a problem with book value, or
why could there be a problem with book value?
Well, what you see in the statements in the financial accounts is accountants
recording asset values at what it cost the company,
the corporation, to purchase the asset in the first place.
And what they do next is apply an asset depreciation scheme, very
frequently a linear depreciation scheme, and subtract accumulated depreciation,
the deterioration of value over time of the asset from its acquisition cost.
So if you take out the value at which the asset diminishes over time,
doesn't that mean that you actually get the market value?
Well not quite.
So here's what Kellogg's statements
tell you about how they record value of their assets.
The company's property assets are recorded at cost and
depreciated over their estimated useful lives using straight-line methods.
So there you have it, linear depreciation.
Is that realistic?
Do assets really deteriorate in value neatly,
linearly over an estimated 30 years, 50 years?
Kellogg's book value of assets also says something about how to deal with Goodwill.
Goodwill is not amortised, but tested at least annually for impairment of value.
So what Kellogg’s does there is, in the absence of market value,
do an occasional reality check of what the goodwill could still be valued at,
but still, according to book value.
We've already seen in an earlier module, that book value is not particularly
meaningful for some balance sheet items, for some of the non current assets,
particularly when there is a readily available market value, equity.
We've seen a large gap between the book value of equity, and
the market value of equity for Kellogg's.
So why is that the case?
Why is the market value of equity so
very different in the particular example of Kellogg's from the book value?
Well market value is established right here on the New York Stock Exchange.
Market value is a reflection of what the market is prepared
to invest in a share of Kellogg's.
Investors do that by looking forward.
So rather looking at acquisition costs, what Kellogg's paid for its assets ten
years ago, 20 years ago, the investors that are interested in shares of Kellogg's
are actually looking forward, in terms of what Kellogg's will do in the future,
how the value of its assets will translate into earnings.