Inventories at Net Realizable Values

The introduction of International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) ushered in more disclosure requirements in an entity’s financial statements. Oftentimes, additional narrative explanation are required for a particular note item in the Notes to Financial Statements. Transparency in financial reporting, you say, huh.

IAS 2, Inventories, in particular, requires a company to disclose among others, the accounting policies adopted in measuring inventories, the carrying amount of inventories carried at cost and the carrying amount of inventories carried at net realizable value.

Complexities, however, arise when a company allocates a provision for inventories specifically identified as obsolete or are impaired, and in such a case are measured at net realizable values. Generalizing in the notes that “Inventories are stated at net realizable value,” (when in fact only a few distinguished items are affected) cast a serious hassle on the part of the reporting entity.

If you take this statement to layman user of the financial statements (FS), who at the same time can be an investor or a prospective investor, the first question will be what’s the definition of “net realizable value” or NRV. Quoting IAS 2 paragraph 4:

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

If I were the user of this particular FS, from that finical disclosure regarding inventory alone, I’m going to have this impression that the company is not making any profit at all.

Inventories are stated at net realizable values, it means to me that the enterprise can only be able to sell its products at particularly lower than the cost to produce and sell those products. The company as a whole doesn’t sound to be a good investment.

I don’t know, that statement just doesn’t sound so good. Masakit sa tenga pakinggan.

If you’re not yet convinced, just try listening to Joel Dizo say:
[audio:http://www.geocities.com/deuts008/joel.mp3%5D

joel dizo

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21 thoughts on “Inventories at Net Realizable Values

  1. yeah.. in my opinion to disclose inventories just that way is obvious non-compliance. IAS 2 is straight forward on that.. well, sometimes auditors tolerate small things coz they think users and even regulators dont care anyway.. sabi nga nila basta tolerable pwede na!! hehehe tama ba?

  2. I don’t think it’s non-compliance. It’s more of a false information, and as such a “MISSTATEMENT” on the part of the reporting entity. Yeah, and a misstatement at that that users, preparers, auditors, and regulatory agencies opt to ignore. Fantastic!

  3. I think Deuts concern is all about generalization of the word “net realizable value” (NRV). Well, inventory carried at cost is also considered at its net realizable value. Because the standard says so, it is understood, the accountant and the auditors have done an approach that shall present the inventory at NRV. If no adjustment is made on historical cost, a presumption that inventory is carried at NRV exists, and any mistatements are deemed immaterial.

  4. Sense? It will give comfort to the financial statements users the real value of inventory. If you will just say inventory carried at cost, doubt as to its recoverability still exist.

    in short, as much as possible you have to value your asset good as cash.

  5. Well, inventory carried at cost is also considered at its net realizable value.

    There is a big difference between cost and net realizable value. Cost is not net realizable value.

    If you will just say inventory carried at cost, doubt as to its recoverability still exist.

    Basically, inventory should be carried at the LOWER of cost or net realizable value. It’s not valued at cost, nor in net realizable value as an absolute rule. It should be the “lower” of the two.

    in short, as much as possible you have to value your asset good as cash.

    Do you mean that inventory should be valued “always” at net realizable value? Nope, it’s the lower of cost and net realizable value.

  6. Hehehe.. there we go. IAS2 requires split disclosure of inventories carried at cost (thats lower than NRV)and goods carried at NRV.

    Parang ganito:

    FG 100
    WIP 200
    Spare parts 50

    Inventories are stated at lower of cost or net realizable value. The amount of inventories carried at cost is 88 in 2005 and 24 in 2006. The amount of inventories carried at NRV is 45 in 2005 and 34 in 2006.”

    What auditors are doing is simply lump inventories (mostly per classification) and add a paragraph that says “inventories are stated at lower of cost or NRV” period. ganun lang dba?

    Is that a full disclosure compliance? Hindi…

  7. Based on that kind of disclosure, it’s some kind of “bitin“.

    However, I would like to point out what was actually disclosed in the financial statements of certain companies in 2004. Just the fact that there was an allowance for inventory obsolescence (even though that amount was specifically identified to particular inventory items), some claim that a statement that “inventories are stated at net realizable value” should accompany the note item for inventory. For me, as I’ve stated earlier, that’s a total misstatement. It’s simply false information, which if taken seriously, can lead to misinformed judgement. Auditors, regulators, preparers, and users of financial statements alike just simply ignored.

  8. Provision for inventories can either be general, specific, or both. Generally, provisions that are taken up in the books of most companies are in the nature of inventory obsolescence. I agree with you guys that most companies, especially here in the Philippines, do not take up provision for inventory writedown to NRV(in case the NRV is lower than cost). The challenge for companies is to have a valuation system in place that is cost effective. On the other hand, the challenge for auditors is to raise this to management and consider this in the audit opinion.

    With all due respect to Jamal’s opinion, I agree with Deuts comments. Net realizable value is estimated selling price less cost to dispose and cost to sell. Cost, on the other hand, is the purchase cost including conversion costs and all incidental costs that are necessary to bring the inventory to their present location and condition. In case the cost is lower than the net realizable value then, inventories should be valued at cost.

  9. Very well said.

    Nagpalit ka na naman ng Name mo! Hindi n nman yan mag-a-add sa top 8 favorite visitors ko. pare-pareho lng kau ni jogar/jamal at edwin/edwinboy/edwin boy. Papalit palit ng pangalan….hehehehe:)

  10. Palitan mo naman Name ko sa comments, please… Isama mo na rin sina Jogar at Edwin boy.

    I encourage everyone, especially our colleagues in CLMC, to participate in every topic. Let us “speak our mind,” so to speak.

  11. “There is a big difference between cost and net realizable value. Cost is not net realizable value”

    I did’t say cost is net realizable value, its either way as the statement lower of cost or net realizable value say

    “Basically, inventory should be carried at the of cost or net realizable value. It’s not valued at cost, nor in net realizable value as an absolute rule. It should be the “lower” of the two”

    Correct, my explaination is only for the sake of argument.

    “Do you mean that inventory should be valued “always” at net realizable value? Nope, it’s the lower of cost and net realizable value”

    In a manner, inventory should be valued good as cash. Even though inventory is valued at cost, I will conclude cost is lower than NRV. Therefore cost is more liquid under the rule of conservatism.

  12. In Comment #3, you said that and I quote:

    “Well, inventory carried at cost is also considered at its net realizable value. Because the standard says so, it is understood, the accountant and the auditors have done an approach that shall present the inventory at NRV.”

    You said that inventory carried at cost is also considered at its NRV. However, in your last comment, you said and I quote:

    “I didÂ’t say cost is net realizable value, its either way as the statement lower of cost or net realizable value say

    “Basically, inventory should be carried at the of cost or net realizable value. It’s not valued at cost, nor in net realizable value as an absolute rule. It should be the “lower” of the two”

    Can you please elaborate what you meant in your two comments that I quoted above?

  13. In the first statement, I am referring to the notes to the financial statements, because the statement did not specify which is cost and NRV, hence they are interchangeable.

  14. HAHAHAHAHA. Ayos kayo!

    Good job. Hope to read blogs like this – very educational and mind stimulating.

    Deuts request – i-discuss mo naman tungkol sa Impairment of assets.

  15. haha! langya, inikot mo n ata lahat ng entries ko ah. anyways, impairment of assets? I have one in the drafts about it actually. Matagal na un nasa draft. I just don’t have time yet to elaborate on it. I’m planning to discuss the effect of income tax on the disposal of impaired assets.

    Just watch out for it…hhe

  16. I forgot the my IAS already, but what i can still recall is that in IAS, inventories should be stated at the lower of cost or net realizable value so to disclose in general that “Inventories are stated at net realizable value,” is misleading. Unless, there is a reason why the entity use such disclosure. What is the nature of business of the entity ba?

    In my world now (hehehe), we are using US GAAP, inventories are carried at cost unless there is a decline in market value of the inventory – in such a case – LCM rule will apply. Another exception to the cost rule is that if inventory is damaged or repossesed – in this case inventory should be stated at replacement cost. Also, other types of inventories can be carried at sales price – which maybe due to inability to determine approximate cost or there is an immediate marketability of quoted market prices. Example of inventories valued at sales price includes precious metals & agriculture products

  17. Whew! can’t think of anything else to say! 🙂 in your world now huh! okay, in my world today, i don’t know…hehehe anyway, great insight there! you’re the man!

  18. Deuts.NET - Deuts.net No. 100

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