Net realisable value – As a general rule (not only in IFRS) assets should not be carried at amounts greater than those expected to be realised from their sale or use. In the case of inventories this amount could fall below cost when items are damaged or become obsolete, or where the costs to completion have increased in order to make the sale.
In fact we can identify the principal situations in which the net realisable value (NRV) is likely to be less than cost, ie where there has been:
- An increase in costs or a fall in selling price
- A physical deterioration in the condition of inventory
- Obsolescence of products
- A decision as part of the company’s marketing strategy to manufacture and sell products at a loss
- Errors in production or purchasing
A write down of inventories would normally take place on an item by item basis, but similar or related items may be grouped together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) or a whole business.
The assessment of NRV should take place at the same time as estimates are made of selling price, using the most reliable information available. Fluctuations of price or cost should be taken into account if they relate directly to events after the reporting period, which confirm conditions existing at the end of the period.
The reasons why inventory is held must also be taken into account. Some inventory, for example, may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in contrast, be assessed according to general sales prices when NRV is estimated. (IAS 2 31)
Net realisable value must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the lower of cost and the new NRV.
This may be possible when selling prices have fallen in the past and then risen again. The amount of the write-down of an item of inventory can be reversed at such an occasion (IAS 2 33).
Net realisable value is different from fair value less cots to sell, because NRV is an entity specific value whereas fair value is not (IAS 2 7).
An important indicator when estimating NRV is the last available selling price, including selling price realised after the reporting date which usually provides evidence of conditions that existed at a reporting date (IAS 2 30).
IAS 2 leaves some room for interpretation when it comes to deciding which selling costs should be included in estimating NRV as there is no indication whether these should be only direct costs or maybe allocated indirect costs as well. It is therefore an accounting policy choice that should be applied consistently.
Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. Therefore, a write-down to NRV is not allowed simply because the price of raw material fell or the future profit margins will be unsatisfactory.
But if the entity would not be able to recover the cost of finished products, materials are written down to their net realisable value which can be based on the replacement cost of such materials (IAS 2 32).
On occasion a write down to NRV may be of such size, incidence or nature that it must be disclosed separately.
Net realisable value
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