NET REALIZABLE VALUE

(NRV)

Jearemy Janvier Wijaya

2113041

ACCOUNTING STUDY PROGRAM

FACULTY OF ECONOMIC AND BUSINESS

Atma Jaya Makassar University

2023
 PREFACE

Praise God the Almighty for all His blessings and mercy so that the writer was
able to finish this paper on time. This paper was prepared under the title "Net
Realizable Value” and was made as a substitute for the end of semester exams for
Financial Accounting I. The author would also like to thank the various parties
concerned, especially to Mr. Marselinus Asri as a lecturer in Financial Accounting I
class B, as well as friends who gave their presentations during the lecture.

The author thanks Dr. Marcelinus Asri., SE, M.Si., Ak., CA., CPITA. as a
powerful lecturer in the Financial Accounting course I who has given this Semester
Final Examination so that it can add to the author's knowledge and insight in
accordance with the field of study that the author is engaged in.

The author realizes that the paper she is writing is still far from being perfect.
Therefore, constructive criticism and suggestions will be awaited by the author for the
perfection of this paper.

Makassar, 24 January 2023

Writer
 Abstract

The purpose of this article is to find out what Net Realizable Value is. This article will
also discuss LCNRV or Lower of Cost and Net Realizable Value, how to calculate NRV&
LCNRV, and What Factors Affect an NRV Keyword: Net Realizable Value, Lower of Cost
and Net Realizable Value, calculate NRV & LCNRV, What Factors Affect NRV.

CHAPTER I

INTRODUCTION

Net realizable value (NRV) is the value that an asset can be sold for, reduced by the
estimated costs of selling or disposing of the asset. NRV is typically used in the estimation
of the ending inventory value. the Inventories is the current asset account found on the
balance sheet, which consists of all the raw materials, work-in-progress, and finished goods
that the company has accumulated. It is often considered the least liquid of all current assets
- therefore, it is excluded from the numerator in the quick ratio calculation. or receivables

1
 CHAPTER II

DISCUSSION

NET REALIZABLE VALUE (NRV)

Net realizable value is an important measure in inventory accounting under

Generally Accepted Accounting Principles (GAAP) GAAP GAAP, or Generally Accepted
Accounting Principles, is a set of generally recognized rules and procedures designed to
govern corporate accounting and financial reporting. GAAP is a comprehensive set of
accounting practices jointly developed by the Financial Accounting Standards Board
(FASB) and International Financial Reporting Standards (IFRS). The calculation of NRV
is very important as it prevents overvaluation of assets.

In practice, companies will use the method called Lower of Cost or Net Realizable
Value (LCNRV) to account for inventory in their financial statements. This means that the
value of inventory recorded on the company's balance sheet will be the lower of the cost of
inventory or its net realizable value. Thus, companies can ensure that the value of inventory
recorded on the balance sheet is in line with the actual value of the inventory.

However, it should be noted that determining NRV requires accurate estimates of

the selling price, the cost required to complete the inventory, and the cost required to make
the sale. Therefore, companies should be cautious in making these estimates to ensure that
the value generated is in line with actual conditions.
 How to Calculate the NRV

The calculation of the NRV can be broken down into the following steps:

1. Determine the market value or expected selling price of an asset.

2. Find all costs associated with the completion and the sale of an asset (cost of
production, advertising, transportation).
3. Calculate the difference between the market value (expected selling price of an
asset) and the costs associated with the completion and sale of an asset. It is a net
realizable value of an asset.

Mathematically, the net realizable value can be found through the following equation:

However, the net realizable value is also applicable to accounts receivables. For the
accounts receivable, we use the allowance for doubtful accounts instead of the total
production and selling costs.

Example of Calculating the NRV

Company ABC Inc. is selling the part of its inventory to Company XYZ Inc. For reporting
purposes, ABC Inc. is willing to determine the net realizable value of the inventory that
will be sold.
The expected selling price of the inventory is $5,000. However, ABC Inc. needs to spend
$800 to complete the goods and an additional $200 for transportation expenses.
Considering the available information, the net realizable value of the inventory should be
calculated in the following way:

NRV = $5,000 – ($800 + $200) = $4,000

Another example

Company A is a seller of high-tech machinery. The company has an inventory of 20,000

units, which it sells for Rp. 4,200,000 per unit. Of these 20,000 units, an estimated 3% are
defective, and the repair cost is Rp. 100,000 per unit. Other selling costs are estimated at
Rp. 50,000 per unit.

The first step is to calculate how many items are damaged and what the net price per
damaged unit is

Defective units = 20,000 x 3% = 600

Price per unit = Rp. 4,200,000

Net price per defective unit = price per unit - repair cost - selling cost

= 4,200,000 - 100,000 - 50,000 = Rp. 4,150,000

NRV of damaged units = Rp. 4,050,000 x 600 = Rp. 24,300,000

The second step is to calculate the net price per unit of goods:

Available units = 20,000 - 600 = 19,400

Price per unit = Rp. 4,200,000

Net price per unit of goods = price per unit - cost of sales = Rp. 4,200,000 - Rp. 50,000 =
Rp. 4,150,000

NRV of good units = Rp. 4,150,000 x 19,400 = Rp. 80,510,000

Therefore, the total NRV = Rp. 24,300,000 + Rp. 80,510,000 = Rp. 104,810,000.

Examples of Using the NRV Formula

As mentioned above, net realizable value is used on three occasions. Here is the
explanation.

1. Receivables

Accounts receivable balances are converted to cash when buyers pay outstanding invoices.
However, this balance must be realigned for clients who have not or do not pay. These are
called bad debts.

The net realizable value for receivables is calculated as the full receivables balance minus
an allowance for doubtful accounts, aka bad debts, which is the amount of receivables that
cannot be paid. These bad debts are booked as expenses.

The way to calculate net realizable value for receivables is as follows.

• Record the client's total receivables.

• Record the parts of the receivables that may be uncollectible. Then set aside the
doubtful receivables.
• Total receivables minus bad debts. From this, the NRV result is obtained.

2. Inventory
The rules in previous GAAP required accountants to use the lower of cost or market method
(LCM) to calculate inventory on the balance sheet. If the market price of inventory falls
below historical cost, the principle of conservatism requires accountants to use the market
price to calculate the value of inventory. Market price is referred to as lower than
replacement cost or NRV. When a company purchases inventory, it may incur additional
costs to store or prepare the raw materials before they are sold. This cost associated with
storing inventory is referred to as transportation cost.

For example, a retailer buys a large and expensive piece of furniture as inventory. The
company then has to build a display case and hire a contractor to carefully move the
furniture to the buyer's home. These extra costs are then deducted from the sales price to
determine the net realizable value.

3. Cost Accounting

Net realizable value is also used to calculate costs when two items are made together in a
shared cost system until production reaches a separation point. Each product is produced
differently after that point.

NRV is used to allocate the previous shared costs to each product. This allows the
company to calculate the total cost and determine the sales price of each.

LCNRV (Lower Cost of Net Realizable Value)

Inventories are carried at cost. However, if the value of inventories falls below their
cost, the entity must write them down to net realizable value to report the loss. Net realizable
value is the estimated selling price of inventories in the ordinary course of business less
estimated costs of completion and estimated costs to realize the sale. Net realizable value
refers to the net amount that the entity expects to realize through sales (in the ordinary course
of business).
 Estimates of net realizable value are based on the most reliable evidence available
at the time the estimate is made of the inventory expected to be realized. This estimate
considers price or cost fluctuations that are directly attributable to events occurring after the
end of the period to the extent that they confirm the conditions that existed at the end of the
period.Inventory write-downs may be due to obsolescence, declining selling prices, or
damage.The practice of writing down inventory below cost to net realizable value is
consistent with the view that assets should not be stated at more than the estimated amount
that can be realized from their sale or use.Estimates of net realizable value also consider the
purpose for which the inventory is held. For example, if the net realizable value of the
amount of inventory held to fulfill a firm sales or service contract is based on the contract
sales price being less than the amount of inventory held, then the net realizable value for the
excess is based on the general selling price.Materials and other supplies held for use in
producing inventory are not written down below cost if the finished product is expected to
be sold at or above cost. However, if a decrease in the cost of materials indicates that the
cost of the finished product will exceed the net realizable value, the value of materials is
written down to their net realizable value. In such circumstances, the replacement cost of
the material is the best available measure of its net realizable value. The company should
report its inventories in the statement of financial position at the amount of Lower-of-Cost-
or-Net Realizable Value (LCNRV).

Lower of Cost and Net Realizable Value (LCNRV) Rule

Like many other assets, inventory is recorded and reported at cost in accounting
books following historical cost principle following a certain cost flow assumption either
FIFO, LIFO, AVCO or other methods. Another way of measuring inventory value is based
on net realizable value (NRV).
 Under normal circumstances, cost of inventory is always lesser than the net amount
business can earn by selling the inventory, called net realizable value (NRV). Common
sense dictates that cost has to be lesser than NRV to make profit. But following a concept
of conservatism, even if NRV is higher than cost, value of inventory is kept at cost and gain
is not recognized until the inventory actually sells.

However, if NRV of inventory falls below the cost of inventory, following the same
concept of conservatism, entity must write down the value of inventory to the amount that
can be realized. Hence the recognition of loss to the extent expenditure on inventory are not
expected to be recovered. It does not make sense to report an asset at any value higher than
the amount it can recover and may overstate the assets materially. Therefore, entity must
switch to NRV basis from historical cost basis of measurement if recoverable amount falls
below cost of asset.

Example of LCNRV:

PT Makmur has unfinished inventory with an acquisition cost of Rp.950,000. The

selling price of the inventory is Rp.1,000,000, the estimated cost of completion is
Rp.50,000, and the estimated selling cost is Rp.200,000. The calculation of the net realizable
value of the inventory is as follows

PT Makmur reports inventories in the statement of financial position at Rp.750,000. In the

income statement, PT Makmur reports an inventory write-down loss of Rp.200,000 (from
Rp.950,000 minus Rp.750,000) The value of inventory is usually written down to net
realizable value separately for each individual unit of inventory. However, in some
circumstances, an inventory write-down may be more appropriate if it is calculated against
a group of similar (related) units or even against the total inventory. For example, in the
garment industry it is not possible to determine the selling price for each textile individually,
so a net realizable value valuation is applied to all textiles that will be used to produce
clothes in a particular season (by product line).

LCNRV BY INDIVIDUAL ITEMS

The inventory value used by PT Pangan Sejahtera above is Rp.38,400, which is the total
LCNRV of each type of fruit. For example, the inventory value of apples is Rp.8,000
which is the lowest value between the acquisition cost and the realizable value. Likewise,
for jackfruit, the inventory value is Rp.4,000 which is the lowest value between the
acquisition cost and the net realizable value.

What Factors Affect NRV

Organizational decision-makers on company performance may consider accounting

procedures such as NRV bookkeeping. Business development can be affected by production
efficiency and collection of receivables.

What are the factors that can affect a company's net realizable value? Here's an explanation.
1. Situation of the Economy

The economic situation affects the net realizable value at the end of the period. Whether in
receivables or inventories. Businesses can be affected by micro and macro factors, such as
employment levels, gross productivity, and inflation.

When the economy is expanding, loans flow and industries grow. Meanwhile, when the
economy is contracting, business growth is stunted as budgets decrease. Budgets also have
to be strategically placed as consumers are stretched thin.

2. History of Accounts Receivable Collection

The company can realize the collection of receivables based on its collection history. There
are industries that are not stable enough, so the percentage of defaults is higher. Businesses
that are able to collect debts creatively will see a good difference in their net realized value
at the end of the period.

3. The Market Demand

Market conditions are always changing according to consumer tastes. Sales value can move
up and down according to the market's willingness to pay the price of an item, and their
ability to pay for substitute products. Businesses that operate in an extremely competitive
market will definitely feel the ups and downs of prices.

4. Cost of Production and Inventory Maintenance

Production costs include raw materials, employee wages, and production equipment.
Changes in production costs will affect the company's NRV. Increasing the selling price for
profit does not always bring benefits to the company.
 CHAPTER III

CONCLUSION

The conclusion of the NRV calculation is the estimated value of the company's inventory
after taking into account all selling expenses. This value is then used to determine the value
of the company's inventory on the balance sheet.

Determining NRV is important for a company, as it helps the company to determine the
right selling price for the inventory. It also helps the company to determine the amount of
inventory to be purchased or sold. NRV is also used in the company's liquidity analysis. If
NRV is low, the company may face liquidity problems because they do not have enough
funds to pay debts or develop their business.

Overall, the calculation of NRV is an important concept in accounting that helps the
company to determine the value of inventory and to manage liquidity well.
 BIBLIOGRAPHY

Kieso, Weygandt, & Warfield. (2019). Intermediate Accounting. New York: Wiley.

https://corporatefinanceinstitute.com/resources/valuation/net-realizable-value-nrv/

https://pakaccountants.com/courses/inventory/lower-cost-net-realizable-value-lcnrv-rule/

https://www.modalrakyat.id/blog/net-realizable-value-nrv