On the balance sheet, assets minus liabilities equal equity. The equity on the b

Question

On the balance sheet, assets minus liabilities equal equity. The equity on the balance sheet is known as the company’s book value. The book value of the company is different than a company’s market value (market capitalization or market cap). The market value of a company is determined by multiplying the company’s number of shares of common stock outstanding and multiplying that by the company’s stock price. Presently for U.S. companies, median book value is about one-half of market value, yielding a 2.0 market-to-book ratio. This means that the market draws on additional information than that provided in the company’s financial statements in valuing companies’ stock.

There are many things the market considers when valuing a company's stock that are not included on the company's financial statements. For example, Generally Accepted Accounting Principles (GAAP) prohibits a company from having employees listed as assets on the balance sheet. This is because placing a dollar value on employees is deemed to be too subjective a measure. Steve Jobs was never listed on Apple's Balance Sheet, but investors surely considered his vision and marketing talent when valuing the Company.

List two other reasons as to how the application of Generally Accepted Accounting Principles (GAAP) in financial statement preparation can cause a difference between a company’s book value and its market value.  

Explanation / Answer

1)Long-term assets are the value of a company's property, equipment and other capital assets, minus depreciation. This is reported on the balance sheet. Be aware that long-term assets are usually recorded at the price at which they were purchased and do not always reflect the current value of the asset.

so therefore GAAP the long term assets are recorded at book value rather than market value , whereas the market discounts these values of companies assets, therefore the market value differs from company's book value

2)Prudence principle-way of looking at prudence is to only record a revenue transaction or an asset when it is certain, and record an expense transaction or liability when it is probable. Another aspect of the prudence concept is that you would tend to delay recognition of a revenue transaction or an asset until you are certain of it, whereas you would tend to record expenses and liabilities at once, as long as they are probable. In short, the tendency under the prudence concept is to either not recognize profits or to at least delay their recognition until the underlying transactions are more certain.

FOR EXAMPLE if a company has a new growth-potential project in future , the revenues from that project will come in the financial statements once the will actually happen, but the market forsees this and the benfit from the project gets discounted in the market value

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