Last editedAug 20212 min read
What is the value of a business’s inventory? While there are several metrics to use, one of the most common is the net realisable value, or NRV. But what is NRV exactly, how is it calculated, and why is this NRV meaning important for your business? We’ll answer these questions below.
What is NRV?
While it’s most applied to inventory valuation, NRV can be used with any business asset. Net realisable value is the estimated selling price of an asset after you’ve subtracted the sale-related cost. Examples of sales-related costs include things like fees and taxes as well as the predicted costs of transport and asset disposal.
In the case of inventory, it’s important for businesses to continually assess whether recorded cost is accurate. Factors like reduced demand, spoilage, and outdated technology all can have an impact on the eventual sale cost. For accounting purposes, businesses need to know what they can expect to earn from the disposal of their inventory. When recording inventory as an asset, you can use NRV as the basis of this valuation.
Understanding the NRV meaning
We’ve covered the general definition, but what does NRV mean in real life and for accounting purposes? On the balance sheet, a company lists its accounts receivable and inventory as assets. NRV can be applied to both types of assets and used to estimate value. It’s recognised as a valid method by the international financial reporting standards (IFRS) as well as the generally accepted accounting principles (GAAP).
Apart from inventory valuation, NRV can be used to estimate the value of accounts receivable as an asset. When customers pay their invoices, accounts receivable converts into cash. However, NRV adjusts this cash value to account for non-paying clients. To calculate NRV for accounts receivable, you’d subtract an allowance for bad debts from the total receivable balance.
What does NRV mean for your business?
NRV is used as part of a wider conservative approach to accounting, meaning that the accountant uses valuation methods that avoid overstating asset worth. Because NRV takes the cost of sales out of the equation, it gives a more conservative estimate than some other valuation methods. This means that when the sale goes through, the asset could potentially generate more profit than anticipated. However, for conservative accounting it’s better to underestimate value rather than overestimate. Any claims must be verified. This means that uncertain liabilities are recognised at the point of discovery, and revenues are only recorded when they’re 100% certain.
How to calculate NRV
Calculating the NRV of inventory is a simple process.
Calculate the inventory item’s market value.
Calculate all costs that would arise because of selling the asset, including distribution, taxes, and fees.
Subtract these selling costs from the item’s market value.
Here’s what this looks like written as a formula:
NRV accounting examples
It’s easy to apply the NRV accounting formula above to real-life situations when you need to value your assets.
Imagine that Company ABC has 20,000 units with a selling price of £25 each. The cost of selling each unit will be £3 due to taxes and transporting them from the warehouse to the seller. This makes the NRV of each unit £22, for a total net realisable value of £440,000.
As a second example of NRV accounting, imagine that Company XYZ has a product in inventory that costs £50 each. However, its market value is £100 per unit and the cost to prepare each unit for sale is £20. The NRV of each unit is therefore £30 (£100 market value - £50 production cost - £20 sales cost). Because the NRV is lower than the cost of production, the company should record an estimated loss of £20 for each item. This loss would need to be applied to the financial statements accordingly.
There are many different applications of the NRV metric, making it a useful tool when taking stock of inventory or balancing your financial statements for future valuation.
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