What is an Inventory Write-Off?

An inventory write-off is an official way for an accountant to show that a piece of a company’s inventory is no longer valuable. There are two ways to record a write-off of goods. It can be charged straight to the cost of goods sold (COGS) account or used to reduce the value of an asset account that holds inventory. This account is often called the inventory reserve or allowance for obsolete inventory.

How to Understand Inventory Write-Off

Inventory is the things a business owns that it plans to sell for money or turn into goods it can sell for money. Generally accepted accounting standards (GAAP) say that an asset is anything that has a future economic value for a business.1Because inventory is an asset, it is shown on a company’s balance sheet at its cost under the heading for present assets.

Inventory can sometimes go out of date, wrong, harmed, stolen, or lost. When these things happen, the company has to write off the goods.

Keeping track of inventory write-offs

When you write off inventory, you remove any items from the general sheet that are no longer useful. The straight write-off method and the allowance method are the two ways businesses can eliminate their inventory.

The direct write-off method and the allowance method

When a business uses the straight write-off method, it will add money to the inventory asset account and take money out of the expense account. Take the case of a company that has $100,000 worth of inventory and chooses to write off $10,000 of it at the end of the year. First, the company will take the value of the write-off and put it into the inventory account. This will lower the amount. This is how the worth of the gross inventory will go down: $100,000 – $10,000 = $90,000. Next, a debit will be made to the inventory write-off cost account to show the loss.

The expense account shows up on the income sheet, meaning the company’s net income and retained earnings go down. If the amount of retained earnings decreases, the amount of owners’ equity on the balance sheet also decreases.

Often, a company will put a write-off for inventory that isn’t important to the cost of goods sold (COGS) account. When the amount is charged to the COGS account, it changes the business’s gross margin because no revenue is recorded for the sale of the goods. Most inventory write-offs are small costs that happen once a year. A hefty inventory write-off, like one caused by a warehouse fire, could be considered a one-time loss.

It may be better to use the allowance method instead of the other way to write off inventory when it is likely that the inventory has lost value but has not been thrown away yet. If a business uses the allowance method, it will make a notebook entry and put money into a contra-asset account, like the inventory reserve or the allowance for old inventory. An equal amount will be taken out of a spending account.

When the item is sold, money will be taken out of the inventory and reserve accounts to lower them. This helps keep the cost from the past in the original inventory account.

Extra Careful Consideration

Large, regular inventory write-offs can indicate that a business isn’t good at managing its stock. The business might be buying too much or duplicate inventory because it has forgotten about some items or isn’t making good use of its already-established inventory. Companies that don’t want to accept problems may use dishonest methods to make it look like they don’t have as much old or useless inventory. These methods might be considered inventory theft.

How to Write Off or Write Down an Inventory

It will not be written off if the product has some fair market value but is less than its book value. Instead, it will be written down. The market price of an item goes below its cost, and that’s when accounting rules say the item’s reported value on the financial statement has to be written down to the market value.

The amount that needs to be put down is the difference between how much the inventory is worth on paper and how much cash the business can get by selling it in the best way. It’s the same way to report a write-down as a write-off, but an inventory write-down expense account is deducted instead of an inventory write-off expense account.

It would help to record a write-off (or write-down) of goods immediately. The value loss can’t be spread out and recognized over several periods because that would mean the inventory will be helpful in the future.

Conclusion

• An inventory write-off is when a business officially recognizes that some of its stock hasnoy value.
• Write-offs usually happen when stock goes out of date, goes wrong, gets destroyed, is stolen, or is lost.
• The straight write-of and allowance methods are the two ways to write off inventory.
• If the value of an item only goes down and not away, it will be written down instead of written off.