Whether it’s maintaining compliance with accounting standards or ensuring asset values are not overvalued for internal stakeholders or external existing or potential new investors, looking at net realizable value (NRV) is an important concept to understand and discuss how it’s implemented.
Defining NRV
Net realizable value examines what an asset can be sold for after accounting for selling or disposal costs. This results in the final value of inventory or accounts receivable. Used by both the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), it embodies the concept of accounting conservatism that compares NRV to the inventory’s cost. This notion leads accountants to value assets to produce lower profits and not overvalue assets when expert analysis is mandated for the deal review.
NRV is used in the lower-cost or market method of accounting reporting. The market method reporting approach requires a business’ inventory must be reported on the balance sheet at a lower value than either the historical cost or the market value. If there’s no known market value of the inventory, the NRV value can be used to approximate the market value.
Calculating NRV
Step 1: The asset’s projected selling price or market value must be determined.
Step 2: The manufacturing and sales expenses connected with the asset must be determined. This also includes advertising and conveyance fees, for example, when factoring in costs.
Step 3: Determine the gap between the asset’s projected asking amount and the fees the company incurs to finish the goods and sell it.
This is calculated via the following formula:
NRV = Expected Selling Price – Total Production and Selling Costs
If a company is looking to sell a percentage of its inventory, it needs to figure out the NRV of the inventory that will be sold.
Assuming the selling price is $10,000, it needs to spend $1,500 on finishing costs and another $750 in transportation expenses. Therefore, NRV is calculated as follows:
NRV = $10,000 – ($1,500 + $750) = $7,750
When it comes to valuing current assets such as accounts receivable (AR), this approach can similarly determine the NRV of the unpaid invoices from their clients. This is accomplished by summing their ARs and then subtracting the uncollectible accounts. For example, if there’s $100,000 in outstanding invoices, but $20,000 is uncollectible due to clients’ inability to pay or otherwise cannot be collected. In this type of calculation, instead of determining the production and sales amounts, a business’ allowance for doubtful accounts is substituted.
Conclusion
While these calculations assist investors and business owners in determining accurate costs of current assets, there are some considerations. For example, in periods of inflation or deflation, businesses must continually evaluate the net amount of the resulting calculation instead of the gross figures. Along with the increased and continual updating of NRVs, since the future price discovery of asset prices is unknown, there’s always room for uncertainty, which investors are constantly trying to determine how efficiently the market is presently pricing things.
While NRV is a single type of calculation, it’s an important one that can help businesses make the most of their inventory, accounts receivable, and similar accounting entries.
Disclaimer 
