Realisable value measurement

An asset’s realisable value is the amount for which it could be sold, and a liability’s realisable value is the amount for which it could be settled. Realisable value measurements are often made on a net basis, and here realisable value will be considered in the sense of net realisable value; that is, net of selling costs (for assets) and grossed up for settlement costs (for liabilities). As the actual use of realisable value is limited, it is difficult to say exactly how it would be calculated in practice if it were applied to assets and liabilities generally.

The view could be taken that, in substance, realisable value and fair value are the same except that the former is usually measured net of the costs of realisation. If an attempt were made to apply realisable value generally, therefore, alternative measures would need to be found to produce the numbers in situations where there is no active market to provide them. This would presumably result in the same kind of list of proxies for realisable value as that developed for fair value in IFRS 3.

An alternative view of realisable value is that it should be measured on the basis of disposal in the ordinary course of business. For example, the IASB states that:

‘Net realisable value refers to the amount that an entity expects to realise from the sale of inventory in the ordinary course of business. Fair value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the marketplace. The former is an entity-specific value; the latter is not. Net realisable value for inventories may not equal fair value less costs to sell.’ (IAS 2 Inventories)

But this approach to realisable value is clearly limited to assets that would be disposed of in the ordinary course of business – such as inventories. It could not be applied sensibly to all of a business’s assets.

Another view of realisable value is that it reflects what could be received on a forced sale – if the business were liquidated, for example.

Why we like or object realisable value measurement?

The characteristics of the realisable value basis depend on how one interprets it. To the extent that it is in substance the same as fair value, but net of realisation costs, its strengths and weaknesses are similar.

Where realisable value is measured on the basis of disposal in the ordinary course of business, sometimes its measurements would be more objective than fair value, sometimes less. For example, stock (or inventory) subject to a contract-for-sale or actually sold shortly after the balance sheet date could be measured objectively in circumstances where a hypothetical market price might be more difficult to determine. In other cases, the adjustments required for an ordinary course of business basis might be more subjective.

Why is realisable value measurement relevant?

Information prepared on a realisable value basis might be more relevant for some purposes than information prepared on other bases. For example, where realisable value shows current market prices, net of realisation costs, it allows investors, lenders and regulators to see what could be realised (net) on disposal of the business’s separable assets. Some may see it as more useful than fair value because it adjusts for known entity-specific factors, such as contractual terms that would apply to the disposal of assets. Also, where realisable value shows what could be realised in a forced sale, it is particularly relevant where a business is not a going concern or is perhaps intended to have a limited life.

The argument for realisable value as a measure of opportunity cost is that a gross figure represents an amount that can never be wholly realised, because in practice there will always be relevant costs that will reduce the gain (or increase the loss) apparently sitting in the balance sheet waiting to be realised. The user of the accounts could therefore be misled as to the prospective value of realisations. Those who regard fair value, rather than realisable value, as a measurement of opportunity cost could be misled into overestimating the likely benefits of selling assets rather than using them within the business (the calculations for which will be net of relevant costs).

What do we hold against realisable value measurement?

The same objections to realisable value’s relevance apply as for fair value, except as regards the possible superiority of net measurements and its application to businesses that are either not expected or not intended to be sustained.

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