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Net Realisable Value and IAS 2: Inventories
Introduction
This page is concerned solely with the net realisable value (NRV) aspect of IAS 2. To some extent there is some repetition of the other page in this series but then the specific NRV questions in the second half of this page are new.
Nevertheless, to avoid the repetitions causing any problems, I have moved the majority of the direct references to IAS 2 to the end of this page: if you are happy with your knowledge of the Standard, attempt the questions that follow; but if you are unsure of the direct references to NRV in the Standard, they are given below.
From IAS 2
4 … Net realisable value, is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the estimated
costs necessary to make the sale.
6 Inventories should be measured at the lower of cost and net realisable
value.
Two Fully Worked Questions on NRV
Question 1
Determine the Net Realizable Value for each of the following items of
inventory
 | |||
| Item | Cost | Estimated Selling Price | Cost to Complete |
| |||
| A | 2 | 2.5 | 0.5 |
| B | 4 | 4 | 0.8 |
| C | 6 | 10 | 1 |
| D | 5 | 6 | 2 |
| E | 1 | 1.2 | 0.25 |
| |||
Solution 1
The figure in bold and italics in either the Cost and/or the Net Realizable Value (NRV) column represents the value that should be used in valuing the inventories for Balance Sheet purposes.
| |||
| Item | Cost | NRV | |
| |||
| A | 2 | 2 – 0.5 = | 2 |
| B | 4 | 4 – 0.8 = | 3.2 |
| C | 6 | 10 – 1 = | 9 |
| D | 5 | 6 – 2 = | 4 |
| E | 1 | 1.20 - 0.25 = | 0.95 |
| |||
Finally, if we imagine the number of units in stock of each of items A to E as shown in the following table, we can then calculate the overall value of inventories of these items.
| |||||
| Item | Cost | NRV | No of Units | Total Value | |
| |||||
| A | 2 | 2.5 – 0.50 = | 2 | 500 | 1,000 |
| B | 4 | 4.0 – 0.80 = | 3.2 | 1,000 | 3,200 |
| C | 6 | 10.0 – 1.00 = | 9 | 750 | 4,500 |
| D | 5 | 6.0 – 2.00 = | 4 | 750 | 3,000 |
| E | 1 | 1.2 – 0.25 = | 0.95 | 2,500 | 2,375 |
| Total | 14,075 | ||||
| |||||
Question 2
Company ABC started their commercial activity in the accounting period
with capital stock 500,000000, contributed by its owners. The Company
bought 1,000 units of inventories for 100,000,000, for which the freight
charges were 10,000,000. During the year, the Company sold 750 units at
150,000 per unit. At the end of year ABC had 250 units of inventories;
but 50 of them were damaged. Damaged units could be sold at 25,000 per
unit and the rest, 200 units, at 150,000 per unit.
1 Calculate the value of the inventory as at the end of year
2 Show the impact of the sale of damaged units on income statement for
the current financial reporting period
Solution 2
1 Cost of inventory
Cost of inventory per unit
100,000,000+10,000,000
= 110,000,000/1,000 units
= 110,000 per unit
Net realizable value
In the balance sheet inventories are recorded at the lower of cost and net realizable value:
| ||
| Damaged items | 50 x 25,000 = | 1,250,000 |
| Undamaged items | 200 x 110,000 = | 22,000,000 |
| Total value of inventories | 23,250,000 | |
| ||
2 Impact of sale
| ||
| Sales revenue | 750 x 150,000 = | 112,500,000 |
| ||
| Cost of goods sold | 750 x 110,000 = | -82,500,000 |
| Losses from damaged items: | ||
| Net realisable value | 50 x 25,000 = | 1,250,000 |
| Cost | 50 x 110,000 = | -5,500,000 |
| ||
| Losses from damaged items | -4,250,000 | |
| Gross margin on sales | 25,750,000 | |
| ||
Other Direct References from IAS 2 re NRV
25 The cost of inventories may not be recoverable if those inventories
are damaged, if they have become wholly or partially obsolete, or if their
selling prices have declined. The cost of inventories may also not be
recoverable if the estimated costs of completion or the estimated costs
to be incurred to make the sale have increased. The partial disposal of
the cost of inventory, the practice of writing inventories down below
cost to net realisable value is consistent with the view that assets should
not be carried in excess of amounts expected to be realised from their
sale or use.
26 Inventories are usually written down to net realisable value on an
item by item basis. In some circumstances, however, it may be appropriate
to group similar or related items. This may be the case with items of
inventory relating to the same product line that have similar purposes
or end uses, are produced and marketed in the same geographical area,
and cannot be practicably evaluated separately from other items in that
product line. It is not appropriate to write inventories down based on
a classification of inventory, for example, finished goods, or all the
inventories in a particular industry or geographical segment. Service
providers generally accumulate costs in respect of each service for which
a separate selling price will be charged. Therefore, each such service
is treated as a separate item.
27 Estimates of net realisable value are based on the most reliable evidence
available at the time the estimates are made as to the amount the inventories
are expected to realise. These estimates take into consideration fluctuations
of price or cost directly relating to events occurring after the end of
the period to the extent that such events confirm conditions existing
at the end of the period.
28 Estimates of net realisable value also take into consideration the
purpose for which the inventory is held. For example, the net realisable
value of the quantity of inventory held to satisfy firm sales or service
contracts is based on the contract price. If the sales contracts are for
less than the
Inventory quantities held, the net realisable value of the excess is based
on general selling prices. Contingent losses on firm sales contracts in
excess of inventory quantities held and contingent losses on firm purchase
contracts are dealt with in accordance with IAS 10, Contingencies and
Events Occurring After the Balance Sheet Date.
29 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. However,
when a decline in the price of materials indicates that the cost of the
finished products will exceed net realisable value, the materials are
written down to net realisable value.
30 A new assessment is made of net realisable value in each subsequent
period. When the circumstances which previously caused inventories to
be written down below cost no longer exist, the amount of the write down
is reversed so that the new carrying amount is the lower of the cost and
the revised net realisable value. This occurs, for example, when an item
of inventory, which is carried at net realisable value because its selling
price has declined, is still on hand in a subsequent period and its selling
price has increased.
© Duncan Williamson
October, 1999 revised August 2002
© Duncan Williamson
October, 1999 revised August 2002
© Webmaster Duncan Williamson 2002