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The working definition of net realizable value (see paragraph 84) 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.
363. In contrast with cost-based measurement bases (historical cost and current cost), net realizable
value is a measure of the benefit value of an asset. The question is whether it is the most
relevant measure of the benefit value of an asset on initial recognition.
364. Current realizable value models have been strongly advocated over historical cost and current
cost models by a few prominent academics. They disagreed among themselves on some
fundamental issues, however, including what should be the unit of account (that is, what
should be the level of aggregation of assets) and whether the objective should be to assume sales
in the ordinary course of business or on the basis of liquidation prices. Net realizable value, as
defined above, has generally been used in financial accounting in a rather limited role, being
largely restricted to lower of cost and recoverable value determinations.
365. One major reason why realizable value has been rejected as a general measurement basis is that
it results in seemingly unrealistically low values for most productive assets such as plant and
equipment, and would often require large write-offs on the acquisition of such assets.
COMPARISON WITH FAIR VALUE
366. There appear to be two possible areas of difference between net realizable value and fair value:
(a) Focus of net realizable value on realization through sale.
(b) The dependency of net realizable value on entity-specific expectations.
Focus on Sale
367. Net realizable value is generally interpreted to presume realization through sale, rather than
through holding or using an asset. While the phrase in the definition "selling price in the
ordinary course of business" is presumably intended to avoid a forced or liquidation sales price,
the term "net realizable value" is generally interpreted to preclude a value in use connotation.
In contrast, fair value reflects the price of an asset in what the market perceives to be its highest
and best use. The fair value of an asset is not its net selling price on a measurement date, if this
is not its highest and best use in the marketplace. For example, there may be no market
(as defined at paragraph 107) for a particular specialized non-contractual asset. This asset
might be saleable only as a non-specialized asset (with adjustment for the costs to remove its
specialization features) or for the scrap value of its components. Such determinations are not
relevant measures of this asset's fair value when its highest and best use in the marketplace can
be reasoned to lie in its use as a specialized asset in a revenue-generating process. See discussion
of this situation and related issues at paragraphs 260-262 and 269-275.
368. Net realizable value is reduced by costs that are estimated to be necessary if the asset is sold,
but that would not otherwise be incurred. It has been explained (see paragraph 199) that fair
value excludes transaction costs or penalties that would be incurred to sell an asset. If such
costs are avoidable, that is, they would not be incurred in the highest and best use of an asset
in the marketplace, then they would be recognized only if the asset is sold and thus would be
an expense of the sales transaction. On the other hand, if certain exit costs are unavoidable,
that is, the entity is obligated to incur them to realize the fair value of an asset, then such costs
may qualify as liabilities and, if so, should be separately recognized as such. Netting such
liabilities against the fair value of the asset would contravene the conceptual distinction
between assets and liabilities.
369. The net realizable value of an asset may generally be expected to differ from fair value by the
amount of transaction costs deducted in determining net realizable value, and by the extent to
which estimates of the costs of completion (if any) differ from the adjustment that the market
could be expected to make. In addition, the phrase "the estimated selling price in the ordinary
114 See, for example, R. J. Chambers, Accounting, Evaluation and Economic Behaviour, and Accounting for Inflation: Methods and
Problems, and R. R. Sterling, Theory of the Measurement of Enterprise Income.
Discussion Paper November 2005
course of business" could be interpreted in an entity-specific context that is not consistent with
the fair value measurement objective. These possible differences reflect the effects of
differences between entity-specific and market expectations.
370. The basic question thus again arises as to the comparative relevance of entity-specific and
market value measurement objectives. In this case, could entity-specific adjustments entering
into the determination of net realizable value be reasoned to have relevance not considered in
arriving at the tentative conclusion in chapter 4 (that the market (fair) value measurement
objective is more relevant than entity-specific objectives on the initial recognition of an asset)?
The above analysis and review of accounting standards and supporting literature on net
realizable value did not reveal any evidence or arguments that would give cause to change this
conclusion. This paper therefore proposes that fair value is more relevant than net realizable
value for measuring assets on initial recognition.
371. As noted in paragraph 85, the liability equivalent of net realizable value seems not to have been
defined and analyzed in accounting literature. However, it is proposed that it be described as
the release amount and defined as follows: The estimated amount that would be incurred in the ordinary course of business to be
released from a liability on the measurement date plus the estimated costs necessary to
secure that release.115
372. The focus on current release, and the inclusion of entity-specific transaction costs, mirrors the
two areas of difference between net realizable value and fair value of assets addressed above.
Thus, the liability equivalent to net realizable value is subject to the same types of differences
and relevance limitations as is the net realizable value of assets.
Summary - Conclusion on Relevance
373. This paper proposes, based on the above analysis, that net realizable value, and its liability equivalent, is
a less relevant measurement basis than fair value on the initial recognition of assets and liabilities.
Net Realizable Value as a Substitute for Fair Value on Initial Recognition
374. The question then is whether net realizable value could be an appropriate substitute for fair
value on the initial recognition of assets and liabilities when fair value is not capable of reliable
estimation. This paper proposes that, as a substitute for fair value, net realizable value should
be applied on a basis that it as consistent as possible with the fair value measurement objective.
This would mean:
(a) interpreting "the estimated selling price in the ordinary course of business" as a market
value measurement objective,
(b) excluding transaction costs (that is, adding them back to net realizable value), and
(c) interpreting "costs of completion" within a fair value context.
The result would no longer be net realizable value. It would be an estimate of fair value, if it is
substantially based on information that is consistent with market expectations. Alternatively,
an estimate of realizable value that is significantly dependent on entity-specific inputs could
be considered to be the best substitute for fair value in some situations. For example, it might
be determined that the closest substitute for the fair value of a work-in-process inventory
115 The term "release" is considered to include direct settlement with the creditor, effective settlement resulting from an
entity acquiring its traded debt instruments in the marketplace, and an arrangement under which a third party
assumes an entity's obligation.
Measurement Bases for Financial Accounting - Measurement on Initial Recognition
acquired as part of a business acquisition is to adjust the observable market price of the
finished good by an entity-specific estimate of the costs of completion.116 The question would
then be whether this measurement could be accepted to be a reliable estimate of the fair value
of the work in process, or whether its dependency on entity-specific expectations is so
significant that it should be treated and described as a hybrid measurement basis substitute for
375. Thus, following from the above analysis, there is no role for net realizable value, as traditionally
defined, in the measurement of assets and liabilities on initial recognition. In other words, the
concept requires substantial reinterpretation as a possible estimate of, or substitute for, fair
value on initial recognition.