Net realizable value is defined as estimated selling price less purchase price

What is Net Realizable Value (NRV)?

Net Realizable Value is the 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 valuation of the ending inventory or receivables of the company.

Steps to Calculate Net Realizable Value

1. Determine the Market Value of the Asset
2. List all the cost associated with selling the Asset (including transportation, insurance, production, testing, tax, etc.)
3. Calculate NRV = Market Value of Asset – Selling Cost of the Asset

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Source: Net Realizable Value (wallstreetmojo.com)

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A company XYZ Inc. is trying to get rid of some of its outdated phones, and it expects to sell them for $5,000 to a local buyer, but it must pay $240 to have them shipped and insured and another $40 to complete the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 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.

Let us take an example to understand this in detail –

Year 1

Company ABC has an inventory i2 that costs $70. The market value of this inventory i2 is $200, and the preparation cost to sell this inventory i2 is $30.

NRV = $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. However, inventory i2 and the preparation cost to sell this inventory i2 remain the same at $70 and $30, respectively.

NRV = $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-DownInventory Write-Down refers to decreasing the value of an inventory due to economic or valuation reasons. When the inventory loses some of its value due to damaged or stolen goods, the management devalues it & reduces the reported value from the Balance Sheet. read more = $70 – $50 = $20

In the context of net realizable valueRealizable value is the net consideration from sales proceeds of any assets in the normal course of business after deduction of incidental expenses. It is common for the valuation of inventories under International Financial Reporting Standards and other accepted accounting policies.read more inventory, it is also important to understand that the companies using retail or the last in first out accounting would probably not use the net realized value or the lower of cost methodThe cost method is a method of accounting for investments in which the investment remains at its original cost on the balance sheet. Many financial instruments, such as investments and inventory/fixed assets, are accounted for using this method.read more, but would rather NRV inventory at lower of cost or marketLower of cost or market (LCM) is the conservative way through which the inventories are reported in the books of accounts. It states that the inventory at the end of the reporting period is to be recorded at the original cost or the current market price, whichever is lower.read more.

It is worth noting 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 cost or NRV. Once curtailed down, the inventory account becomes the new basis for reporting purposes and valuation.

US GAAP does not permit a write up of write-downsWhen the carrying value (purchase price – accumulated depreciation) of an asset exceeds its fair value, it is referred to as a write down.read more 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 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 accountAsset Accounts are one of the categories in the General Ledger Accounts holding all the credit & debit details of a Company’s assets. The examples include Short-Term Investments, Prepaid Expenses, Supplies, Land, equipment, furniture & fixtures etc. read more.

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.

NRV Video

Conclusion

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. It is commonly used in the context of inventory valuation and account receivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more. 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 sheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.

Recommended Articles

This has been a guide to what is Net Realizable Value. Here we calculate the NRV of inventory and accounts receivables and practical examples. You may learn more about accounting basics from the following articles –

• Net Realizable Value Formula
• Allowance for Doubtful Accounts
• Bad Debt Reserve