What Is Net Realizable Value (NRV)?

Net realizable value is the expected selling price of an asset, less any reasonable projection of costs associated with the sale of the asset.  Although it can be applied to any asset, it is most commonly used in the valuation of accounts receivable and inventory for accounting purposes, in accordance with the principal of conservatism.

Many times when posting transactions, accountants must make judgment calls.  The principle of conservatism mandates that accountants select the more conservative approach when recording transactions.  More specifically, the principal requires that accountants post transactions in a manner that avoids overstating the value of an asset.  Net realized value provides a conservative valuation method since it is an estimate of the actual amount the seller will receive if and when the asset is sold.

Net realizable value can be thought of most simply as the net amount of cash flow the asset will generate at the time it is disposed or sold.  In the case of accounts receivable, the net realizable value is considered to be the accounts receivable of the firm less the allowance for doubtful accounts.  In the case of inventory, the net realizable value is the expected selling price of the inventory less any costs incurred associated with the completion, disposal, and/or transportation of the inventory.

Net Realizable Value Formula

NRV for Accounts Receivable

The formula for the net realizable value of accounts receivable is very straightforward:

NRV_{Accounts Receivable} = Accounts Receivable Debit Balance – Allowance for Doubtful Accounts

To put some numbers to this, consider the current asset accounts of the International Motor Corporation:

Using the formula for NRV:

NRV_{Accounts Receivable} = Accounts Receivable Debit Balance – Allowance for Doubtful Accounts

and substituting with the values from the table above:

$16,900 – $3,000 = $13,900

You can see that the net realizable value of the accounts receivable can be read directly from the balance sheet:

The calculation has already been done for you; it is recorded as “net accounts receivable.”

NRV for Inventory

The net realizable value of inventory is not so easy:

NRV_inventory = Estimated Selling Price of the Inventory – Sum of Costs Associated With the Sale

The costs associated with the sale include (but are not limited to) the costs of finishing or repairing the inventory, directly related advertising expenses, selling commissions, and transportation costs.

Thus, in order to calculate the net realizable value for inventories, you first need to determine the expected selling price of each of your items in inventory.  Then you need to estimate how much you will have to spend to prepare each of the items for sale and sell them.  For example, assume your firm sells artwork, and you expect a particular piece to sell for $850.  You pay your sales associate a commission of 10%, and it will cost you $150 in packaging and shipping costs.  Then, the net realizable value of the item is $850 – ($85 – $150) = $615.

GAAP and IFRS Rules Relating To NRV

Both the General Accepted Accounting Principles (GAAP), which is the primary source of guidance for the accounting of inventories in the U.S., and the International Financial Reporting Standards (IFRS) that many other countries utilize define inventory in the same way, and both include the direct expenses incurred in preparing the inventory for sale in the cost of inventory.  However, the accounting rules for posting the inventory account differs between the two.

Under GAAP, inventory is recorded at the lower of cost or market, whereas under IFRS, inventory is recorded at the lower of cost or net realizable value.  Furthermore, under GAAP, a firm need not apply the same formula in determining the cost of different inventories, even if the inventories are similar in nature and use.  IFRS mandates that the same formula be applied to all inventories with a similar nature and use.  Under GAAP, write-downs taken to reduce inventories to the lower of cost or market may not be reduced if the inventories later increase in value, but IFRS allows write-downs taken to reduce inventories to the lower of cost or net realizable value to be reversed if a subsequent increase in value is realized.

When GAAP rules are applied, the term “market value” generally means the current replacement cost of the inventory.  However, this “market value” is bounded by a “ceiling” and a “floor.”  Specifically, the market value may not exceed the net realizable value of the inventory (ceiling) or be less than the net realizable value minus a normal profit margin (floor).  Mathematically speaking,

NRV ≥ Market Value ≥ (NRV – Normal Profit Margin)

How to Use the Net Realizable Value Calculation

Assume the Weibracht Stein Company imports beer steins from Germany to be sold to retail collectors in the United States.  The steins cost Weibracht $12 each, which includes the customs costs Weibracht must pay when the steins enter the U.S.  Prior to shipping the steins to its individual customers, Weibracht numbers the base of each stein and inserts a card stating that the stein is certified as a “collectible.”  It then repackages each stein in a decorative box and inserts it in a sturdy shipping box with packing material.  The costs related to the numbering and the collectible cards amount to $1 per stein.  The cost of the packaging material is $2.00 per stein, and shipping costs amount to $5 per stein.  Weibracht can sell the steins for $20 each in the year the stein is introduced, but because a new version is produced each year, the selling price of the stein typically decreases by 12% every year thereafter.

Due to the obsolescence factor, the net realizable value of the stein will be different each year that the stein remains in inventory.  The net realizable value of the stein for the first two years is calculated below: