Net Realizable Value
Net Realizable Value (NRV) is the estimated selling price of an asset minus any direct costs associated with selling or disposing of that asset. These costs could include selling, packaging, or preparation expenses.
NRV is a conservative valuation method and is typically used in the context of inventory accounting or accounts receivable.
- For inventory, the NRV would be the estimated selling price of the inventory in the ordinary course of business, less any costs necessary to make the sale, such as preparation, packaging, and transportation costs. If the NRV of inventory is less than its cost, the business may write down the value of the inventory to its NRV to comply with the principle of conservatism.
- For accounts receivable, the NRV is the total amount of receivables that the company expects to actually collect. It is the face value of receivables less an allowance for doubtful accounts, which represents the amount of receivables the company does not expect to collect.
The formula to calculate NRV is:
Net Realizable Value = Estimated Selling Price – Estimated Cost of Completion and Disposal
NRV gives a realistic estimate of the value of an asset that the company would realize upon its sale or disposal. It’s important in financial reporting and is required under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
Example of Net Realizable Value
Suppose you own a business that sells handcrafted furniture. You have a stock of tables that originally cost you $200 each to make. Due to a change in market trends, you estimate that you can sell each table for $250. However, to make the tables ready for sale, you need to spend an additional $20 per table for polishing and packaging. And, let’s say you also have to spend $10 per table for transportation to the sales outlet.
The Net Realizable Value (NRV) for each table would be calculated as follows:
Net Realizable Value = Estimated Selling Price – Estimated Cost of Completion and Disposal
Net Realizable Value = $250 – ($20 + $10)
Net Realizable Value = $250 – $30
Net Realizable Value = $220
So, the NRV of each table is $220. This is the amount you can realistically expect to receive from the sale of each table after accounting for the costs to get them ready for sale and delivered.
If for some reason, the cost of your tables increased to say $230, you would then have to write down the value of the inventory from the original $200 to the NRV of $220 to reflect this loss, in accordance with the principle of conservatism in accounting.
