Sales Price based Valuation Methods
Another way to value Inventories is to value at its current market price or Net Realizable Value (NRV). This method reflects the most updated value of the goods and any gains due to buying decisions during fluctuation of prices can also be realized. However, unlike the historic cost methods of valuing inventory, sometimes sale price methods of valuation are not objective and not easily auditable, especially for very specialized products for which there is no established market price.
Current Selling Price
There are many essential products, which are priced by the Government and regulatory authorities. A very common such product is Gasoline/ Petrol. Such products are usually valued at its current price instead of its cost.
However, it is important to note here that usually only finished goods with a highly active market and with an established price are valued at their current market price. This is important because valuing raw material and semi-finished goods at market price rather than its cost may lead to realizing premature gains, even if the products are not yet sold. Further, only current sale price is considered for valuing and any further selling and marketing expenses are ignored.
Net Realizable Value (NRV)
Net Realizable Value (NRV) is based on the prudence concept of Accounting, which requires that gain/ profits shall not be realized and recorded into books of accounts until it is not earned or certain, however, if there is any expected loss, this shall be recorded immediately.
This conservative and cautious approach in financial accounting requires that if the realizable value of a finished goods is lower than its cost, such an inventory shall be valued at Net realizable value (NRV) instead of cost.
IAS-2 further defines the Net Realizable Value (NRV) as current Sales Price less and expense necessary to make the inventory saleable. However, if it is difficult to estimate the further expense required for sale, the Inventory shall be valued at marketable/ quoted prices.
IAS-2 requires that inventory shall be valued at the Lower of
Cost OR
Net Realizable Value (NRV)
Whereas
NRV= Sale price – any expenses required to make the goods saleable.
Usually inventories and finished goods are valued using FIFO or AVCO, where by-products are valued at NRV because it becomes very difficult to apportion production costs accurately to the by-products.
Although valuing inventories at the lower of cost or NRV is required due to the prudence concept and accounting best practices, however this method of valuing inventory contradicts with the matching concept of accounting, which requires that all the costs incurred to earn the revenue shall be matched against with the revenue, in order to calculate the profit for the period. Reducing the value of closing inventory from its costs to NRV will result in booking some of the expense before the period in which the goods are actually sold.
Moreover, application of NRV for valuing inventories may also result in inconsistency while reporting financial results as next year the company may again value its inventory at any cost based method.
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