Accounting – Net Realisable Value

Accounting – Net Realisable Value

The net realisable value refers to the estimated selling price of goods, subtract costs of disposal or sale. Business owners may use this value to identify the lower of cost or market for the inventories they are owning. The costs of disposal or sale are any costs of transporting, disposing or completing the inventory that the company can predict reasonably. This is based on the Conservative concept similar to impairment (Also see What is Impairment Testing for Goodwill?).

Companies should assess the values of inventories (Also see FRS 2 Inventories) they have on hand continually so that they can determine whether they should reduce the recorded cost of the inventories. There are various reasons for the reduction, which may include obsolescence, spoilage, damage, as well as lower customer demand. Also, if a company tracks and writes down the inventories when necessary, it may prevent itself from bringing forward any losses and recognise them in an upcoming accounting period. Hence, business owners should make use of net realisable value for them to record the values of inventory asset conservatively.

If accounting is not your thing, the steps below may help you in identifying the net realisable value of an inventory item, or you may seek help from an accounting firm Johor Bahru to get these tasks done.

  1. Identify the inventory item’s market value.
  2. List down all the cost related to the completion and sale of that asset. These costs may include preparation, testing, and final production costs.
  3. To calculate the asset’s net realisable value, minus the selling costs from its market value.

As you can see from the steps above, the formula for net realisable value is:

Net realisable value = Market value of inventory – Cost of disposal or sale

As an example, XYZ corporation sells second-hand cars. There is a used car in inventory with a cost of RM20,000. The market value of the car is RM60,000. The cost the company needs to prepare that car for sale is RM5,000. Thus, by using the formula above, the net realisable value is RM55,000 (RM60,000 (market value) – RM5,000 (cost of sale) ).

As the net realisable value (RM55,000) is higher than the cost (RM20,000), XYZ corporation will still record the inventory at RM20,000, which is its cost.

In the next year, the market value of that second-hand car has decreased to RM20,000. Its cost remains at RM20,000, and the same goes to the cost of sale (RM5,000). Hence, the net realisable value of the car becomes RM15,000 (RM20,000 (market value) – RM5,000 (cost of sale) ).

As the net realisable value (RM15,000) is lower than the cost (RM20,000), XYZ corporation should record a loss of RM5,000 on that inventory. This reduces the recorded cost of the second-hand car to RM15,000.

If the calculation has caused a loss, the double entry accounting you should make is:

– Debit the loss to the cost of goods sold expense account

– Credit the same amount to the inventory account

If the loss is material, you may prefer separating it in another loss account. This makes it easier for the readers of the financial statements to discover the loss.

Besides, some people also use net realisable value to refer to the offsetting allowance for doubtful accounts a type of contra account, as well as the accumulated sum of the ending balances of accounts receivable account. However, it is important to note that this concept does not apply to trade receivable as the FRS 109 has spelled out the way expected credit loss should be accounted for.

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