Net Realizable Value is value at which the asset can be sold in the market by the company after subtracting the estimated cost which the company could occur for selling the said asset in the market and it is one of the essential measures for the purpose of valuation of the ending inventory or receivables of the company.
What is Net Realizable Value (NRV)?
Net Realizable Value is the value of an asset excluding a reasonable estimate of costs associated with the disposal of the asset or the eventual sale, which is realized or derived upon the sale of that asset, is the net realizable value. It is commonly used in the context of inventory valuation and account receivables.
Steps to Calculate Net Realizable Value
- Step 1 – Determine the Market Value of the Asset
- Step 2 – List all the cost associated with the process of selling the Asset (including transportation, insurance, production, testing, tax etc)
- Step 3 – Calculate Net Realizable Value = Market Value of Asset – Selling Cost of the Asset
Net Realizable Value Example
A company XYZ Inc. is trying to get rid of some of its outdated phones and it expects to sell them for $5,000 to a local buyer but it must pay $240 to have them shipped and insured and another $40 to complete the paperwork.
So the telephones’ NRV can be calculated as $5,000 – $240 -$40 which is equal to $4,720.
Net Realizable Value in Inventory Valuation
NRV is a conservative method, which means that the accountant should post the transaction that does not overstate the value of assets and that potentially generates less profit, for valuing assets. It usually requires certified public accountants (CPAs) to do the job as it involves a lot of judgment on their part.
Let us take an example to understand this in detail –
Year 1
Company ABC has an inventory i2 has a cost of $70. The market value of this inventory i2 is $200 and the preparation cost to sell this inventory i2 is $30.
Net Realizable Value of the inventory = $200 – $70 – $30 = $100.
Since the cost of the inventory i2 is $70 is lower than NRV of $100, we value the inventory on the balance sheet at $70
Year 2
The market value of the inventory i2 declines to $150. Inventory i2 cost and the preparation cost to sell this inventory i2 remains the same at $70 and $30, respectively.
Net Realizable Value of the inventory = $150 – $70 – $30 = $50.
Since the cost of the inventory i2 is $70 is higher than the NRV of $50, we value the inventory on the balance sheet at NRV at $50
Inventory Write-Down = $70 – $50 = $20
In the context of net realizable value inventory, it is also important to understand that the companies using retail or the last in first out (LIFO) method would probably not use the net realized value or the lower of cost method, but would rather NRV inventory at lower of cost or market.
It is worth to note that the adjustments can be made for each item in inventory or for the aggregate of the entire net realizable value inventory, to the lower of cost or NRV. Once curtailed down the inventory account becomes the new basis for reporting purposes and valuation going forward.
US GAAP does not permit a write up of write-downs reported in a prior year, unlike international reporting standards, even if the NRV for inventory has recovered.
Net Realizable Value of Accounts Receivables
NRV is actually the amount that is expected to turn into cash. Account receivables minus the credit balance give you the NRV which can also be expressed as a debit balance in the asset account.
For instance, if the debit balances in the account receivables are $10,000 and have a credit balance of $800, then $9,200 is the resulting NRV of accounts receivables.
Net Realizable Value (NRV) Video
Conclusion
NRV is the total amount a company should expect to receive once its assets are sold or disposed of minus costs that come from its disposal or sale. This method is very useful for an accountant as it allows them to follow the conservatism principle of accounting while reporting assets on the balance sheet.
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This has been a guide to what is Net Realizable Value. Here we calculate NRV of inventory and accounts receivables along with practical examples. You may learn more about accounting basics from the following articles –
