When the inventory’s market value drops below its book value.
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What is an Inventory Write Down?
An inventory write down is an accounting process used to record the reduction of an inventory’s value and is required when the inventory’s market value drops below its book value on the balance sheet.
Why Do Write Downs Happen?
A business cannot avoid having stocked inventory unless the company uses the “Just in Time” inventory strategy. An inventory’s lifespan depends largely on what it is. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded by either reducing the value of the inventory or removing it entirely.
Goods that are damaged in production or when in transit also contribute to inventory write-downs. Other common causes of inventory write-downs are stolen goods and inventory used as in-store displays (goods put on display are not fit for consumption).
What is the Effect of an Inventory Write Down?
An inventory write-down is treated as an expense, which reduces net income. The write-down also reduces the owner’s equity. This also affects inventory turnover for subsequent periods.
Key Highlights
- An inventory write down is an accounting process that records the reduction of an inventory’s value. This is required when the inventory’s market value drops below its book value on the balance sheet.
- The write down will reduce the balance sheet value of inventory and create an expense on the income statement.
- If the write down is large enough, the company may report a separate expense account on its income statement named something like Inventory Write Down.
How to Perform an Inventory Write Down?
First, the accountant needs to determine the size of the inventory’s reduction. If it is relatively small, the accountant can factor the decrease in the company’s cost of goods sold. This is done by crediting the inventory account and debiting the cost of goods sold.
If the reduction is larger, then the accountant typically reduces the value of inventory by crediting a contra asset account called reserve for obsolete inventory (or something similarly/appropriately named) and debiting expense (the expense may be cost of goods sold or an expense labeled “inventory write down”).
Reversal of Inventory Write Down
In rare cases, a company may need to reverse the inventory write-down. For example, this happens when the initial write-down estimated loss is higher than the net realizable value of the inventory. An assessment is done during each reporting period and, if there is clear evidence of a value difference, then a reversal of inventory write-down is executed.
Another possible scenario for reversal is when there is an increase in the inventory’s market value.
Note, that GAAP does not allow for the reversal of write downs, while IFRS does allow reversals (except for goodwill).
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FAQs
How to Perform an Inventory Write Down? First, the accountant needs to determine the size of the inventory's reduction. If it is relatively small, the accountant can factor the decrease in the company's cost of goods sold. This is done by crediting the inventory account and debiting the cost of goods sold.
What is the write-down of inventory entries? ›
An inventory write-down is the required process used to reflect when an inventory loses value and its market value drops below its book value. The write-down impacts the balance and income statement of a company—and ultimately affects the business's net income and retained earnings.
What should I write in inventory? ›
What to Include on Inventory Lists
- Name of the item.
- SKU (stock-keeping unit), serial number and/or barcode that identifies an item.
- Category and/or brief item description.
- Name of manufacturer or supplier.
- Unit cost.
- Sale price.
- Quantity in stock.
- Total value.
Inventory write-down is written down when an asset's value depreciates but still holds some value, whereas a write-off is when an asset loses all of its value and must be removed from accounting records entirely.
What is an example of a write-down asset? ›
Write-Down Example. Company X's warehouse, worth $500,000, is heavily damaged by fire, but it's still partially usable. Its value is written down by half to reflect the event. It's now worth $250,000.
Is inventory a write-down or write-off? ›
An inventory write-off is where the item is removed from stock-on-hand, which means the full cost of the item is removed from the balance sheet. Effectively the stock no longer exists. An inventory write-down, however, is where the value of the stock is reduced, but the item is still available for sale.
How do you calculate write-down in accounting? ›
Under IFRS accounting standards, on the other hand, the write-down equals the difference between the historical value and net realizable value (NRV). The market value must be less than the net realizable value (NRV), including the NRV reduced by the normal profit margin.
Why is it important to write-down inventory? ›
Inventory that has become obsolete, spoiled, or damaged often triggers the need for an inventory write-down. Raw materials, finished goods and even in-process products may depreciate throughout the year. Ordering too much inventory, or ending up with too much on hand is often the culprit.
How to do inventory journal entries? ›
Inventory purchase journal entry
Say you purchase $1,000 worth of inventory on credit. Debit your Inventory account $1,000 to increase it. Then, credit your Accounts Payable account to show that you owe $1,000. Because your Cash account is also an asset, the credit decreases the account.
How do you write a good inventory report? ›
How to write an inventory report
- Create a column for inventory items. Similar to an inventory sheet template, create a list of items in your inventory using a vertical column. ...
- Create a column for descriptions. ...
- Assign a price to each item. ...
- Create a column for remaining stock. ...
- Select a time frame.
Inventory serves a useful purpose in the supply chain. That said, firms can help minimize the need for inventory by carefully managing those factors that drive inventory levels up. Inventory items can be divided into two main types: Independent demand and dependent demand items.
How do you avoid write-off inventory? ›
9 Ways to Reduce Inventory Write-Offs
- Don't buy too much inventory. ...
- Reevaluate purchasing plans. ...
- Check inventory upon arrival. ...
- Protect inventory against damage or theft. ...
- Consider selling aging items at a discount. ...
- Return the items to the manufacturer or sell them to another business. ...
- Sell items for parts.
An inventory write-off is nearly identical to an inventory write-down—it only differs in the severity of the loss. When inventory decreases in value but doesn't lose all it's worth, it's written down. It could still be sold—just not at as high of a price. A write-off occurs when inventory has lost all of its value.
Are inventory write downs tax deductible? ›
Mitigating Losses by Writing Down Inventory
Writing down unsalable inventory is a way for you to speed up a tax deduction that might otherwise weigh down your balance sheet. A write-down lowers your total liability by reducing taxable income.
Can you write-off unsold inventory? ›
These products take up storage space, they could meet their expiration dates and spoil, and may lead to financial losses. You could be forced to sell these items at a discounted price to clear up storage space or be stuck with unsold inventory that you have to write off as a loss.
What is the journal entry for inventory? ›
This inventory accounting journal entry is where production-related expenses for your inventory such as rent, utilities, storage, and materials used in the manufacturing process are recorded. The entry debits your manufacturing overhead and credits your raw materials inventory to record your indirect material costs.
What is an example of a write-down in accounting? ›
A common example of a write-down in accounting is related to inventory. Businesses that produce or sell goods maintain an inventory of items that can potentially lose value over time if they go unsold. For instance: A technology company may have to write down the value of older electronics once new models are released.
Why would a company write-down inventory? ›
If the inventory needs to be zeroed out or loses all of its value, the accounting process called an inventory write-off is used. Inventory that has become obsolete, spoiled, or damaged often triggers the need for an inventory write-down.
