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Net Realizable Value Definition, How to Calculate, Example

5 min read

Net realizable value can also refer to the aggregate total of the ending balances in the trade accounts receivable account and the offsetting allowance for doubtful accounts. This net amount represents the amount of cash that management expects to realize once it collects all outstanding accounts receivable. ABC International has a green widget in inventory with a cost of $50. The cost to prepare the widget for sale is $20, so the net realizable value is $60 ($130 market value – $50 cost – $20 completion cost).

Consequently, officials for Dell Inc. analyzed the company’s accounts receivable as of January 30, 2009, and determined that $4.731 billion was the best guess as to the cash that would be collected. The actual total of receivables was higher than that figure but an estimated amount of doubtful accounts had been subtracted in recognition that a portion of these debts could never be collected. Because of various uncertainties, many of the figures reported in a set of financial statements represent estimations. Accounts receivable is shown at its net realizable value, the amount of cash expected to be collected.

How to Perform Net Realizable Value (NRV) Analysis

Net realizable value is the estimated selling price of goods, minus the cost of their sale or disposal. It is used in the determination of the lower of cost or market for on-hand inventory items. The deductions from the estimated selling price are any reasonably predictable costs of completing, transporting, and disposing of inventory. GAAP rules previously required accountants to use the lower of cost or market (LCM) method to value inventory on the balance sheet. If the market price of inventory fell below the historical cost, the principle of conservatism required accountants to use the market price to value inventory. Market price was defined as the lower of either replacement cost or NRV.

  • Say Geyer Co. bought 200 Rel 5 HQ Speakers five years ago for $110 each and sold 90 right off the bat, but has only sold 10 more in the past two years for $70.
  • Consequently, officials for Dell Inc. analyzed the company’s accounts receivable as of January 30, 2009, and determined that $4.731 billion was the best guess as to the cash that would be collected.
  • If this is not done, the company has failed to properly use the net sales value method in the accounting process.
  • NRV is important to companies because it provides a true valuation of assets.

Just determining whether the $78 million in uncollectible accounts is a relatively high or low figure is quite significant in evaluating the efficiency of Dell’s current operations. In Principles of Financial Accounting 1, the term “accounts receivable” was introduced to report amounts owed to a company by its customers. All in all the NRV for Star Company’s sale statement of retained earnings of inventory is $6,700. When doing the NRV calculations for accounts receivable, the allowance for doubtful accounts or bad debts takes the place of total selling costs. NRV is a common approach used by many companies to estimate the value of their assets. These assets usually include value estimation for inventory, accounts receivable, and cost accounting.

What can Net Realizable Value tell you about your business?

As discussed in Principles of Financial Accounting 1, the amount of accounts receivable is the total of all the customers that owe Dell money for purchasing products and services. The NRV is used in inventory accounting to estimate the proceeds of a sale or how much the selling price exceeds the costs incurred in the sale of an asset. Usually, when using NRV, analysts employ the lower of cost or market (LCM) method, under which the value assigned to inventory is the lower market replacement cost, usually equaling the initial purchase price. NRV is also used when calculating how much of the expected accounts receivable might turn into cash.

Examples of NRV

Business X believes it can sell its basketballs to Company Y for $20 each because the current market situation for basketballs is not strong since football is becoming increasingly popular. There is a transportation fee of $320 for transporting all of the heavy couches from the business to the local mall. Toward the end of the process, the baskets will no longer be identical due to the different design ideas that customers have requested to add to their baskets. The “Generally Accepted Accounting Principles” (GAAP) and “International Financial Reporting Standards” (IFRS) both acknowledge this valuation method as a credible one. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

What is Inventory Reserve, Defined and How to Use in Accounting

Now that you’ve got a clearer understanding of the practical applications for net realizable value, let’s take a closer look at what these figures can tell you about your business. After all, you can then use this information to action necessary changes that will take your company to the next level. When accountants face uncertainties in potential profits or gains, they should not be recorded but uncertainties on expenses and losses must always be recorded.

How to Calculate Net Realizable Value

The expected selling price is calculated as the number of units produced multiplied by the unit selling price. This is often reduced by product returns or other items that may reduce gross revenue. In regards to accounts receivable, this is equal to the gross amount to be collected without considering an allowance for doubtful accounts. The Net Realizable Value (NRV) is the amount we can realize from an asset, less the disposal costs.

Example 2 – Calculating the NRV of an account

Inventory management is essential to maintain balanced information about products’ value, and overstating inventory assets can significantly affect business. In inventory accounting, NRV estimates the current value of investments, which compares existing assets to current liabilities. It’s used to calculate products in inventory and helps in cost accounting. With this article, businesses can understand what is net realizable value, its uses, advantages, disadvantages, and how it affects businesses. NRV is a conservative method as it estimates the real value of an asset, after deducting selling costs or costs of disposal.

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