Formula to Calculate Net Realizable Value (NRV)
Net Realizable Value formula is primarily used to value the inventory or receivables and is calculated by subtracting the estimated cost for selling the asset from the cost related to the sale or disposition of the assets.
Net Realizable is a value of an asset at which it can be sold, after deducting the cost in selling or disposing of the asset. It is mainly used in identifying the value of inventory or account receivables. Since in NRV, a firm takes into account the cost also, hence it is known as a conservative approach of the transaction. A conservative approach means that the firm should not overstate the profit by showing a lesser value of its assets.
Calculation of Net Realizable Value (Step by Step)
For calculating NRV, below steps is to be taken:
- Step 1. Identify the market value of the asset.
- Step 2. Identify the cost related to the sale of the asset.
- Step 3. Subtract the cost from the market value of the asset.
- Step 4. It is calculated by subtracting the cost of selling or disposing of the asset from its market value.
NRV = Market Value of Asset – A Cost of Selling that Asset
- Step 5 – Under the cost of selling, the firm calculates any kind of costs which are associated with the sale of that asset, such as transportation or commission cost.
- Step 6 – If the asset is Accounts Receivable, then, there is no physical cost such as transportation. But there can be some customers who can default on paying to the company. For calculating NRV of Account Receivables, a firm will have to calculate that amount that can be defaulted by customers, which are known as “Provision for Doubtful Debts.”
NRV of Account Receivables = Market Value- Provision for Doubtful Debts
Examples
Example #1
Let’s say a firm is having an asset, which is having a market value of $100. The cost of shipping that asset is $20, and commission charges are $10.
Use the following data for the calculation of the Net Realizable Value.
Calculation of Net Realizable Value can be done as follows,
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The total cost of selling = $30
Hence Net Realizable Value of Asset = $100 – 30
NRV will be –
NRV =$70
Example #2
IBM is a US-based software company with more than $80 Bn of revenue per year. Let’s say in the Financial year 2019, the market value of Accounts Receivable (which is an asset) for IBM is $10 Bn. This means IBM is expected to receive this amount from customers who have already been recognized as revenue in its accounts. So, the value of this asset is $10 Bn. But for calculating the Net Realizable Value, IBM will have to identify the customers who can default on their payments. This amount is entered into accounts as “Provision for Doubtful Debts.” Let’s say this amount is $1 Bn.
Use the following data for the calculation of the Net Realizable Value.
So Net Realizable value for “Account Receivable” for IBM can be calculated as follows:
NRV = Market Value- Provision for Doubtful Debts
NRV= 10- 1
NRV will be –
Hence with conservative method NRV of Account Receivable for IBM is $9 Bn.
Example #3
Walmart is a US-based retail supermarket chain-based company with around $500Bn of revenue as per the financial year 2018. Let’s say in the Financial year 2018, a market value of Inventory (which is also an asset) for Walmart is around $44 Bn. Let’s say out of it, Walmart is going to sell some part of the inventory to another company for $4 Bn for offloading purposes. Walmart needs to decide the NRV of this part of Inventory. For that, Walmart needs to calculate the cost associated with the Sale of Inventory. Let’s say transportation cost is $500 Mn and legal and registration charges are $100 Mn.
Use the following data for the calculation of the Net Realizable Value.
So NRV can be calculated as per below method:
NRV Formula = Market Value- Transportation Cost – Legal and Registration Cost
NRV = 4-0.5- 0.1
The NRV will be –
Hence with the conservative method, the NRV of Inventory is $3.4 Bn.
Relevance and Use
- Net realizable value (NRV) formula can be used to find out the value of an asset in a more conservative way. Usually, GAAP requires companies to not overstate the value of an asset that can increase the profit and send some wrong signals to investors.
- NRV takes into account the cost of selling in its equation also, so NRV comes out to be lower than the market value of an asset.
- NRV is an important metric in “lower cost or market method of accounting.” In the lower cost or market method, the value of inventory should be shown lesser between the historical cost and the market value of it in the accounts. If the company cannot find out the market value of inventory, then NRV can be proxy for the same.
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