Comparative Analysis of Net Realizable Value and Replacement Costing

RECENT proposals for financial accounting models based on net realizable value or current replacement cost have resulted in a conflict among financial accounting theorists.' This controversy has not been examined precisely yet such an analysis is needed to provide a basis for future discussion of this issue and development of a solution. Basically, the issue is whether or not society is better served by the valuation of assets for public reporting at the cash they command upon sale (current exit value) or at the cash required to have them available for use by the firm (current entry value). It might appear that under pure and perfect competition, with equally well informed actors, the gap between the net realizable value and the replacement cost would be minimal and could be ignored. This is not the case due to the existence of frictions in the market place, such as commissions, transportation costs and the like. Frictions are not minor elements in our society. Even on the stock exchange, entry and exit values differ between a buyer and a seller by the total amount of commissions.2 That is, the net receipts to a seller of stock differ from the cash payments made by the buyer. Because this gap exists in most markets and is frequently significant,3 the conflict between net realizable value and current replacement cost as valuation bases should be investigated. In order to provide perspective for this issue, it may be appropriate to set forth illustrative statements in support of each of the alternatives.