Definition of Carrying Amount
Carrying Amount is the amount for an asset that is reflected in the books after deduction of depreciation. There are several assets that a company purchases. All the assets have different depreciable life. So the value of each asset after depreciation in the books is termed as the Carrying amount of the asset.
An asset’s value in the market is not the same as its value in a company’s books. As the asset’s depreciation is accounted for each year, so its carrying amount changes. The profit or loss from the sale of an asset is calculated based on the asset’s carrying amount.
How to Calculate Carrying Amount?
- Step 1: Asset is recorded at its purchase price in the balance sheet of a company. So whenever an asset is purchased, cash moves out of the company, and the asset is added.
- Step 2: Assets have a depreciable life. The management of the company estimates the depreciable life and salvage value. It helps a company to keep track of the assets for the proper functioning of the business. If an asset is about to reach the end of its life, then it must be replaced to maintain production.
- Step 3: At the end of the Financial Year, the depreciation of the asset is deducted from the purchase price. The residual value is called the carrying amount.
Carrying Amount =Price of the Asset – Accumulated Depreciation
Example of Carrying Amount
A piece of machinery was purchased for $10,000. The depreciable life of the machine is considered to be for 10 years. At the end of 10 years, the salvage value of the machine will be $2,000.
Calculate the carrying amount at the end of year 2.
Depreciation per Year = (Purchase Price of Machine – Salvage Value) / Depreciable Life.
- Depreciation per Year = (10,000 – 2,000) / 10
- Depreciation per Year = 800
So per year, depreciation will be $800. See excel for Carrying amount calculation. The carrying amount at the end of Year 2 is 8,400.
Carrying Amount of Investment
Investments are done to make money. They don’t depreciate like normal Fixed Assets (Ex: Machinery). Investments can be Current or Long term. Current Investments are investments in Financial Securities which are supposed to be sold in a short span. So the carrying amount of the current securities will be lower than Fair Value or Cost of the asset. Fair Value is the value of the asset that informed buyer and seller agree to trade with. In the case of Long Term assets, the carrying value is usually the cost of the investment. If there is a decline in the value of the asset, then the carrying value is recorded at a reduced value.
Carrying Amount of Debentures
Debentures are fixed income securities that are purchased in order to receive fixed payments. If a company has bought a debenture at a premium, then the debenture’s purchase price will be recorded in the books. At the end of the maturity of the asset, the company will receive the Face Value of the debenture, but the company paid premium money to buy the debenture, so the carrying value of the asset will be:
Carrying Value = Purchase Price – Amortisation of Premium Paid.
If the purchase price of a debenture is $1,050 and the face value is $1,000. Then the company has paid a premium of $50 to purchase the debenture as the company will receive $1,000 at maturity. Say the maturity of the debenture is in 10 years. So the premium of $50 will have to be amortized in 10 years.
Per year Amortisation of Premium is calculated as
Per year Amortisation of Premium = Total Premium Paid / Maturity of Debenture.
- Per year Amortisation of Premium = 50 / 10
- Per year Amortisation of Premium = 5
The carrying Value of Debenture is calculated as
Carrying Value of Debenture at the End of Year 1 = Purchase Price – Amortisation of Premium for 1St year
- Carrying Value of Debenture = 1,050 – 5
- Carrying Value of Debenture = 1,045
So the carrying value of the debenture after year 1 is $1,045. Similarly Carrying value of debentures can be found for bonds purchased at a discount.
Carrying Value vs Market Value
Carrying Value is the value that is reflecting in the books after deduction of depreciation. Market value is the value of the asset that is prevailing in the market. If an asset has a carrying value of $500 and its market value is $700. So there will be a profit of $200 if the company sells the asset in the market.
Profit is calculated as
Profit = Market Value – Carrying Value
- Profit = $700 – $500
- Profit = $200
So carrying value is the value of the asset as per books. Whereas market value is the value at which the asset is trading in the market.
Some of the advantages are given below:
- Carrying amount help managers and other stakeholders to draw a conclusion regarding the quality of the firm’s assets. If the carrying value of all the assets are very less, then the asset position of the company is weak, and capital expenditure is required in order for the company to sustain its daily operations.
- Fair value is very subjective. Carrying the amount is a conservative way to show the value of assets in the balance sheet. If, instead of Carrying value, fair value was used, then many companies would have inflated profit by showing higher fair value for assets.
Carrying the Amount of different assets will be different as the depreciable life is not the same. Thorough analysis of carrying value by auditors must be performed as a company may show less depreciation in order to inflate profit. There are several tricks that companies perform on carrying value in order to save taxes. So proper checks should be performed in order to ensure the authenticity of the carrying value of assets.
This is a guide to Carrying Amount. Here we also discuss the definition and how to avoid capitalized interest along with advantages and example. You may also have a look at the following articles to learn more –