What is Appreciation?
Appreciation is an increase in the value of an asset over time. The term is widely used in several disciplines, including economics, finance, and accounting.
In accounting, appreciation refers to the positive adjustment made to the initially booked value of an asset. Moreover, accountants determined additional criteria to define the concept:
- The new value of an asset is higher than its depreciable cost.
- The value of an asset increases due to some market or economic conditions.
- The increase in the value of an asset does not result from improving or adding to the asset.
In finance, appreciation is an essential concept. The possibility of an increase in the value of the asset over time encourages investors to purchase financial assets to earn a profit.
Appreciation can affect different types of assets, including financial assets (e.g., stocks), currencies, and real estate. It can occur with tangible assets, as well as with intangible assets. For example, the value of a company’s trademarks can increase due to higher brand recognition among its customers.
There are several reasons for assets to appreciate or increase in value:
- Increased demand for an asset
- Reduced supply of an asset
- Changes in the interest rate
Appreciation vs. Depreciation
Appreciation is the direct opposite of depreciation, a decrease in the value of an asset over time. Most assets can either appreciate or depreciate. However, assets with a finite useful lifespan (e.g., machinery and equipment) are more prone to depreciation rather than appreciation. On the other hand, assets such as financial assets and real estate are expected to appreciate rather than depreciate.
Appreciation vs. Gain
Appreciation is often confused with gain. Both terms are related to an increase in an asset’s value. The main difference between the two is that the former is not a realized increase in the asset’s value. When an asset whose value has increased is sold, a company recognizes a gain.
According to accounting standards, gains on assets are frequently reported by companies. On the other hand, the appreciation of an asset may or may not be reported in financial statements. If a company decides to report the increase in the asset’s value, it can do so by the asset’s revaluation. In such a scenario, a company will report an unrealized gain, which will be equal to the increased value.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following CFI resources: