Definition
Deprival Value: Deprival value is an accounting measure used to determine the loss a business would incur if it were deprived of an asset. It represents the lower of the replacement cost (cost to replace the asset) and the recoverable amount (the higher of net realizable value and economic value). This concept is vital in providing a more accurate reflection of an asset’s worth to the business, often used in current-cost accounting practices.
Examples
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Manufacturing Equipment: Assume a company owns a piece of manufacturing equipment that would cost $100,000 to replace with similar functionality. However, the equipment could be sold for $70,000, or its value in use (the present value of future economic benefits derived from the asset) is $80,000. The deprival value, in this case, would be $80,000, as it is the lesser between the replacement cost and the recoverable amount.
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Office Building: A business owns an office building with a replacement cost of $2 million. The building could be sold for $1.5 million, but its value in use is assessed at $1.8 million. The deprival value of the office building would be $1.8 million, again representing the lower value between replacement cost and recoverable amount.
Frequently Asked Questions
What is the purpose of deprival value?
Deprival value aims to provide an accurate measurement of the loss a business would incur if deprived of an asset. It helps in offering a realistic valuation that reflects both current costs and the specific value of the asset to the business.
How is deprival value different from fair value?
While both deprival value and fair value provide asset valuations, fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants. Deprival value, on the other hand, focuses on the loss to the business if an asset is deprived, emphasizing the asset’s replacement cost and recoverable amount.
In what accounting systems is deprival value commonly used?
Deprival value is frequently utilized in current-cost accounting, where the focus is on the cost to replace the assets currently owned, providing a more dynamic and practical approach to asset valuation compared to historical cost accounting.
Current-Cost Accounting
A method of accounting in which assets and liabilities are recorded at their current cost to the business, often updated to reflect current market conditions and replacement costs.
Replacement Cost
The cost to replace an asset with another asset of similar functionality and efficiency.
Recoverable Amount
The higher of an asset’s net realizable value (estimated selling price minus selling expenses) and its value in use (present value of future cash flows expected from the asset).
Net Realizable Value
The estimated selling price of an asset in the ordinary course of business, less the costs necessary to make the sale.
Value in Use
The present value of the future cash flows expected to be derived from an asset or a cash-generating unit.
Online Resources
Suggested Books
- “Accounting and Valuation Guide: Valuation of Privately-Held-Company Equity Securities Issued as Compensation” by American Institute of Certified Public Accountants
- “Financial Reporting, Financial Statement Analysis, and Valuation” by James M. Wahlen, Stephen P. Baginski, and Mark T. Bradshaw
- “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc. & Tim Koller
Accounting Basics: “Deprival Value” Fundamentals Quiz
### What does deprival value measure?
- [ ] The maximum profit potential of an asset
- [x] The loss a company would experience if it were deprived of an asset
- [ ] The historical cost of an asset
- [ ] The net realizable value of an asset
> **Explanation:** Deprival value measures the loss that a company would incur if it were deprived of an asset.
### Which two components are compared to determine the deprival value of an asset?
- [ ] Fair value and historical cost
- [x] Replacement cost and recoverable amount
- [ ] Market value and book value
- [ ] Original cost and selling price
> **Explanation:** Deprival value is determined by comparing the replacement cost and the recoverable amount of an asset.
### What does the term "recoverable amount" refer to?
- [x] The higher of an asset's net realizable value and its value in use
- [ ] The tax-allowable deduction for an asset
- [ ] The sale price minus the cost of disposal
- [ ] The future market value of an asset
> **Explanation:** The recoverable amount is the higher of an asset's net realizable value and its value in use.
### In which accounting system is deprival value most commonly used?
- [ ] Historical-cost accounting
- [ ] Tax accounting
- [ ] Managerial accounting
- [x] Current-cost accounting
> **Explanation:** Deprival value is most commonly used in current-cost accounting, which focuses on asset replacement costs.
### How is "net realizable value" defined?
- [x] The estimated selling price minus the costs necessary to make the sale
- [ ] The future income from an asset divided by inflation
- [ ] The original purchase price plus depreciation
- [ ] The scrap value of an asset
> **Explanation:** Net realizable value is defined as the estimated selling price of an asset minus the costs necessary to make the sale.
### Which of the following best describes "value in use"?
- [x] The present value of the future cash flows expected from using an asset
- [ ] The market price for which an asset could be sold
- [ ] The book value of an asset on the balance sheet
- [ ] The insured replacement cost of an asset
> **Explanation:** Value in use refers to the present value of the future cash flows expected from using an asset.
### When the replacement cost of an asset is higher than its recoverable amount, what is the deprival value?
- [ ] The average of the two amounts
- [x] The recoverable amount
- [ ] The replacement cost
- [ ] The net realizable value
> **Explanation:** When the replacement cost is higher than the recoverable amount, the deprival value is the recoverable amount.
### What aspect of deprival value emphasizes its practical application over other methods?
- [ ] It aligns with historical costs
- [x] It reflects the current cost and business-specific value appropriately
- [ ] It focuses on the potential selling price in the market
- [ ] It considers the highest possible valuation
> **Explanation:** Deprival value reflects the current cost and the value to the specific business appropriately, making it more practical.
### Why is deprival value considered useful in financial reporting?
- [ ] It simplifies tax calculations
- [ ] It offers a historical snapshot
- [x] It accurately reflects the economic loss of losing an asset
- [ ] It inflates asset values
> **Explanation:** Deprival value is useful in financial reporting because it accurately reflects the economic loss a company would face if deprived of an asset.
### What is the primary difference between deprival value and fair value?
- [ ] Deprival value looks at original cost; fair value looks at market price
- [x] Deprival value considers the cost of deprivation; fair value focuses on market transactions
- [ ] Deprival value is used for personal assets; fair value for business assets
- [ ] There is no difference; they are interchangeable
> **Explanation:** Deprival value focuses on the cost of deprivation and replacement from the business perspective, whereas fair value is based on market transactions.
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