Net realizable value
Encyclopedia
Net realizable value is a method of evaluating an asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...

's worth when held in inventory
Inventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...

, in the field of accounting. NRV is part of the Generally Accepted Accounting Principles
Generally Accepted Accounting Principles
Generally Accepted Accounting Principles refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards...

 and International Financial Reporting Standards
International Financial Reporting Standards
International Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....

 (IFRS) that apply to valuing inventory, so as to not overstate or understate the value of inventory goods. Net realizable value is generally equal to the selling price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...

 of the inventory goods less the selling costs (completion and disposal). In formula:

Inventory Sales Value - Estimated Cost of Completion and Disposal = Net Realizable Value

Companies need to record the cost of their Ending Inventory
Ending Inventory
Ending inventory is the amount of inventory a company have in stock at the end of this fiscal year. It is closely related with ending inventory cost, which is the amount of money spent to get these goods in stock. It should be calculated at the lower of cost or market.-References:1...

 at the lower of cost
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...

 and NRV, to ensure that their inventory and income statement
Income statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...

 are not overstated. For example at a company's year end, if an unfinished good that already cost $25 is expected to sell for $100 to a customer, but it will take an additional $20 to complete and $10 to advertise to the customer, its NRV will be $100-$20-$10=$70. In this year's income statement, since the cost of the good ($25) is less than its NRV ($70), the cost of the good will get recorded as the cost of inventory. In next year's income statement after the good was sold, this company will record a revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....

 of $100, Cost of Goods Sold
Cost of goods sold
Cost of goods sold refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out , or average cost...

 of $25, and Cost of Completion and Disposal of $20+$10=$30. This leads to a profit
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...

 of $100-$25-$30=$45 on this transaction.

Suppose we changed the example so that it costs $60 to advertise to the customer. Now the good's NRV will be $100-$20-$60=$20. In this year's income statement, since the NRV ($20) is less than the cost of the good ($25), the NRV will get recorded as the Cost of Ending Inventory. To do so, an inventory write down of $25-$20=$5 is done, and hence a decrease of $5 in this year's income statement. In the next year's income statement after the good was sold, this company will record a revenue of $100, Cost of Goods Sold of $20, and Cost of Completion and Disposal of $20+$60=$80. This leads to the company breaking even on this transaction ($100-$20-$80=$0).

Inventory can be valued at either its historical cost or its market value
Market value
Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...

. Because the market value of an inventory is not always available, NRV is sometimes used as a substitute for this value.
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