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Help & Guidance - 27 05 2022

What is Net Realisable Value in Accounting?

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Net Realisable Value (NRV) is the amount by which the estimated selling price of an asset exceeds the sum of any additional costs expected to incur during the sale of the asset. NRV has significant importance in the valuation of inventory.

Both GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards), require us to consider the NRV of inventory for valuation purposes. Under GAAP, inventories are measured at Lower of Cost or market, provided that the market value must not exceed the NRV of inventory. Under IFRS, inventories must be valued at Lower of Cost and NRV.

The NRV

Net Realisable Value is a derivation of the estimated selling price of goods, minus some deductions. The derivation is used in the determination of the Lower of Cost or market for on-hand inventory items. The deductions from the estimated selling price are any reasonably predictable costs of:

  1. Finishing the stock
  2. Transporting the stock
  3. Discarding the stock

 

There is an ongoing need to examine the value of inventory to see if its recorded cost should be reduced, due to the negative impacts of factors such as damage, spoilage, obsolescence, and reduced demand from customers. Furthermore, writing down inventory prevents a business from carrying forward any losses for recognition in a future period. Thus, the use of NRV is a way to enforce the conservative recordation of inventory asset values.

The NRV formula

Thus, the formula for Net Realisable Value is:

  1. Net Realisable Value = Sale Value – Cost to Make Saleor
  2. Net Realisable Value = Inventory Market Value – Costs to complete and sell goods

This is where the sale value is the estimated selling price of inventory in the ordinary course of business; and the cost to make the sale is the sum of any additional costs expected to be incurred to make the sale including, but not limited to, the costs of finishing, repair, advertising expenses directly related to inventory and transportation costs borne by the owner etc. if any.

Example 1

Calculate the Net Realisable Value of inventory based on the following information:

Total Units 19,000
Estimated selling price each 35
Units damaged (all together) 700
Cost to repair each damaged unit £6
Other selling costs per unit £2

Solution

Good Damaged
Estimated price per unit £35 £35
– Repair cost £6
– Other selling costs £2 £2
NRV per unit £33 £27
x units £18,300 £700
Net Realisable Value £603,900 £18,900
Total Net Realisable Value £622,800

Example 2

ABC Ltd has a green gadget in stock with a cost of £50. The market estimation of the gadget is £130. The cost to set up the gadget is £20, so the Net Realisable Value is £60 (£130 market value – £50 cost – £20 finish cost). Since the cost of £50 is lower than the Net Realisable Value of £60, you keep on recording the inventory item at its £50 cost.

In the next year, the market estimation of the green gadget decreases to £115. The cost is still £50, and the cost to set up the gadget is £20, so the Net Realisable Value is £45 (£115 market value – £50 cost – £20 finish cost). Since the net realisable value of £45 is lower than the cost of £50, you should record a loss of £5 on the stock item, subsequently decreasing its recorded cost to £45.

If this calculation does result in a loss, charge the loss to the cost of goods sold expenses with a debit, and credit the inventory account to reduce the value of the inventory account. If the loss is material, you may want to separate it in a separate loss account, which more easily draws the attention of a reader of a company’s financial statements.

The Net Realisable Value is covered within both the level 3 and level 4 AAT qualifications.

Want to become a qualified accountant through AAT?