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Valuing inventory: the idea of net realisable value

· Evidence · 4 min read

Valuing inventory: the idea of net realisable value

If goods can only sell below cost, carrying them at cost overstates inventory.

A smartphone was bought for 2,400,000 so'm. Today a new model has come out and such phones sell for 2,100,000 so'm. In 1C the figure is still 2,400,000. The warehouse count agreed to the unit, yet the money value of the inventory is overstated. To spot that you have to test the valuation, not the count. And valuation rests on the idea of net realisable value (NRV).

What NRV is

Net realisable value is made of two figures: the price at which the goods are expected to sell in the ordinary course, minus the costs needed to make that sale (delivery, commission, packaging and, where necessary, further processing). The main rule: inventory is carried at the lower of cost and net realisable value. International standards (IAS 2) and many national rules are built on this principle; confirm its exact application with the company's accountant.

The reason is simple: inventory is an asset that should bring in cash in future. If the goods are expected to fetch less than they cost, the difference is a loss, and it is right to show it now rather than wait for the day of sale.

A worked example

Smartphone: cost 2,400,000 so'm, expected selling price 2,100,000 so'm, selling costs (commission and delivery) 150,000 so'm.

NRV = 2,100,000 − 150,000 = 1,950,000 so'm. Cost exceeds NRV by 450,000 so'm. With 30 units in the warehouse, the write-down is 13,500,000 so'm. Inventory is reduced by that amount, and profit is shown lower by the same.

A seasonal item: in March, a winter coat with a cost of 650,000 so'm is now selling at a discount for 420,000 so'm, with costs of 30,000 so'm. NRV is 390,000 so'm, a loss of 260,000 so'm per unit.

When NRV falls below cost

  • the supplier cut the price or a new model came out;
  • the season ended (winter clothes in spring, air conditioners in autumn);
  • the goods are damaged, the packaging is broken or they are outdated;
  • competitors or the marketplace sell cheaper;
  • because of a change in the import price, cost at the exchange rate has risen while the selling price has not;
  • the expiry date is near.

What the auditor tests

  1. Compares the cost of the balance with the latest selling price: lists the items whose selling price is below cost.
  2. Looks at sales after the reporting date. Actual prices in the 1–2 months after the date are the strongest evidence.
  3. Takes market prices from external sources: supplier price lists, the marketplace, Telegram channels. The screenshot should show the date.
  4. Calculates selling costs.
  5. Does the calculation item by item.

The last point matters. A drop on one item cannot be "covered" by a profit on another: if the smartphone loses 13.5 million so'm, then even with an equal margin on a different model, inventory is still reduced. Only similar, interchangeable goods may be grouped when valuing.

How to document the calculation

The NRV calculation is gathered into one table: item, quantity, cost, expected selling price, selling costs, NRV, difference and the total. Next to each price its source is written: "sale after the reporting date, 12 January" or "supplier price list, 5 January". The accountant prepares the table, the head of the product line approves the prices and the director signs. The valuation then becomes an agreed document rather than one person's guess, and when an auditor or a tax inspection asks, the basis for every figure is ready. Write the order of valuation (which price source takes priority) into the accounting policy so that it is applied the same way every year.

Common mistakes

  • A discounted sale is dismissed as a "one-off promotion" and ignored, though the market price has actually fallen to that level.
  • NRV is calculated only at year end, with no control during the year.
  • A provision is created, but the price source the valuation rests on is not kept, so there is nothing to show when the auditor asks.
  • When the price rises again, the value is "lifted" above cost. A write-down can be reversed, but only up to the original cost.

Conclusion

A count answers whether the goods exist; NRV answers whether their book value is close to reality. OmborAudit compares items that have fallen in price with post-period sales and external prices, and finds where the value of inventory is overstated.