Net Realizable Value (NRV)

Written By:
Adiste Mae

When it comes to estimating the ending value of an inventory or accounts receivable, what accountants use for a conservative estimate or valuation method is to compute for the Net Realizable Value (NRV).

This is the value of the asset if it is to be sold less the necessary costs to sell or dispose of the asset.

What is Net Realizable Value?

Computing for the Net Realizable Value is important for businesses to properly bring the valuation of their inventory and accounts receivable in order as to not overstate their assets.

This is stated in the Generally Accepted Accounting Principles (GAAP) and International Financing Reporting Standards (IFRS).

The practice of avoiding the overstatement of assets is called accounting conservatism.

Understanding Net Realizable Value

In the Balance Sheet of the company, the accounts that will have the highest possibility of overstating the assets is the Inventory and the Accounts Receivable.

In inventory accounting, it is essential that these assets should be brought down to their Net Realizable Value to conservatively account for them in the books.

The Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) use the NRV method in inventory accounting.

Under GAAP, it is expected for the accountants to apply a conservative approach in accounting – make sure that the profits and assets of the company are not valued more than they should.

To compute for the NRV, the formula is as follows:

Net Realizable Value (NRV) = Estimated Selling Price – Total Production and Selling Costs

To break down the formula above, the NRV can be determined by the following:

1. Determine the Market Value or expected selling price of the asset.
2. Find all the attributable costs of selling the asset like transportation cost, production cost, and advertising, etc.
3. Compute for the difference of the Market Value or estimated selling price of the asset less the costs of selling the asset. The difference is the Net Realizable Value of the asset.

Examples of Uses of Net Realizable Value

Accounts Receivable

In accounting for Accounts Receivable, accountants always make an estimate for any allowances that would make some outstanding invoices to be uncollectible called the Allowance for Bad Debts.

In the valuation for Accounts Receivable in the Balance Sheet, its Net Realizable Value is computed by taking the difference of the Total Accounts Receivable less Allowance for Bad Debt.

For example, a company has a total Accounts Receivable of $630,000 and it is estimated that at least 10% of this amount is bad debt.

It’s NRV therefore is $567,000 ($630,000 – $63,000).

Inventory

For businesses that hold inventory for long periods of time, these inventories will become obsolete, have a lower market value, or deteriorate over time.

Thus, the Generally Accepted Accounting Principle (GAAP) states that the business must record the inventory using the Lower of Cost or Mark (LCM) method of valuation.

The LCM method states that the cost of inventory must be recorded at the original cost or market price, whichever is lower.

The market price shall be the replacement cost of the inventory and it shall not be less than the NRV.

It shall also be noted that the carrying cost of an inventory such as storage, transportation, or any other costs attached to bring the inventory to its storage shall be subtracted from the selling price in order to come up with the NRV.

In 2015, the Financial Accounting Standards Board (FASB) issued an update on the inventory accounting requirements of companies that they should not use the LIFO (Last In First Out) method.

IFRS rules state that the lower cost or NRV method must now be used by companies.

Cost Accounting

Cost accounting is part of the managerial accounting of a company that aims to capture the production cost of a manufacturing intensive company.

The very essence of cost accounting is to determine the actual costs of products in order to arrive at its sales price.

In some companies, some products are joined together in production.

The NRV plays a vital role in this because after the split off point, the NRV is used as an allocation basis of the joint cost of the product.

While products may be joined at some point in production, they will have to be priced individually later on.

How to Calculate Net Realizable Value

To be able to conservatively report the value of inventory at Balance Sheet date, the Net Realizable Value has to be computed which can be computed by determining the market value or selling price of the asset and subtracting the cost of selling the asset.

This is shown in the formula:

Market Value or Selling Price – Cost of Selling the Asset = Net Realizable Value

To show it as an example, suppose company ABC intends to sell part of its inventory and has determined that the selling price is $3,000 and will have to spend $700 in production cost to complete and transportation cost of $250. The calculation of the NRV therefore is:

$3,000 – ($700 + $250) = $2,050

In the example above, the NRV is $2,050.

What Are Some Examples of NRV Usage?

In Accounts Receivable, the NRV is computed by determining the Allowance for Bad Debts from total outstanding and then subtracting this from the Total Accounts Receivable.

In inventory, the NRV is used to allocate for the joint costs of the products prior to the split off in order to come up with the sales price of the individual products.

What is Accounting Conservatism?

As an accounting principle, Accounting Conservatism simply states that an accountant of a company should always choose the less favorable outcome.

This means that profits should not be overstated and expenses or losses should be recorded.

When accountants face uncertainties in potential profits or gains, they should not be recorded but uncertainties on expenses and losses must always be recorded.

Applying this principle allows stakeholders of the company to feel assured that the financial statements of the company are not overstated and misleading.