In the following year, the market value of the green widget declines to $115. Since the cost of $50 is lower than the net realizable value of $60, the company continues to record the inventory item at its $50 cost. The cost to prepare the widget for sale is $20, so the net realizable value is $60 ($130 market value - $50 cost - $20 completion cost). Inventory market value - Costs to complete and sell goods = Net realizable value Example of Net Realizable ValueĪBC International has a green widget in inventory with a cost of $50. Thus, the formula for net realizable value is as follows: Subtract the selling costs from the market value to arrive at the net realizable value. Summarize all costs associated with completing and selling the asset, such as final production, testing, and prep costs. Lenders and creditors rely on the current ratio to evaluate the liquidity of a borrower, and so might incorrectly lend money based on an excessively high current ratio.įollow these steps to determine the net realizable value of an inventory item:ĭetermine the market value of the inventory item. This can be a concern when calculating the current ratio, which compares current assets to current liabilities. The conservative recordation of inventory values is important, because an overstated inventory could result in a business reporting significantly more assets than is really the case. Thus, the use of net realizable value is a way to enforce the conservative recordation of inventory asset values. Further, writing down inventory prevents a business from carrying forward any losses for recognition in a future period. There is an ongoing need to examine the value of inventory to see if its recorded cost should be reduced, due to the negative impacts of such factors as damage, spoilage, obsolescence, and reduced demand from customers. The deductions from the estimated selling price are any reasonably predictable costs of completing, transporting, and disposing of inventory. It is used in the determination of the lower of cost or market for on-hand inventory items. Net realizable value is the estimated selling price of goods, minus the cost of their sale or disposal.
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