What is Net Realizable Value (NRV)?
Net Realizable Value is a valuation method that reports the value of the sale of an asset substracted the selling cost thereof such as fees, taxes, transport, advertising, among others associated with that sale or disposal; necessary for companies’ accounting inventory valuation, according to International Accounting Standard No. 2.
Thus, it evaluates the estimated selling price of an asset in the normal course of business less the estimated costs to complete production and those necessary to make the sale. Likewise, it is used to ascertain the value of an asset isn’t overstated, evaluate accounts receivable, as well as for cost accounting.
How is the net realizable value determined?
- Determine the Market Value of the Asset
- List all the costs associated with the process of selling the Asset (including transportation, insurance, production, testing, tax, etc.)
- To determine the net realizable value formula is as follows:
VNR = ESTIMATED SALES PRICE – ESTIMATED COSTS TO COMPLETE PRODUCTION – ESTIMATED COSTS REQUIRED FOR SALE
In other words: NRV= Sales value – Costs
It estimates the value of end-of-year inventory and accounts receivable, being reported on the balance sheet, and the income loss on the income statement accurately as possible.
Analysis of Net Realizable Value Inventory
Companies commonly use the NRV to evaluate their assets’ value for inventory accounting, referring to the whole process and system of accounting changes of inventoried changes, classifying them by stage of production (raw goods, in-progress goods, and finished goods ready to sell), and recording them as company assets that probably have future value to the company. Therefore, they must be accurately and orderly valued to have a precise valuation.
The inventory and accounts receivable are two of the largest assets that companies may list on a balance sheet, employing the NRV to value them through the GAAP (Generally Accepted Accounting Principles), which is used by US companies, or the IFRS (International Financial Reporting Standards), used by most other countries. Both systems work as guidelines for companies to classify, measure, and present goods in financial statements.
Should the net realizable value be calculated for each inventory item?
IAS 2 indicates that, generally, the cost of the inventory should be reduced to the net realizable value, thus, calculated for each inventory item. However, it may be appropriate to group the items by family, product lines, etc.
Should the net realizable value be calculated for the entire inventory cycle?
IAS 2 indicates that it is not applicable to write down raw materials and other supplies held for use in the production of inventories, as long as the finished products in which they are incorporated are expected to be sold at or above cost. In other words, it is not advisable to calculate the net realizable value of items in the production process.
Where is the expense presented in the statement of income for reducing the cost of inventory to net realizable value?
The amount of any write-down to net realizable value is recognized as an expense and recognized in the period in which the write-down occurs. In the statement of income, this expense will be presented according to its nature, generally as general expenses.
What is the tax impact of writing down the value of the inventory until the net realizable value is determined?
The tax jurisdiction of each country must be evaluated. If tax authorities do not accept the expense as deductible in determining the income tax, a deferred income tax asset or liability will be determined under International Accounting Standard No. 12 “Income Taxes.”