Net realizable value (NRV) is the value for which an asset can be sold, minus the estimated costs of selling or discarding the asset. The NRV is commonly used in the estimation of the value of ending inventory or accounts receivable.
The net realizable value is an essential measure in inventory accounting under the Generally Accepted Accounting Principles (GAAP) and the International Financing Reporting Standards (IFRS). The calculation of NRV is critical because it prevents the overstatement of the assets’ valuation.
The NRV complies with a more conservatism approach to accounting. The conservatism approach directs accountants to use valuation methods that generate a smaller profit and do not overstate the value of the assets in situations when professional judgment is required for the evaluation of the transactions.
Net realizable value is an important metric that is used in the lower cost or market method of accounting reporting. Under the market method reporting approach, the company’s inventory must be reported on the balance sheet at a lower value than either the historical cost or the market value. If the market value of the inventory is unknown, the net realizable value can be used as an approximation of the market value.
How to Calculate the NRV
The calculation of the NRV can be broken down into the following steps:
Determine the market value or expected selling price of an asset.
Find all costs associated with the completion and the sale of an asset (cost of production, advertising, transportation).
Calculate the difference between the market value (expected selling price of an asset) and the costs associated with the completion and sale of an asset. It is a net realizable value of an asset.
Mathematically, the net realizable value can be found through the following equation:
However, the net realizable value is also applicable to accounts receivables. For the accounts receivable, we use the allowance for doubtful accounts instead of the total production and selling costs.
Example of Calculating the NRV
Company ABC Inc. is selling the part of its inventory to Company XYZ Inc. For reporting purposes, ABC Inc. is willing to determine the net realizable value of the inventory that will be sold.
The expected selling price of the inventory is $5,000. However, ABC Inc. needs to spend $800 to complete the goods and an additional $200 for transportation expenses. Considering the available information, the net realizable value of the inventory should be calculated in the following way:
NRV = $5,000 – ($800 + $200) = $4,000
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