What is Net Realizable Value?
To understand this issue, it is necessary to introduce it with regards to all companies that produce and/or sell inventories and the assessment of the merchandise made by the companies to detect any possible deterioration in a given period according to the International Accounting Standard No. 2 “Inventories”. The same accounting standard establishes that inventories shall be measured at the cost reduction or Net Realizable Value.
Thus, the Net Realizable Value, according to IAS 2, is the estimated selling price of an asset in the normal course of business less the estimated costs to complete its production and those necessary to carry the sale on. In other words, it is a way of determining whether the costs charged to inventories are above or below compared to the Net Realizable Value.
How do I determine Net Realizable Value?
The formula for determining Net Realizable Value (NRV) is as follows:
|NRV = ESTIMATED SELLING PRICE – ESTIMATED COSTS TO COMPLETE PRODUCTION – ESTIMATED COSTS NECESSARY FOR SALE
Should the Net Realizable Value be calculated for each Inventory Item?
IAS 2 indicates that, generally, the cost of inventory should be lowered to Net Realizable Value, calculating for each Inventory Item. However, it may be appropriate to group items by family, product lines, etc.
Should Net Realizable Value be calculated for the entire Inventory Item?
IAS 2 indicates that it is not applicable to lower commodities and other supplies implemented for use in the production of inventories, provided the purpose of the finished products in which they are incorporated is to be sold at or above cost. In other words, it is not advisable to calculate the Net Realizable Value of items being in the process of production.
Where is the expense presented in the income statement for lowering the cost of inventory to Net Realizable Value?
The amount of any value reduction to Net Realizable Value will be recognized both as an expense and in the period the cost reduction occurs. In the income statement, such expense will be presented according to its nature, mostly in general expenses.
What is the tax impact of writing down the value of the inventory to the determined Net Realizable Value calculation?
The tax jurisdiction of each country will have to be evaluated. If the tax administration does not accept this expense as deductible for income tax purposes, a deferred income tax asset or liability will be determined under the International Accounting Standard No. 12 “Income Taxes”.