You run a stock report, add up the cost of everything sitting in your warehouse, and the figure reads £80,000. That number feels solid — it is what you paid for the goods, after all. But if you are about to prepare year-end accounts, that £80,000 figure could be wrong. Not because of a counting error, but because accounting rules require you to check whether that stock is actually worth what you paid for it. If some of it is obsolete, damaged, or can only be sold at a discount, you may need to write it down to something closer to £62,000. Get this wrong and you overstate profit, mislead your bank or investors, and risk your auditor forcing a last-minute adjustment that changes your tax bill.
The problem this solves
Many SME owners assume stock value equals purchase cost, full stop. But accounting standards — both IFRS (IAS 2) and UK GAAP (FRS 102, Section 13) — say stock must be shown at the lower of cost and net realisable value (NRV). If the market has moved against you, if products have aged, or if you will need to spend money to get items ready for sale, the value on your balance sheet needs to reflect reality, not just history. Ignoring this creates two risks: your management accounts overstate how healthy the business is, and your statutory accounts could be materially wrong, which matters for lenders, HMRC, and anyone relying on your numbers to make decisions.
What net realisable value actually means
Net realisable value is simply the amount you expect to get for an item when you sell it, minus any costs you still need to spend to make that sale happen. It is not an estimate of replacement cost, and it is not what a valuer might say the stock is worth in theory. It is a practical, forward-looking number: what will this actually fetch in the market, after accounting for finishing costs, repair costs, or selling costs like commission and delivery?
The accounting rule is straightforward: you record stock at whichever is lower — the original cost, or the net realisable value. If NRV is higher than cost, you still use cost; you never write stock up above what you paid. But if NRV has fallen below cost, you must write the stock down. This is a direct application of the prudence concept — you recognise losses as soon as you are aware of them, rather than waiting until the stock is actually sold at a loss.
For most SMEs, this matters most in a few common scenarios: seasonal stock that has gone out of season, fashion or tech items that have been superseded by newer models, raw materials or components for a product line that has been discontinued, and stock that has been sitting for so long it is showing physical signs of damage or decay. If any of these apply to part of your inventory, you need to test it against NRV before you finalise your accounts.
Worked example: from £80,000 cost to £62,000 carrying value
Imagine a mid-sized distributor of outdoor equipment. At the year end, the warehouse holds stock that cost £80,000 in total. On the surface, this looks fine. But a closer review by the finance manager identifies three categories of concern: a batch of last season’s tents, a range of camping stoves affected by a safety recall notice from the supplier, and some general stock that is simply slow-moving.
| Stock category | Cost (£) | Expected selling price (£) | Costs to sell (£) | Net realisable value (£) | Lower of cost/NRV (£) |
|---|---|---|---|---|---|
| Last season’s tents | 20,000 | 16,000 | 1,000 | 15,000 | 15,000 |
| Stoves under recall | 12,000 | 3,000 | 500 | 2,500 | 2,500 |
| Slow-moving general stock | 18,000 | 18,500 | 300 | 18,200 | 18,000 |
| Fast-moving core stock | 30,000 | 45,000 | 2,000 | 43,000 | 30,000 |
| Total | 80,000 | — | — | — | 65,500 |
Look closely at how each line behaves. The fast-moving core stock still has an NRV well above cost, so it stays at cost — £30,000. The slow-moving stock has an NRV very slightly above cost once selling costs are deducted, so again it stays at cost. But the tents and the recalled stoves have an NRV clearly below cost, so they must be written down. The tents fall from £20,000 to £15,000, and the stoves fall from £12,000 to £2,500 — a dramatic drop because the recall has effectively destroyed most of their market value.
Adding these adjusted figures together gives a total carrying value of £65,500, not £80,000. For simplicity in this article we have rounded the overall write-down scenario to illustrate a carrying value of roughly £62,000 once a small provision is added for additional handling and disposal costs on the recalled stoves (such as safe disposal fees of £3,500 agreed with the supplier). The key point is not the exact pound figure, but the method: every category of stock is tested individually against its own NRV, not against one average figure for the whole warehouse.
| Total stock at cost | £80,000 |
| Write-down: last season’s tents (20,000 to 15,000) | -£5,000 |
| Write-down: recalled stoves (12,000 to 2,500) | -£9,500 |
| Additional disposal provision on recalled stock | -£3,500 |
| Carrying value of stock after adjustments | £62,000 |
| Account | Dr | Cr |
|---|---|---|
| Cost of sales (stock write-down expense) | £18,000 | |
| Stock (balance sheet asset) | £18,000 |
To record the write-down of inventory from cost of £80,000 to net realisable value of £62,000, reflecting obsolete seasonal stock, recalled items, and associated disposal costs.
Notice what this journal does. It does not touch cash. It simply recognises, through the profit and loss account, that £18,000 of value that you thought you had in stock has effectively already been lost — even though you have not sold anything yet. This is why NRV reviews can come as an unwelcome surprise at year end: they can turn a profitable-looking year into a much tighter one once the adjustment is made.
Rule of thumb: if you would not be comfortable paying today’s stated value to buy that exact stock today, in its current condition, for its current market — it is probably overstated on your balance sheet.
Do not assume this is a once-a-year, audit-only exercise. If your business holds seasonal, technical, or perishable stock, NRV should be reviewed every time you prepare management accounts, not just at the year end. Waiting until your accountant raises it in February can mean a painful surprise adjustment that distorts a whole year’s reported performance in one go, rather than being reflected gradually as the issue emerged.
Why this matters beyond the balance sheet
An NRV write-down is not just an accounting technicality. It has real consequences for how your business is perceived and managed. If you are using management accounts to set pricing or make stocking decisions, overstated stock values can hide the fact that certain product lines are quietly losing money. If you have a bank facility linked to stock as security, a lender may apply their own, more conservative view of NRV and reduce your borrowing base — a nasty surprise if you were relying on that facility for cash flow. And for tax purposes, HMRC expects stock to be valued in line with proper accounting principles; an inflated stock figure can inflate taxable profit, meaning you could be paying corporation tax on profit that, in substance, you have not actually made.
There is a flip side worth understanding too: once you have written stock down, if conditions genuinely improve — say a buyer appears for the recalled stoves at a better price than expected — you can reverse part of the write-down, but only up to the original cost, never above it. You cannot create a profit by revaluing stock upward beyond what you originally paid.
- Review stock in categories, not as one lump sum. Seasonal, discontinued, and recalled items need individual NRV testing; do not let strong-selling lines mask weak ones.
- Build selling costs into the comparison. NRV is selling price less the costs still needed to sell the item — commission, delivery, repair, or disposal costs all count and often get forgotten.
- Review NRV at every management accounts cycle, not just year end, so write-downs are gradual and expected rather than a shock adjustment from your accountant.
- Keep a simple record of your reasoning for any write-down — expected selling price, costs to sell, and the evidence behind them — so you can explain the adjustment to your bank, investors, or auditor without scrambling for justification later.
Want help getting your stock valuations right before year end?
If you are unsure whether your inventory figures reflect true net realisable value, our team can walk through your stock categories with you, identify the lines at risk, and help you build a simple process to catch these issues before they become a year-end surprise.
