Definition: Net realizable value (NRV) is the net asset value that a seller receives for selling an asset after deducting the costs associated with the sale or disposal of the product. The net realizable value formula is calculated by subtracting the cost of making the sale from the sale price. It is essentially the amount of money a company will make from selling an asset after it pays the selling costs. Selling costs could include marketing costs, advertising costs, or even product demonstration costs.
What Does Net Realizable Value Mean?
What is the definition of net realizable value? 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. Both GAAP and IFRS principle require companies to use NRV in inventory valuation.
Still asking yourself what is NRV? Let’s take a look at an example.
Take a car dealership trying to sell a used car for example. The dealership has to insure the car and make sure it has proper license plates. It also has to pay a salesman to test drive and sell this car to customers. It also has to have gas in order to be taken on test drives. All of these costs can be considered selling expenses. If the dealership intends to sell this car for $15,000 and incurs $900 in selling expenses, the car’s NRV is $14,100.
This concept is also important to financial accounting in reporting inventory and accounts receivable on the balance sheet. Only assets that can be readily sold can be reported as inventory on a company’s balance sheet. If the inventory is obsolete or damaged, it will probably not sell and should be reported as a different asset. Going back to our car example, if the car was damaged and the dealership decided that it was still sellable, the dealership would report the car as inventory on its balance sheet at the NRV. If the car was too damaged to sell, the dealer would have to remove it from its inventory account.
Here’s another example.
Company A is a seller of high-tech machinery. The company holds an inventory of 20,000 units, which sell for $42 each. Out of these 20,000 units, an estimated 3% is damaged, and the cost of repair is $10 per unit. Other selling costs are estimated at $5 per unit.
How can the firm’s accountant calculate the NRV?
The first step is to calculate how many are the damaged goods and what is the net price per damaged unit:
- Damaged units = 20,000 x 3% = 600
- Price per unit = $42
- Net price per damaged unit = price per unit – repair costs – selling costs = $42 – $10 – $5 = $27
- NRV of damaged units = $27 x 600 = $16,200
The second step is to calculate the net price per good unit:
- Good units = 20,000 – 600 = 19,400
- Price per unit = $42
- Net price per good units = price per unit – selling costs = $42 – $5 = $37
- NRV of good units = $37 x 19,400 = $717,800
Therefore, the total NRV = $16,200 + $717,800 = $734,000
Define Net Realizable Value: NRV means amount of money a seller actually receives for selling a product after all costs are factored in.