Net realizable value is selling price less costs of completion, disposal, and transportation.
Definition of Net Realizable ValueNet realizable value (NRV) is the cash amount that a company expects to receive. Hence, net realizable value is sometimes referred to as cash realizable value. Show
We often find the term net realizable value being associated with the current assets accounts receivable and inventory. While these two assets are initially recorded at cost, there are occasions when the company will collect less than the cost. When that occurs, the company must report the lower of 1) cost, or 2) the net realizable value. In the case of accounts receivable, net realizable value can also be expressed as the debit balance in the asset account Accounts Receivable minus the credit balance in the contra asset account Allowance for Uncollectible Accounts. In the context of inventory, net realizable value is the expected selling price in the ordinary course of business minus any costs of completion, disposal, and transportation. Examples of Net Realizable ValueIf Accounts Receivable has a debit balance of $100,000 and the Allowance for Doubtful Accounts has a proper credit balance of $8,000, the resulting net realizable value of the accounts receivable is $92,000. Adjustments to the Allowance account are reported on the income statement as bad debts expense. Now, let's assume that a company's inventory has a cost of $15,000. However, at the end of the accounting year the inventory can be sold for only $14,000 after it spends $2,000 for packaging, sales commissions, and shipping. Therefore, the net realizable value of the inventory is $12,000 (selling price of $14,000 minus $2,000 of costs to dispose of the goods). In that situation the inventory must be reported at the lower of 1) the cost of $15,000, or 2) the NRV of $12,000. In this situation, the inventory should be reported on the balance sheet at $12,000, and the income statement should report a loss of $3,000 due to the write-down of inventory. Learning Outcomes
Net realizable value (NRV) sounds complicated, and a lot of accountants may still use the old term: Lower of Cost of Market (LCM). However, in July 2015, the Financial Accounting Standards Board (FASB) adopted ASU 2015-11, FASB’s Accounting Standards Codification (ASC) Topic 330, Inventory, that replaced LCM with LCNRV. Lower of cost or market (old rule)The old rule (that still applies to entities that use LIFO or a retail method of inventory measurement) required entities to measure inventory at the LCM. The term market referred to either replacement cost, net realizable value (commonly called “the ceiling”), or net realizable value (NRV) less an approximately normal profit margin (commonly called “the floor”). In other words, market was the price at which you could currently buy it from your suppliers. Except, when you were doing the LCM calculation, if that market price was higher than net realizable value (NRV), you had to use NRV. If the market price was lower than NRV minus a normal profit margin, you had to use NRV minus a normal profit margin. Lower of cost or NRV (new rule)The new rule, LCNRV, was designed to simplify this calculation. NRV is the estimated selling price in the ordinary course of business, minus costs of completion, disposal, and transportation. Say Geyer Co. bought 200 Rel 5 HQ Speakers five years ago for $110 each and sold 90 right off the bat, but has only sold 10 more in the past two years for $70. There are still a hundred on hand, costs using FIFO, but the speakers are obsolete and management feels they can sell them with some slight modifications to each one that cost $20 each. So, the NRV is:
ExampleLet’s say the Geyer Co. looked at the HQ Speakers product # Rel 5 and determined that the current wholesale price was $60. There are a bunch on the shelf at the end of the year, 100 in fact, that using FIFO, are assigned a cost of $110.00. These speakers are antiquated and just aren’t selling, so even though they are on the books at FIFO (which means the cost is based on the most recent purchases, regardless of how old the actual speakers are), they are a couple of years old and could be purchased today for a lot less, if Geyer even wanted them.
So under the old rule of LCM, replacement cost (what our wholesale distributor sells to them to us for) would be the ceiling. Let’s also say we would normally mark them up and expect to make about $20 on the sale, so the floor, the lowest we could adjust them to, would be $30. If we lowered the cost to $30 on our books and sold them for $70 minus the $20 it takes to make them saleable, we’d make a normal profit.
Under the old rule that still applies to LIFO and retail inventory methods, the item could be written down to market because it is lower than the historical cost of $110. Market is somewhere between the ceiling and the floor: between $50 and $30. Since the replacement cost is over the ceiling, we’d use the $50 NRV for market. If the replacement cost had been $20, the most we could write the inventory down to would be the floor of $30. If the replacement cost had been $45, we would write the inventory down to $45. Under the new rule, which Geyer would be using because it is using FIFO cost flow assumption, the calculation is actually simpler: NRV. So, $50. As a result of our analysis, we would write down the cost of Rel 5 HQ Speakers, highlighted below in yellow, by $6,000 so the new cost on our books is $50 each. Inventory List
In the next section, we’ll look at how to adjust total inventory, but first to review: From ASU 2015-11:
By adjusting the inventory down, the balance sheet value of the asset, Merchandise Inventory, is restated at a more conservative number. Notice that we never adjust inventory up to fair market value, only downward. One final note: ASU 2015-11, FASB’s Accounting Standards Codification (ASC) Topic 330 carved out an exception to the new rule for LIFO and retail inventory methods. One of the simplest versions of the retail inventory method calculates ending inventory by totaling the value of goods that are available for sale, which includes beginning inventory and any new purchases of inventory. Total sales are multiplied by the cost-to-retail ratio (or the percentage by which goods are marked up from their wholesale purchase price to their retail sales price) in order to get an estimate of COGS. Using the formula: [latex]\text{Beginning inventory}+\text{purchases}-\text{ending inventory}=\text{COGS}[/latex] Modified slightly: [latex]\text{Beginning inventory}+\text{purchases}-\text{COGS}=\text{ending inventory}[/latex] A large company like Home Depot that has a consistent mark-up can reasonably estimate ending inventory. Home Depot undoubtedly uses a more sophisticated version of this calculation, but the basic idea would be the same. Because the estimated cost of ending inventory is based on current prices, this method approximates FIFO at LCM. Let’s see how companies apply this conservative rule to inventories. Practice QuestionWhat is net realizable value formula?Formula and Calculation of Net Realizable Value
The formula for determining net realizable value (NRV) is: NRV = Expected Selling Price - Total Production and Selling Costs. The expected selling price is calculated as the number of units produced multiplied by the unit selling price.
Is selling price net realizable value?Net realizable value is generally equal to the selling price of the inventory goods less the selling costs (completion and disposal). Therefore, it is expected sales price less selling costs (e.g. repair and disposal costs).
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Net realizable value.. What is net realizable value quizlet?Net realizable value is defined as estimated selling price less purchase price.
What is net realizable value with example?Example of Net Realizable Value
The cost to prepare the widget for sale is $20, so the net realizable value is $60 ($130 market value - $50 cost - $20 completion cost). Since the cost of $50 is lower than the net realizable value of $60, the company continues to record the inventory item at its $50 cost.
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