This is the greater of the net realisable value of an asset (at the date of the balance sheet) and where appropriate, the amount recoverable from its further use (Wood & Sangster 1999). Generally speaking in terms of investment, an asset used in the production of a good or service is capital to the investment. As such it is expected to pay itself back i.e. to recoup the money invested on it. It is therefore entered in the balance at the historical cost, the value expended on it to acquire for trading purpose. As the asset is being used, it is believed that a certain part of the capital expended on it is being taken away, and as a result, the asset is depreciation in its economic value. The economic value of an asset is the sum of the future expected net cash flows associated with the asset, discounted to its present value.
As the asset is depreciating over the period of its life cycle, there comes a time when the machine though still functional end efficient may have paid itself back or may have tasted functional obsolescence owing to advanced technology. It may not have reached the end of its life cycle. The company may therefore decide to sell/dispose it off. The amount expected of such sale is what is referred to as the net realizable value. The net realisable value however, is the estimated amount that would be received from the sales of the asset less the estimated costs on its disposal. Sometimes the term “exit value” is synonymously used with it as it is the amount receivable when an asset leaves the business. However, a very important factor affecting such a valuation (the net realizable value), is the condition under which the asset is to be sold. To realise it in a hurry would often mean accepting a very low price. A very good example is the sale prices received from stock from bankruptcies – usually very low figures. The standard way of approaching this problem is to value as though the realization were in the normal course of business. This is not capable of an absolutely precise meaning, as economic conditions change and the firm might never sell such an asset in the normal course of business. By this statement it is clear that the net realizable income on an asset is difficult let alone that of the recoverable amount which is the net realisable value plus its attributable value over the remainder of its useful economic life. In order to be able to value this, indices such as those published by the government or company’s own index prepared based on experience. However where it is not appropriate to use an index, a Valuer may be relied upon as is the usual case in property valuation.
Reference
Wood, F. & Sangster, A. (1999). Business accounting. Great Britain: Pearson Education Ltd.
