Calculating Net Realisable Value: Formula, Steps and Examples

Net Realisable Value (NRV) is an important inventory valuation concept in accounting, ensuring that the value of inventory is reported at the amount expected to be realised when the item is sold. NRV ensures that the value of inventory isn’t overstated on the financial statements, as some items may need excess time and materials to complete them or be sold less than cost.

The purpose of this guide is to provide you with the formula, a clear step-by-step methodology for calculating NRV, and examples and journal entries that you can utilise in your own calculations.

What Is NRV?

• Net Realisable Value (NRV) refers to an expected selling price minus the estimated costs of completing the product and the estimated selling costs associated with the sale.

• NRV is the estimated net amount you expect to receive from selling an entire inventory item after you have completed the finishing and selling process (if required).

Formula for NRV

• Estimated Selling Price: estimate the price of the item you expect to receive under normal conditions in the marketplace.

• Costs of Completing Inventory: costs incurred to bring the item to final assembly so that it is marketable (including materials, labour, and any manufacturing overhead that is specific to the completion of the inventory).

• Cost to Sell: costs that would be incurred in selling the item (e.g. commissions, freight or shipping to the customer, disposal costs, and any other incremental costs).

When NRV should be used

To assess historical inventory values, an item and/or group of similar items, as well as to determine whether the NRV for an individual or group of items is less than the cost; and in determining any write-downs on any damaged, obsolete or slow-moving inventory.

How to calculate NRV: Step by Step

• Identify the item(s): single SKU, a group of SKUs, and/or an inventory category where NRVs can be estimated.

• Estimate the selling price: the selling price should be based on the sales that can reasonably be expected to occur in the normal course of business.

• Estimate the cost of completing: the cost of completing an item includes all relevant costs incurred to complete the production of the item.

• Estimate the costs of selling: this includes all costs associated with getting the item to the buyer, including commission, packaging for sale, delivery, and disposal.

• Calculate the NRV using the formula.

Compare the NRV to the cost

• If the NRV < Cost, record the write-down to the NRV (reduce inventory/accounting expense).

• If the NRV ≥ Cost, record no write-down and keep the inventory recorded at cost.

Assuming that the write-down amount is material, you must disclose the method used to determine the write-down and include the write-down in the notes.

Brief Overview of Accounting & Financial Reporting 

Inventories are recognised in the financial statements at the lower of cost and their estimated net realisable value. When inventory is subsequently measured at NRV, the amount of the write-down is recognised as an expense in profit or loss (as ‘write-downs’ or included in the cost of sales) depending on presentation.

If conditions change (i.e. the market price of the inventory recovers), a reversal of the write-down to the extent of the original write-down is allowable (treatment of the reversal will depend on the accounting framework used). In all cases, please refer to the applicable standard, and if material, disclose the nature and amount of any write-down or reversal.

Helpful Tips and Common Pitfalls

• Make your estimates of selling prices realistic based on market evidence. Do not assume you will sell at an optimistic list price.

• Only include costs that are directly attributable to completion and selling as incremental costs of completion and selling. Do not include general overheads, unless they are directly related to the completion of the product.

• When determining the NRV of a group of items, consolidate similar items. Do not combine dissimilar items that mask inventory losses in the NRV calculation.

• Document all assumptions that affect the NRV calculation, market evidence, sales commissions, transportation rates, as your auditors will expect to see support for your assumptions.

• Review the NRV of your inventory on a regular basis, especially for seasonal inventory, slow-moving inventory, or products subject to rapid changes in demand.

• The tax effect of an NRV write-down on net income will vary according to the local tax rules, please consult tax advisors.

This is a very basic checklist for determining the NRV. First you need to establish the expected sales price (i.e. real market value). Then subtract your costs of completion, next, the selling costs (commissions, delivery, and disposal) go in the final calculation. Finally, you compare your NRV versus your cost and record the lower amount on the balance sheet if NRV < Cost.

Once you’ve completed the calculations, record your journal entry to reflect the loss, as well as maintain a backup of the calculations and disclose the write-down amount if significant.

Bottomline 

In conclusion, although NRV is a simple concept overall, it is an essential practice in ensuring proper valuation of Inventory to ensure that the Inventory is not overvalued, and losses due to completion, selling (commission and delivery), and market decline are recorded promptly. Stick to this process for consistent groupings and measurements; calculate NRV on an SKU basis if in doubt, document your calculations, and disclose any material losses or write-downs. For businesses seeking expert support, professional accounting services in UAE can assist in applying NRV principles correctly in line with applicable accounting standards.