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
4 steps to perform an inventory write-down
- Calculate the value difference. First, determine the difference between the original book value of the inventory and its current market value. ...
- Create a journal entry. Next, create a journal entry to record the write-down. ...
- Report the write-down. ...
- Evaluate circ*mstances.
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.
How do you write-down inventory for tax purposes? ›
Reduce the amount of available inventory in your inventory system, removing the amount of unsaleable units from your available amount. On your balance sheet, debit your cost of goods sold (COGS) and credit your inventory write-off expense account.
How are inventory write-downs shown on the income statement? ›
Income Statement (P&L) → The loss attributable to the inventory write-down is recognized as either cost of goods sold (COGS) or separately in the non-operating items section. The write-down is a non-recurring item not part of the core operations of the business, however, and reduces pre-tax income (EBT).
What is an example of inventory write-off? ›
Say a company with $100,000 worth of inventory decides to write off $10,000 in inventory at the end of the year. The firm will first credit the inventory account with the value of the write-off to reduce the balance. The value of the gross inventory will be reduced like this: $100,000 - $10,000 = $90,000.
How to calculate write-down? ›
Written down value appears on the balance sheet and is calculated by subtracting accumulated depreciation or amortization from the asset's original value.
What is the IRS inventory rule? ›
Summary. Businesses generally must use inventories for income tax purposes when necessary to clearly reflect income. To clearly reflect income, businesses must take inventories at the beginning and end of each tax year in which the production, purchase or sale of merchandise is an income-producing factor.
What are the two methods of accounting for inventory write-down? ›
For inventory write-downs specifically, there are two primary inventory accounting methods: direct write-off and allowance method. The inventory valuation method you choose depends on how significant the inventory write-down is.
Can a small business write-off inventory? ›
Generally Accepted Accounting Principles (GAAP) requires that inventory be written off as an expense as soon as it is determined to have lost all value. Companies are not allowed to wait until it might be more advantageous to address it or spread it out over multiple periods, like they might treat a depreciating asset.
What is an example of a write-down in accounting? ›
Some common examples of write-downs include: Inventory write-downs: If the cost of goods sold exceeds net realizable value, the company will record a write-down to reduce inventory to its net realizable value.
In general, an inventory list should include the product's name, SKU number, description, pricing, and quantity. With that said, these lists are dynamic, not static — meaning they can be updated or edited as needed.
Does inventory write-down affect cash flow? ›
Inventory write-off affects the company's cash flow statement in several ways. The expense recognized in the income statement reduces the company's net income, which in turn reduces the company's operating cash flow. Additionally, the decrease in inventory value reduces the company's investing cash flow.
How do you write an inventory sheet? ›
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.
How to Write Off Inventory?
- Identify the Obsolete Inventory Items with No Value.
- Appraise the Value Attributed to the Inventory Accounts (i.e., Removal of Recorded Value)
- Record Journal Entry Adjustments in Accounting Ledger (Debit to Inventory Account; Credit to Cost of Goods Sold Account)
Navigate to the Chart of Accounts and select 'New' to create a new account. Then, choose the account type as 'Expense' and name it accordingly, such as 'Inventory Write-Offs'. Next, input a description to clarify the purpose of the account.
