What is Realizable Value?

This principle of realizable value works on the conservatism conceptConservatism ConceptThe conservatism principle of accounting guides the accounting, according to which there is any uncertainty. All the expenses and liabilities should be recognized. In contrast, all the revenues and gains should not be recorded, and such revenues and profits should be recognized only when there is reasonable certainty of its actual receipt.read more, which says that all the foreseeable expenses or losses should be accounted for immediately. As soon as we find out that the realizable value is less than the cost price, we must account for those losses in the books. For example, Inventory is valued at a lower cost or market price. Any increase or decrease in the value of Inventory helps identify any loss or profit we must take into consideration. The market price is nothing but the net realizable value.

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Realizable Value Examples

Example #1

X Ltd. has inventory worth $1,500 at year-end; however, due to advancements in technologies, this product will be obsolete soon, and at this point, it can only fetch $900 in the market. As soon as X Ltd gets this information, it should write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more the value of inventoryValue Of Inventory Inventory Valuation Methods refers to the methodology (LIFO, FIFO, or a weighted average) used to value the company’s inventories, which has an impact on the cost of goods sold as well as ending inventory, and thus has a financial impact on the company’s bottom-line numbers and cash flow situation.read more by $600 ($1500 – $900) value by $600 ($1500 – $900) and show the inventory at $900 only.

The impact of this transaction is that the profit of X Ltd for the current year comes down by $600, and it does not have to pay tax on that money. Also, the books of accounts present the financial position more accurately.

Example #2

Another example is trade receivableTrade ReceivableTrade receivable is the amount owed to the business or company by its customers. It is also known as account receivables and is represented as current liabilities in balance sheet.read more, which includes sundry debtors, bills receivables and other notes receivableNotes ReceivableNotes Receivable is a written promise that gives the entitlement to the lender or holder of notes to receive the principal amount along with the specified interest rate from the borrower at the future date.read more. In any organization, the receipt of money from debtorsDebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read moreis a daily business. Almost every day, we receive money in the bank account from customers as per invoice dates. Whenever there is a default from any customer, the collection team contacts them and evaluates the recovery possibility.

If the recovery seems difficult even after taking all the efforts and sending notices and reminders, we must write off the balances of such debtors and receivables. Also, we should write off the balances in cases where debtors have gone bankrupt.

Nowadays, the organization sells its debts to collection agencies at a reduced value. In these cases, the reduction in receivable value should also be taken to the profit & loss account, and the net realizable value should be shown in the books as trade receivable.

Example #3

Advantages

  • These concepts help the organization show a true and fair financial position by showing the current market price as the realizable value.It avoids over or underpayments of taxes, i.e., it helps organizations in tax planningTax PlanningTax planning is the process of minimizing the tax liability by making the best use of all available deductions, allowances, rebates, thresholds, and so on as permitted by income tax laws and rules imposed by a country’s government. It contributes to better cash flow and liquidity management for taxpayers, as well as better retirement plans and investment opportunities.read more.It also identifies if the products are no longer in demand.Shows the current trend and customer behavior in the current scenario.

Disadvantages

  • Sometimes, it ignores the time factor, leading to over or understating profit.It needs to consider economic, political, geographical, and other factors to reach the exact realisability in the current or future market. Frequent technological changes might make an item obsolete overnight, which is difficult to catch and identify.

This has been a guide to What is Realizable Value & its Definition. Here we discuss this concept along with examples, advantages, and disadvantages. You can also learn more about it from the following articles-

  • Net Realizable ValueAccounting TerminologyAccounting ConceptRecoverable Amount