Inventories should be measured at the lower of cost and net realizable value .Explain the term Net Realizable Value. What are the principal situations in which Net Realizable Value(NRV) is likely to be less than cost? (Part 1)

Generally, an asset should not be carried at amounts greater than those expected to be realized from their sale or use.

In the case of inventories:

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. ( see article on computation on stock valuation based on the lower of cost and net realisable value)

More salient points on using Net Realizable Value

  • A write down of inventories normally take place on an item by item basis but similar or related items may be grouped together ( say items in the same product line)
  • Assessment of NRV should take place at the same time as estimates are made of selling price, using the most reliable information available. This applies to events after the balance sheet  date which confirm the conditions of the inventories at the end of the financial period
  • Net realizable value should be reassessed at the end of each period and compared again with cost. If NRV > cost, the previous write down should be reversed to the extend that the inventory is then valued at the lower of cost and the new NRV. { sometimes due to selling prices which have fallen and then rise again }

Principal situations where Net Realizable Value (NRV) is likely to be less than cost:-

  • Obsolescence of products
  • An increase in costs or a fall in selling price
  • A physical deterioration in the condition of inventory
  • A decision as part of the company’s marketing strategy to manufacture and sell products at a loss
  • Quality defects, errors in production or purchasing

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