How to Apply GAAP to Inventory Reserves

Business owners can test to see if inventory is obsolete by comparing production and sales numbers with the amount of inventory in stock. If not, it may be best to liquidate or donate the inventory to avoid overpaying storage fees. Obsolete inventory must be written off as an expense at the end of the fiscal year, but business owners should see this as a last resort.

Writing off inventory involves removing the cost of no-value inventory items from the accounting records. Inventory should be written off when it becomes obsolete or its market price has fallen to a level below the cost at which it is currently recorded in the accounting records. The amount to be written down should be the difference between the book value (cost) of the inventory and the amount of cash that the business can obtain by disposing of the inventory in the most optimal manner. To write off obsolete inventory, businesses should first assess the inventory to determine its value and potential uses. If the inventory is deemed obsolete with no remaining value, businesses can write it off by adjusting their financial records to reflect the loss.

Obsolete inventory FAQs

However, manufacturing companies and companies that are in industries prone to obsolescence, such as technology or food service, may wish to re-evaluate this reserve on a quarterly basis. While the annual review is required for accounting compliance, the quarterly review obsolete inventory accounting can help management identify ordering issues that increase the chance of products becoming obsolete. This is an example where, even though GAAP does not require more frequent analysis, it may be good for the company to address this issue more often than required.

• The obsolete inventory percentage is used to derive that portion of inventory that is no longer usable.
• Along with inventory management, having visibility over your inventory at all times is key.
• In this section, we will explore some of the most common methods for getting rid of obsolete inventory and discuss the advantages and disadvantages of each.
• By staying up-to-date on changing consumer preferences and market trends, businesses can adjust their production levels and inventory orders to match anticipated demand.
• Write-downs are reported in the same way as write-offs, but instead of debiting an inventory write-off expense account, an inventory write-down expense account is debited.
• Without proper inventory planning — including the tools and technology to help track inventory in real time — optimizing inventory levels can be a challenge.
• In some cases, inventory may become obsolete, spoil, become damaged, or be stolen or lost.

These industries are at high risk of obsolescence because demand for them is often seasonal and/or trend based. The important thing is having a plan for obsolescence inventory and factoring it in as you plan for the upcoming year. Obsolete inventory can cause massive profit losses for businesses, but it’s a risk that can always be mitigated to some extent. By taking a look at historical data, you can predict future demand for each SKU and make informed decisions to avoid purchasing too much of an item that might become obsolete faster than it can be sold. Alternatively, you can try product bundling obsolete items with a fast-selling item (and even offer free shipping).

How to Account for Expired Inventory

The world is always changing, and other companies are coming out with newer, better versions of the same product. In the case of crude oil, the market price is very easy to determine, as it’s a commodity that is traded internationally and the price has a very low bid-ask spread. Rather, it changes to reflect changes in regulations and standards employed by businesses operating in different industries throughout the economy as a whole. Changes are made regularly to what is, and what is not, a generally accepted principle of accounting. In some cases, inventory may become obsolete, spoil, become damaged, or be stolen or lost. Plus, visual inventory systems like Sortly allow you to see what you have on hand—an extra helpful tool when determining whether certain items are at risk of becoming obsolete.

A large inventory write-off (such as one caused by a warehouse fire) may be categorized as a non-recurring loss. While you can always try to recoup some of your obsolete inventory costs, it’s still a losing proposition. And while some inventory obsolescence is simply the cost of doing business, there’s plenty your company can do to reduce that risk. This article will define obsolete inventory and help you understand how to reduce your risk of obsolescence and handle inventory that’s grown too outdated to sell. Accumulating too much obsolete inventory can be bad for business since it cuts into profit margins.

Summary of IAS 2

When businesses are left with excess inventory that they cannot sell or use, they may be forced to write off the value of that inventory, which can result in a significant financial loss. This can have a ripple effect on a business’s financial performance, impacting their revenue, profit margins, and cash flow. To avoid creating obsolete inventory due to poor demand forecasting, businesses should invest in effective inventory management systems and use data analytics to make more accurate predictions about customer demand. Costs of keeping inventory can come in many forms, and most of them are seen by the market as having the potential to negatively affect a corporation’s profitability. They may be in the form of holding costs, storage costs, shrinkage costs, or any type of cost arising from a decrease in the value of the inventoried assets. Inventory reserves or allowances are contra accounts as they may partially, fully, or more than fully offset the balance of the inventory account.

If you’ve determined there’s simply not enough demand to run a sale or bundle inventory, you might need to consider liquidation. Inventory liquidation is the process of selling off undesirable inventory at a significant discount in exchange for cash. Flash sales, buy-one-get-one offers, and other promotions can also help your company move obsolete inventory before losing its value.