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Net Realisable Value meaning is the total estimated selling price of market goods subtracting the disposal or sale expenses. It is used in determining the market for single-hand inventory items or lower costs. Here the deduction from the total estimated selling price is the predicted reasonable cost of completion, disposing, and transporting of inventory.
The net realisable value is an important approach in inventory cost accounting under the IFRS (International Financing Reporting Standards) and the GAAP (Generally Accepted Accounting Principles). Calculating Net Realizable Value is critical as it prevents the overstated asset’s valuation.
The net realisable value approach is more conservative than accounting. This complies with and directs accountants for using the valuation method that is reliable and does not overstate the company’s assets in any professional judgement situation.
Net Realisable Value and Lower Cost
Net Realizable Value is an important approach metric and is used in account reporting. The business should report its inventory in financial statements at cost or NRV whichever is lower than on the Balance sheet date. If the market value is not known, the net realisable value is used for the approximation of the item’s market value.
Understanding the Concept of Net Realisable Value
There is a need to examine and see the inventory cost value if recorded costs should be decreased. This is due to negative factors such as spoilage, damage, reduced demand, and obsolescence. Further noting down the inventories prevents from carrying any business loss recognition in the future period. Thus, the use of net realisable value is to enforce the record of inventory cost value.
The conservative recording of inventory cost value is important because the overstated value can give results of more assets than the case in business reporting. Also, this is an important concern when one is calculating the current ratio value, which is the comparison between current assets and liabilities.
One should note that creditors and lenders rely on the business’s current ratio to calculate the liquidity of the business owner.
Two important assets that any company lists on its balance sheet are inventory and amounts receivable. The net Realizable Value method is used to evaluate both of these types.
Calculation of Net Realisable Value
Below are the steps which help to calculate the Net Realisable Value of an inventory item in business:
- Calculate the market value of the inventory cost item.
- Summarise all the costs related to selling and completing the asset, like testing, final production, and prep costs.
- Subtract all the costs related to selling and completing the asset. And the final value one gets is Net Realisable Value.
Hence, the Formula Expression for Net Realisable Value is:
(Inventory item market value – Costs to sell and complete the asset = Net realisable value)
Net Realisable Value Example
XYZ is a company of furniture with an inventory cost of $50. Here the MV of the furniture is $130. Also, the cost of preparing the furniture is $20.
Net Realisable Value = Inventory item market value – Costs to sell and complete the asset
= $130 MV – $50 inventory cost- $20 completion cost
= $60
The inventory cost of $50 is less than NRV; hence the company continues recording the inventory item at $50 cost.
The next year, the market value of the company XYZ product declined $15. The inventory cost and preparation cost for sale are still the same, i.e. $50 & $20 respectively.
Net Realisable Value = Inventory item market value – Costs to sell and complete the asset
= $115 MV – $50 inventory cost- $20 completion cost
= $45
Since the NRV is $45 which is lower than the inventory cost; hence the company XYZ records a loss of $5, reducing its cost on record to $45.
Net Realisable Value Example (Usage)
- Net Realisable Value is used for calculating accounts receivable
- And if the receivable balance is less than the allowance then the account is doubtful and the company’s business is in bad debt
- Net Realisable Value is used to account for two different products manufactured on joint costing until they are on the stage to split-off
- Net Realisable Value is also used to allocate the joint cost of products invested previously
How to handle the Accounting of Net Realisable Value?
If the calculation of accounts shows a loss, then charge the loss there to the cost of items sold as a debit, and also credit the inventory cost to reduce the value of the account. Here if the loss is in material and if one wants to segregate this in separate loss accounts, it easily draws the reader’s attention to the financial statement in reports.
Net Realisable Value advantages and disadvantages can also show the aggregate total in the ending balance of a trade account receiving an offset allowance to doubtful accounts. The net total cash represents the amount the company’s management expects to realise and collect from receivable outstanding accounts.
Conclusion:
Net Realisable Value accounts for the total value of the asset in terms of the total amount it would receive after-sale and subtract selling costs. Net Realisable Value advantages and disadvantages is a conservative approach that is used by business accountants to value that the company’s asset is not overstated. Net Realisable Value is a common approach to evaluating inventory, account receivable, and total cost accounting.
