Formula and examples of net realizable value according to IFRS

The net realizable value is calculated using the estimated selling price less the estimated costs to finish production and those necessary to carry out a sale.

This article will carry out a series of examples related to the net realizable value according to IAS 2.

This value is essential to set out if the inventories present impairment.

In other words, if when comparing the carrying amount asset against the net realizable value, the latter is below that of the carrying amount means that the entity must adjust inventories for this difference.

The estimated costs to complete the sale are all those costs necessary to carry out the transaction.

For example, if an entity hires a sales agent or carries out an advertising campaign to promote the company products, these costs must be deducted from the sale price to calculate net realizable value.

Example 1 net realizable value

In January of year 1, an entity located in the United States purchased inventory from a supplier in the European Union.

The acquisition costs are presented below.

Purchase price: 120,000

Import duties: 24,000

Non-recoverable taxes: 12,000

Recoverable taxes: 10,000

Transportation from the port to the warehouse: 5,000

The company receives a 5% discount on the total asset cost and a 10% discount if the entity pays for the merchandise within two months.

The entity pays for the inventory on January 28 of year 1, and on January 31 of that same year, the inventory is ready for sale.

As of December 31 of year 1, the estimated sale price is 140,000, and the estimated cost to complete the sale is 25,000

According to the above information, what is the asset’s carrying amount as of January 31 of year 1 and December 31 of the same year?

The entity must consider paragraphs 10 and 11 of IAS 2 to calculate the asset cost.

These paragraphs set out that a company should not include within the cost of inventories:

Recoverable taxes.
Abnormal amounts of material waste.
Storage costs.
Indirect administration costs.
Selling costs.

In this way, the cost of the asset is as follows:

Purchase price: 120,000

Import duties: 24,000

Non-recoverable taxes: 12,000

Transportation 5,000

Total inventory: 161,000

Commercial discount 5% 8,050 (161,00X5%)

Net amount: 160,200

Cash discount: 16,020 (160,200X10%)

Carrying amount Inventory: 144,180

According to the proposed example, the net realizable value at the end of year 1 is the following.

Net realizable value : Estimated sales price – estimated costs to complete the sale.

The net realizable value is: 140,000 – 25,000

The net realizable value is: 115,000

Inventory Impairment: Carrying amount vs. net realizable value

Inventory Impairment: 115,000 – 144,180

Inventory Impairment: 29,180

 Thus, the carrying amount as of January 31 of year 1 is 144,180 and as of December 31 of the same year is 115,000

Example 2 net realizable value

In December of year 1, a manufacturing company produced inventory with the following characteristics.

Raw material: 105,000

Labor Cost: 15,000

Indirect manufacturing costs: 45,000

Total production cost: 165,000

The entity estimates that it will complete its production in February of year 2; for this, it will need to incur 55,000 to end production at that date.

In addition, it is also estimated that the sale price of the finished product will be 210,000, and the estimated costs to complete the sale of 25,000

What is the carrying amount as of December of year 1?

To calculate the impairment of inventories in a production process, the following formula is used:

Inventory Impairment: Production Costs - (estimated selling price - estimated costs to complete production - estimated costs to complete sale)

Formula NRV

Inventory impairment: 165,000 – (210,000 – 55,000 – 25,000)

Inventory Impairment: 165,000 – 130,000 = (35,000)

The carrying amount as of December of year 1 is 130,000

Many people think that the calculation of net realizable value and impairment is used only for finished products.

However, paragraph 32 of IAS 2 sets out that generally, the raw materials held in inventory production are not impaired.

The above considering that the final cost of the finished products is not above the selling price, less the estimated costs to complete the sale.

Now, since the company, as of December of year 1, does not know what the final cost of the finished product will be, it must estimate this value to determine whether there is impairment.

In this way, specifically, paragraph 32 states the following:

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 exceeds net realizable value, the materials are written down to net realizable value.

In such circumstances, the replacement cost of the materials may be the best available measure of their net realizable value.

Example 3 net realizable value

A company has two lines of business, line 1 and line 2; in number one, it has two products, A and B, and in the second line, it has products C and D.

The financial information at the end of the reporting period is shown below:

net realizable value According to IFRS-min

Products A and B: Product A shows an impairment of 5,000, equivalent to the difference between the carrying amount and its net realizable value.

And on the other hand, product B does not show impairment since its carrying amount is below the net realizable value.

However, before recognizing impairment from product A, we must review paragraph 29 of IAS 2.

This paragraph establishes that when determining whether an inventory is impaired, we must consider whether the products belong to the same business line since an entity must assess the loss of value of the products as a whole.

In this way, if we evaluate the inventory of line 1 comprehensively, we obtain the following:

As you can see, the impairment check as a whole gives a result that the carrying amount is below the net realizable value, for this reason, it is not necessary to reduce the inventory.

Paragraph 29 determines the following:

Inventories are usually written down to net realizable value item by item.

However, it may be appropriate to group similar or related items in some circumstances.

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 on the basis of a classification of inventory, for example, finished goods, or all the inventories in a particular operating segment.

Finally, in the other line of business, the deterioration of the inventory of each product must be recognized, since the carrying amount of the two is above the net realizable value, that is, product C must be adjusted by 8,000 and product D in 10,000.

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