WFU Law School
Law & Valuation
5.1.1 Book Value

5.1.2 Adjusted Book Value

Sometimes the assets stated on the company's balance sheet can be adjusted to reflected fair market value -- that is, either their replacement value or their salvage value. This method of valuation may be appropriate for --
  • asset-intensive businesses with little value from goodwill or other intangible factors
  • not-for-profit organizations
  • businesses to be purchased by a competitor in the same industry

But there are limitations. Often a business will be worth more than the sum of its tangible assets or fixed liabilities. This method fails to account for intangible assets (reputation, quality, service) or contingent liabilities. In addition, it does not reflect discounts that may be appropriate if the valuation is of a minority interest. The value of a minority interest in a real estate partnership, for example, is rarely a pro rata share of the partnership's book assets.

Use of adjusted book value. Book value represents the historical cost of a company's assets in excess of its liabilities. This is the accountant's preferred method for valuing a corporation, familiar to the reader of annual reports and balance sheets. In computing adjusted book value, such intangible items as goodwill, patents and copyrights are often deducted from the net worth, and assets such as equipment, inventories, and real estate are adjusted to fair market value. This method is often considered appropriate for valuing real estate holding companies, investment companies and businesses that are anticipated to be liquidated, although Revenue Ruling 59-60 states that earnings are normally the most important criterion.

[cross reference to industry standard ratios]

Siegel, Mark R. Recognizing asset value and tax basis disparities to value closely-held stock. 58 Baylor L. Rev. 861-892 (2006). [L][W]

 

Legal reception of book value

Although the adjusted book value method of valuing a company is relatively simple and may be used as a factor, it is seldom accepted as the true or realistic fair market value of a profitable operating company.

But if the company is unstable, showing a loss of earnings, and financially in trouble, the liquidation value may be a prima facie approximation of value. Baum v. Baum, 120 Ariz. 140, 584, P.2d 604 (1978); McCune v. McCune, 120 Ariz. 402, 586 P.2d 651 (1978).

In Ahlenius v. Bunn and Humphreys, Inc., 358 Ill. 155, 192 N.E. 824 (1934), the Illinois Supreme Court criticized the "book value" approach:

The value of shares of corporate stock has been held to mean not merely the market price, if the stock is traded in by the public, to determine which all the assets and liabilities of the corporation must be ascertained…Among the factors which have been considered in analogous cases are earning capacity...; the investment value of the stock which is largely determined by the rate of dividends, the regularity with which they have been paid, the possibility that they will be increased or diminished, the selling price of stocks of like character, the amount of preferred stock in comparison with the common stock, the size of the accumulated surplus applicable to dividends, the record of the corporation and its prospects for the future…and goodwill. Id. at 167-68, 192 N.E. at 829.

If book value is used, commentators point out that courts should be careful that adjustments are made to book entries to reflect current market values. See generally, B. Goldberg, Valuation of Divorce Assets, § 6.5 (1984).

5.1.1 Book Value

©2003 Professor Alan R. Palmiter

This page was last updated on: March 7, 2007