Realizable Price Method, Standard Price Method, Inflated Price Method

Realizable Price Method

Net realizable value (NRV) is the value for which an asset can be sold, minus the estimated costs of selling or discarding the asset. The NRV is commonly used in the estimation of the value of ending inventory or accounts receivable.

The net realizable value is an essential measure in inventory accounting under the Generally Accepted Accounting Principles (GAAP) and the International Financing Reporting Standards (IFRS). The calculation of NRV is critical because it prevents the overstatement of the assets’ valuation.

NRV and Lower Cost or Market Method

Net realizable value is an important metric that is used in the lower cost or market method of accounting reporting. Under the market method reporting approach, the company’s inventory must be reported on the balance sheet at a lower value than either the historical cost or the market value. If the market value of the inventory is unknown, the net realizable value can be used as an approximation of the market value.

Calculation of NRV:

The calculation of the NRV can be broken down into the following steps:

• Determine the market value or expected selling price of an asset.
• Find all costs associated with the completion and the sale of an asset (cost of production, advertising, transportation).
• Calculate the difference between the market value (expected selling price of an asset) and the costs associated with the completion and sale of an asset. It is a net realizable value of an asset.

Net realizable value (NRV) = Expected Selling Price – Total productions and Selling Cost

Standard Price Method

Calculate of a pre-determined price, and this price is kept constant for a definite time period. In this method of inventory valuation, we post all receipts into the stock ledger account and sales/ issues are valued at the pre-determined price (standard price). If there is any difference between the actual price and standard price, it is transferred to the material price variance account.

At that standard price materials issued are valued. For establishing standard price, the factors usually considered are:

(a) Due to possible changes in market conditions, apprehended changes in price.

(b) Depending upon the quantity to be ordered, the amount of discount that may be available from the suppliers.

(c) Expenses which are related to purchases i.e. freights & carriage, customs duty, godown expenses, packing, handling etc.

Difference, if any, between the standard price & the actual purchase price, is known as material variance. However, the variance which arises due to the difference between standard rate of purchase & the actual rate of purchase is known as rate variance. On the other hand, variance due to difference between total actual material cost & total standard material cost, there being no difference in rates, the variance is called usage variance. Either at the time of actual purchase or at the end of accounting period, the variance may be worked out. The variance is analyzed into causative reasons & by taking suitable measures its recurrence is prevented.

Advantages:

(a) Efficiency of the purchase department can be revealed.

(b) As all the issues are charged at a standard price, the method is easy to apply.

(c) Even if standard costing method is not applied in any industry, the method can be used there.

(d) By setting the standard price, control on material cost may be exercised by the method, which may be called the price that should be.

Disadvantages:

(a) At actual cost, the issues are not charged.

(b) Profit or loss on materials may be there.

(c) The purpose for which it is set may be spoiled by a very low or high standard price.

(d) Fixing a reliable standard price is difficult, since upon a number of unknown variable factors, the price depends.

Inflated Price Method

There are some materials which are subjected to natural wastage. Examples are: (1) material lost due to loading and unloading, and (2) timber lost due to seasoning. In such cases, the materials are issued at an inflated price (a price higher than the actual cost) so as to recover the cost of natural wastage of materials from the production.

In this way, the total cost of the material is recovered from the production. For example, if 100 tonnes of coal are purchased at Rs 75 per tonne and if it is expected that 5 tonnes of coal will be lost due to loading and unloading, the inflated issue price in this case will be Rs 78.95 (i.e. 100 x Rs 75/95) per tonne. With the actual issue of 95 tonnes of coal the actual cost of Rs 7,500 (100 tonnes purchased @ Rs 75 per tonne) will be recovered from production (95 tonnes @ Rs 7 78.95).

Specific Price Method of Stock Valuation:

When materials are purchased fora specific job or work order, they should be issued to that specific job or work order at their actual cost. This method is used where job costing is in operation and the actual materials issued can be identified.

Base Stock Price Method of Stock Valuation:

Each concern always maintains a minimum quantity of material in stock. The minimum quantity is known as safety or base stock and this should be used only when an emergency arises. The base stock is created out of the first lot of the material purchased and therefore, it is always valued at the cost price of the first lot and is carried forward as a fixed asset.