Difference between fair value & net realisable value
Fair value and net realisable value are two accounting measures of the amount of money that could be raised for an item.
The goods that are valued by these metrics are the regular products of a company. Therefore, these measurements are not applied to asset sales, like the sale of premises.
Net realisable value
Net realisable value puts a price on the sales stock of a business. This value can be entered into the accounts as an asset classified as stock on hand.
The formula for deciding this value uses the regular selling price that the business gets for those goods during the normal course of trading. Therefore, it is simple to calculate the price of those goods because it is just the price that the company sells those items at. It is the sticker price.
To convert price to net realisable value, however, the accountant needs to deduct selling costs from the valuation of each item. Unfinished goods should have the cost of completion deducted from the resultant calculation to give them a value.
The fair value may be higher or lower than the net realisable value.
This value finds that price that these goods would fetch in the general marketplace.
For example, a business may make sales in an economically depressed region of the country. It may have to force down its prices in order to make sales. The same product may sell for more money in other areas of the country. In short, the fair value assesses the price of goods if the company were not constrained by its particular circumstances and location.
Net realisable value includes the cost of selling the goods whereas fair value does not. It could be decided, therefore, that net realisable value is the same as fair value minus selling costs. It is not. One subtle difference is that net realisable value deals with the regular price of goods, whereas fair value deals with the achievable price of goods on a specific date. That date usually being the date of the balance sheet. For example, take a business that deals with scrap metal. It takes the monthly price of scrap iron and uses that when it buys from regular customers. Therefore, its stock would be valued at the price of metal on the first of the month to derive the net realisable value. The fair price valuation appearing on a balance sheet would use the price of scrap metal on the date of the balance sheet.
Both definitions include the same selling conditions on judging the selling price of goods. Those conditions are that the price should be judged on an “arms length” sale which is “orderly.” That means that the definition of fair value, which specifies the price that could be achieved by selling stock on that specific day, does not imply a fire sale or panic conditions, which would depress or enhance the price of the goods.