19 julio, 2024

Net realizable value: what it is, characteristics, calculation, examples

What is Net Realizable Value?

He net realizable value (VNR) is the value for which an asset can be sold, after subtracting the costs associated with the disposal or final sale of said asset.

It is a common method used to calculate the value of an inventory asset in accounting. The VNR is used by applying generally accepted accounting principles (GAAP) to accounting transactions.

GAAP rules require certified public accountants to apply the principle of conservatism to their accounting work.

The accountant is required to render an opinion for many transactions, and the principle of conservatism demands that accountants select the most conservative view for all transactions.

A conservative perspective means that the transaction that does not overstate the value of the assets and generates less potential earnings should be recorded in the books.

Net realizable value is a conservative technique for valuing assets, because it calculates the amount the seller will actually receive if the asset is sold.

Net Realizable Value Characteristics

Accounts receivable and inventory are two of the largest assets a company can include on a balance sheet. The VNR is used to value the balances of both assets.
Although these two assets are initially recorded at cost, there are times when the company will charge less than that cost. When that happens, the company must report the lesser of cost or net realizable value.

Valuation of accounts receivable

When customers pay outstanding invoices, an account receivable balance is converted to cash. However, this balance must be adjusted by customers who have not made the payment.
In the case of accounts receivable, the net realizable value can also be expressed as the debit balance in the accounts receivable account, less the credit balance in the asset against account for uncollectible accounts.

Inventory Valuation

In the context of inventory, net realizable value is the expected sales price in the ordinary course of business less costs of completion, advertising, transportation, etc.
GAAP requires accountants to use the least of cost or market value rule to value inventory on the balance sheet.
If the current market price of the inventory is below cost, the principle of conservatism requires that the market price be used to value the inventory. It may happen that the market price is lower when the inventory becomes obsolete.

Inventory Value Review

There is an ongoing need to review the value of inventory to see if its recorded cost should be reduced, due to the negative impacts of factors such as damage, spoilage, obsolescence, and lower customer demand.
By writing down inventory, a company is prevented from having to bear the recognition of any losses in a future period.
Therefore, the use of net realizable value is one way of enforcing a conservative record of inventory asset values.

How is net realizable value calculated?

To determine the net realizable value of an inventory item, follow these steps:

Determine the expected market value or sales price of the inventory item.
Find all costs associated with preparing and selling the asset, such as production, transportation, and advertising costs.
The difference between the market value and the associated costs of sale is calculated to arrive at the net realizable value. Therefore, the formula is:

Net realizable value = Market value of the inventory – Costs to prepare and sell the products.

For example, when a company purchases inventory, the company may incur additional costs to prepare those products for sale. Suppose a retailer buys large pieces of furniture as inventory. The company has to build a showcase and also hire a company to move the furniture to the buyer’s house. Those additional costs must be subtracted from the sales price to calculate the VNR.
For accounts receivable, the VNR is calculated as the balance receivable less the allowance for doubtful accounts, which is the amount of invoices that the company qualifies as bad debt.

Examples of Net Realizable Value

If the accounts receivable have a debit balance of $100,000 and the allowance for doubtful accounts has an adequate credit balance of $8,000, the resulting net realizable value of the accounts receivable is $92,000. Adjustments to the allowance account are reported in the income statement as bad debt expense.
A company’s inventory costs $15,000. However, at the end of the accounting year, the inventory can be sold for only $14,000, in addition to spending $2,000 on packaging, sales commissions, and shipping. Therefore, the net realizable value of the inventory is $12,000, which is the selling price of $14,000 less $2,000 of costs to dispose of the goods. In that situation, the inventory should be reported at the lower of the cost of $15,000, and the VNR of $12,000. Consequently, inventory should be reported on the balance sheet at $12,000, and the income statement should report a loss of $3,000 from inventory reduction.
ABC International has an item in inventory with a cost of $50. The market value of the item is $130. The cost to prepare the item for sale is $20, so the net realizable value is: $130 Market Value – $50 Cost – $20 Preparation Cost = $60. Because the cost of $50 is less than the VNR of $60, the inventory item continues to be recorded at its cost of $50. The following year, the market value of the item drops to $115. The cost is still $50, and the cost to prepare it for sale is $20, so the net realizable value is: $115 Market Value – $50 Cost – $20 Preparation Cost = $45. Since the VNR of $45 is less than the cost of $50, a loss of $5 must be recorded on the inventory item, thereby reducing its recorded cost to $45.

References

Net Realizable Value (NRV). Retrieved from investopedia.com.
Net realizable value. Retrieved from accountingtools.com.
What is net realizable value? Recovery from accountingcoach.com.
Net Realizable Value. Retrieved from corporatefinanceinstitute.com.
What is Net Realizable Value (NRV)? Retrieved from myaccountingcourse.com.

Deja una respuesta

Tu dirección de correo electrónico no será publicada. Los campos obligatorios están marcados con *