NRV – net realizable value in accounting is a widely used inventory valuation method. It aims to calculate the value realized by selling some specific inventory item. This value can be calculated by deducting selling expenses from the selling price. Following formula can be used to calculate NRV value.
Net realizable value formula
NRV = Selling price – cost of selling
Cost of selling refers to the additional cost required for selling the inventory. These costs may fall in the areas of marketing expenses, modification costs, and other costs associated with the sale of inventory items.
International Accounting Standard – IAS2 requires inventory to be valued at a lower of cost and NRV. Cost is the amount incurred in purchasing the inventory during normal business activity. In simple words, it’s an invoice amount that you pay to purchase inventory. On the other hand, NRV is what you can realize by selling some specific asset.
An accounting standard requires to value inventory lower of the cost and NRV. So, it’s a prudence concept because it requires selecting the lower amount from cost or NRV.
Prudence concept – The prudence concept advocates conservatism. Its aims show a conservative picture of the financial statement. In simple words, it encourages expenses to be recorded. However, asset/profit should only be recorded when it’s certain that economic benefit will be realized.
Net realizable value example
Suppose you have item-A in the inventory books. An item-A was purchased two years back and at the cost of $300 per unit. However, today this item-A can be sold at $320 by incurring a marketing expense of $50.
Let’s understand the above scenario under the guidance of an IAS-2. In the above case, the cost of item-A is $300 and NRV can be computed as follows.
NRV = Selling price – cost of selling
NRV = $320-$50
Here we find that NRV is $270 and the cost of this item was $300. Under the guidance of IAS-2, we need to select a lower amount which is $270. This amount should be recorded in the financial statement. So, the valuation loss of $30 ($300-$270) should be recorded in the financial statement as followings.
|Profit and loss (inventory impairment)
|Inventory for item-A
The debit impact of the transaction is the recording of impairment as realizable value has declined. On the contrary, the credit impact of the transaction is the removal of the inventory balance.
Net realize value vs. fair value.
Net realizable value is the amount that can be realized by selling a specific inventory item. It’s calculated by deducting selling expenses from selling prices.
NRV is considered a reliable valuation method because we analyze the realization of net cash at the end. Further, it considers the related cost of selling an inventory.
On the other hand, fair value is a market-based measure that reflects the market potential of a specific inventory item. It helps to obtain the selling price of specific inventory items. In other words, fair value is the amount that can be received against the sale of an asset/ settlement of liability between knowledgeable and willing parties, carrying the transaction at arm’s length in the active market. So, it’s a market-based measure.
Further, NRV is specific to an entity (internally calculated), and fair value is about market based measure.
IAS-2 requires inventory to be valued at a lower of cost and NRV. Cost is the amount incurred in purchasing specific inventory. On the other hand, NRV is the amount that can be realized by selling an item after incurring some selling cost. These selling costs may be marketing, modification, or any other cost. This treatment is dependent on the international accounting standard-2.
Frequently asked questions
Why should external auditors perform NRV testing?
The external auditors perform NRV testing for the valuation of the inventory balance. In fact, it’s required by IAS-2 to ensure inventory is recorded at a lower of cost and NRV.
NRV is a net realizable value that can be realized in cash. It’s calculated by deducting selling expenses like modification/marketing cost from the selling price.
What is the net realizable value for the accounts receivables?
Net realizable value for accounts receivable refers to deducting provision from gross accounts receivable balance. It’s a conservative balance that reflects balances to be collected with higher assurance.
What’s the difference between market value and net realizable value?
Market value refers to the price the product can be sold in the market. On the contrary, net realizable value is the amount that can be collected in cash. So, market value is more relevant when want to purchase and realizable value is more important when willing to sell.