Net Realizable Value

Net realizable value, abbreviated NRV, is the amount a business expects an asset to bring in when it is sold, after subtracting what it will still cost to finish the item and get it sold. US accounting standards define it as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation (FASB Accounting Standards Update 2015-11, Master Glossary). The phrase does two separate jobs in US practice: it caps what inventory outside the last-in, first-out and retail inventory methods is carried at, and it is used for the part of a receivable a business expects to collect.

Where US GAAP Uses Net Realizable Value

Inventory measured using any method other than last-in, first-out (LIFO) or the retail inventory method, which includes inventory measured using first-in, first-out (FIFO) or average cost, is measured at the lower of cost and net realizable value, and when evidence exists that net realizable value is lower than cost the difference is recognized as a loss in earnings in the period in which it occurs (FASB Accounting Standards Update 2015-11, paragraph 330-10-35-1B). Inventory measured using LIFO or the retail inventory method sits on the other side of that line and stays under the lower of cost or market rule (FASB Accounting Standards Update 2015-11, paragraphs 330-10-35-1A and 330-10-35-2).

The standard names the causes that push inventory off cost, and they are damage, physical deterioration, obsolescence, changes in price levels, or other causes (FASB Accounting Standards Update 2015-11, paragraph 330-10-35-1B). Obsolescence, one of those causes, is set out in obsolescence. The cost side of the comparison is a separate question, worked through in FIFO and LIFO.

How IFRS Defines Net Realisable Value

IFRS carries the same term with the British spelling. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale (IAS 2, paragraph 6), and inventories are measured at the lower of cost and net realisable value (IAS 2, paragraph 9).

The wording differs from the US formulation in two small ways. IFRS says selling price where US GAAP says selling prices, and it folds disposal and transportation into one phrase, the estimated costs necessary to make the sale.

Whether a write-down can later be taken back, and inside what window, is the place the two frameworks genuinely split, and that is worked through in GAAP vs IFRS.

The Formula

Net realizable value = estimated selling price
                       less estimated costs of completion
                       less estimated costs of disposal and transportation

Estimated selling price is the price the goods would fetch in the ordinary course of business, which means the business’s normal way of selling them rather than a forced or distress sale. Under IFRS the purpose the inventory is held for enters that estimate, so where a quantity is held to satisfy a firm sales or service contract the estimate is based on the contract price, and where the quantity held exceeds the contracted quantity the excess is estimated at general selling prices (IAS 2, paragraph 31).

Costs of completion are what still has to be spent to bring unfinished goods to a saleable state. Costs of disposal and transportation are what it takes to get the finished goods into the buyer’s hands, freight and selling costs among them.

Estimates are based on the most reliable evidence available at the time they are made, and they take into account price or cost movements arising from events after the period end to the extent those events confirm conditions that already existed at the period end (IAS 2, paragraph 30). The line that draws is between an event that confirms what was already true at the period end and one that reflects something new, and only the first belongs in the estimate.

A Worked Example

Say a client holds one batch of inventory that still needs finishing work, with an estimated selling price, an estimated cost to finish it, and estimated costs to move it.

Cost of the batch                                 40,000

Estimated selling price                           46,000
  less estimated costs of completion               3,000
  less estimated costs of disposal and transport   5,000
Net realizable value                              38,000

Carried at the lower of the two                   38,000
Loss recognized in earnings                        2,000

Net realizable value comes in below cost, so the batch is carried at net realizable value and the shortfall is recognized as a loss in earnings in the period in which it occurs (FASB Accounting Standards Update 2015-11, paragraph 330-10-35-1B). Raise the selling estimate until net realizable value clears cost and nothing happens, because the rule takes the lower of the two and never carries the inventory above cost.

Which Unit the Write-Down Test Is Applied To

The comparison is not made against the inventory balance as a whole by default. Under US GAAP the most common practice is to apply the subsequent measurement guidance separately to each item of the inventory. Where stocks of particular materials or components are excessive in relation to others, the guidance is applied to the individual items making up the excess, and unless an effective method of classifying categories is practicable the rule is applied to each item (FASB Accounting Standards Update 2015-11, paragraphs 330-10-35-9 and 330-10-35-11).

US GAAP does leave the choice open. Depending on the character and composition of the inventory, the applicable guidance may properly be applied either directly to each item or to the total of the inventory, or in some cases to the total of the components of each major category, and the method has to be the one that most clearly reflects periodic income. Applying it to the totals of the entire inventory rather than to the individual items carries conditions: the items have to enter into the same category of finished product, they have to be in balanced quantities, and the procedure has to be applied consistently from year to year (FASB Accounting Standards Update 2015-11, paragraphs 330-10-35-8 and 330-10-35-10).

IFRS starts in the same place and then draws a line that US GAAP does not. Inventories are usually written down item by item, similar or related items may be grouped, and it is not appropriate to write inventories down on the basis of a classification such as finished goods, or all the inventories in a particular operating segment (IAS 2, paragraph 29).

One case runs the other way. Materials and supplies held for use in production are not written down below cost if the finished products they go into are expected to sell at or above cost (IAS 2, paragraph 32), so a raw material whose own price has fallen is left alone while the product it feeds still clears.

The size of a write-down reaches the disclosures as well as the balance. Substantial and unusual losses that result from the subsequent measurement of inventory should be disclosed in the financial statements (FASB Accounting Standards Update 2015-11, paragraph 330-10-50-2).

Net Realizable Value on the Receivables Side

The same phrase gets attached to receivables and similar assets, where it means the part of a balance a business expects to actually collect rather than the amount invoiced. Current US standards describe that presentation in their own words, and the allowance for credit losses is a valuation account deducted from the amortized cost basis of the financial asset to present the net amount expected to be collected (FASB Accounting Standards Update 2016-13, paragraph 326-20-30-1).

So receivables are presented net of the allowance. How that allowance is measured, and what the matching charge does to the income statement, are set out in allowance for doubtful accounts and bad debt expense.

What Net Realizable Value Is Not

It is not fair value. Net realisable value refers to the net amount an entity expects to realise from the sale of inventory in the ordinary course of business, while fair value reflects the price at which an orderly transaction to sell the same inventory would take place between market participants at the measurement date, so the former is an entity-specific value and the latter is not, and net realisable value for inventories may not equal fair value less costs to sell (IAS 2, paragraph 7). Two businesses holding identical goods can therefore arrive at different net realizable values, because each estimate is built from that business’s own selling prices and its own costs.

It is not market value, and it is not replacement cost. Before the FASB simplified inventory measurement, Topic 330 required inventory at the lower of cost or market, where market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin (FASB Accounting Standards Update 2015-11, Summary). That three-way choice no longer applies to the inventory inside the amended rule. Replacement cost still sits inside the market test that LIFO and retail-method inventory continue to run, where utility is indicated primarily by the current cost of replacement of the goods (FASB Accounting Standards Update 2015-11, paragraphs 330-10-35-1C and 330-10-35-4).

It is not salvage value. Salvage value is an estimate made for a fixed asset when the asset is acquired, of what the owner will realize on it once it is retired from service, and it works by capping depreciation rather than by capping a carrying amount; it is set out in salvage value.

It is not the impairment test for assets outside inventory. Long-lived assets answer to a different comparison with a different floor, described in impairment losses.

Common Questions

Accountably places trained offshore accountants inside US CPA and EA firms, and a firm can put a block of its own inventory valuation and close work through a trial task before anything client facing depends on it.