what affects net realizable value
there are often four primary factors that affect a company s net realizable value collectability economic conditions obsolescence and market demand the ultimate goal of nrv is to recognize how much proceeds from the sale of inventory or receipt of accounts receivable will actually be received for this reason one of the primary drivers of nrv is collectability this relates to the creditworthiness of the clients a business chooses to engage in business with companies that prioritize customers with higher credit strength will have higher nrv collectability also pertains to a company s internal processes depending on the industry the company is it the company may decide to accept a certain amount of uncollectable sales the company may also lack the resources to pursue delinquent receivables as economies thrive clients often have more money at their disposal and are able to pay higher prices they are also able to pay on time and potentially purchase more goods alternatively when the economy is down clients may pass on orders or find it more difficult to make full payments this is especially true during inflationary periods when the federal reserve is interested in raising rates as prices are elevated the government may choose to combat rising prices however this leads to a contracting economy that increases unemployment in either situation high inflation or high unemployment it may be more difficult for clients or businesses to find budget for additional goods to buy as technology evolves and production capabilities expand unsold inventory items may quickly lose their luster and become obsolete this is true for even recently manufactured products companies not in tune with market conditions may be producing goods that are already outdated broadly speaking companies must often widely mark down products that are obsolete to garner any interest in the product as a result the company runs the risk of needing to sell goods at or below cost to retain any value from the outdated goods loosely related to obsolescence market demand refers to customer preferences tastes and other influencing factors in addition to a good becoming outdated broad markets may be interested in substitute products advanced products or cheaper products competition always runs the risk of supplanting a good s market position even if both goods are still relevant and highly functioning uses for net realizable valuean accounts receivable balance is converted into cash when customers pay their outstanding invoices but the balance must be adjusted down for clients who don t make payments nrv for accounts receivable is calculated as the full receivable balance less an allowance for doubtful accounts which is the dollar amount of invoices that the company estimates to be bad debt gaap rules previously required accountants to use the lower of cost or market lcm method to value inventory on the balance sheet if the market price of inventory fell below the historical cost the principle of conservatism required accountants to use the market price to value inventory market price was defined as the lower of either replacement cost or nrv the financial accounting standards board fasb the independent organization that establishes gaap standards issued an update in 2015 to its code that changed the inventory accounting requirements for companies provided they do not use last in first out lifo or retail methods companies must now use the lower cost or nrv method which is more consistent with ifrs rules in essence the term market has been replaced with net realizable value 2