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More Inventory Content
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More Inventory Content
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Get the latest e-commerce industry news, best practices, and product updates!
Table of Contents
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More Inventory Content
Get the latest e-commerce industry news, best practices, and product updates!
Inventory write-down occurs when things are stolen or lost or their worth decreases. Write down should be done right away so that the inventory’s lowered value is shown in the income statement. Consequently, the stock value will be too substantial, which will be deceptive to the company’s financial auditors.
With the basics out of the way, let us look at inventory write-down and its importance.
What is an Inventory Write-Down?
Write down applies to a compulsory accounting procedure followed when a stock loses some of its value but not all of it. Businesses must always make the change as quickly as feasible.
Depending on the importance of the write-down, a log record is created in the inventory write-down expenditure report or the COGS (cost of goods sold) account when the fair value of an asset falls below its market price. Inventory write-down improves accounting accuracy while also lowering the tax burden. Finally, inventory write-down also decreases the period’s closing inventory value, affecting both the company’s balance sheet and income statement.
What Is an Example of an Inventory Write-Down Journal Entry?
A corporation can create the inventory write-down entries by subtracting the total loss on stock write-down accounts and crediting the inventory account.
Losses on inventory write-down are a debit-balanced expenditure category on the revenue statement. Similarly, cash reserves on the financial statements are reduced, but the stock write-down losses increase expenses on the financial statements.
What Items Are Eligible for a Write-Down?
Finished commodities, in-progress goods, and raw materials are eligible for a write-down. If the value of items impacted by loss, damages, or changing market dynamics falls below their book value, they are suitable for an inventory write-down. These items are not qualified for inventory write-downs if they lose all of their worth.
Why Do Write-Downs Happen?
There are numerous factors why a stock can lose its value, ranging from purchasing too much stock to a drop in demand. The following are among the most typical reasons for inventory write-downs:
Excess Inventory
Businesses often order too many goods based on subjective thinking rather than expected future demand. Poor sales tactics and erroneous demand projections might result in a surplus of finished goods.
The more unsold goods sit in the storage, the higher the storage expenses and the greater the risk of holding outdated stock. The cost of equipment and warehousing fees, each of which must be written off, are included in this charge.
Expired Inventory
The shelf life of the physical stock of perishable products is shorter. Merchandise that has passed its expiration date can no longer be sold.
If SKUs (Stock Keeping Units) remain unwanted in your warehouses for an extended period, they will expire and lose all value. Businesses cannot write down outdated stock; instead, it must be “written-off” and reported as a total loss.
Companies can reduce stock waste by keeping accurate item records and ensuring that the initial set of inventories is sold first.
Damaged Inventory
Acquired merchandise might be damaged during transport, picking, or holding. Fragile objects are more likely to break, bend, or otherwise become defective while being stored and shipped, resulting in lost revenue.
Fortunately, much of it is avoidable. A well-designed warehousing system, the necessary gear, well-trained warehouse staff, correct shipment of fragile commodities, and efficient warehouse reception operations can help lower the risk of the stock dropping in value.
Effect of Write-Downs on Financial Statements and Ratios
A write-down affects the financial statements and the capital structure. On the financial statements, a loss is recorded. The write-down may be reported as a cost of goods sold if it is connected to inventories. Alternatively, investors and lenders may assess the influence of depreciated goods by listing them as a particular damaged item on the financial statements.
If the inventory degradation isn’t significant, you can include it in the cost of goods sold (COGS). This discrepancy is worth the inventory cost, and its current price is credited to the basic COGS account.
The debt-to-equity ratio grows when shareholders’ equity declines. A write-down to a fixed asset can boost present and future fixed-asset rotations since a reduced fixed capital foundation will now split net revenue. With a smaller asset base, debt-to-asset proportions will be more significant because future depletion cost is reduced due to the decreased asset value, and future net revenue potential increases.
How to Perform an Inventory Write Down?
If a company’s assets have lost value, the financial statements must reflect this by lowering the reported market value to the genuine NRV (Net Realizable Value). While any corporation may be compelled to write down unplanned stock, most write-downs may be attributed to inadequate stock management, which comprises having the relevant goods in the appropriate quantities.
These steps will help you write down inventory:
Step 1: Determine The Difference In Value
Recognize the worth of the stock as recorded in the company’s books and its importance in the current market.
Step 2: Choose A Spot For The Journal Entry
Inventory write-downs can be recorded as a particular item in the cost of goods sold or income statement, depending on the significance of the change in value.
Step 3: Report The Reduction In Value
If the depreciation turns out to be moderately diminutive, it is debited from the cost of goods sold account, and the difference is credited to the balance sheet account. If depreciation is considered significant, it is debited from the inventory depreciation line, and the difference is credited to the inventory statement.
Step 4: Examine The Situation
Examine why you wrote down the stock and what precautions you can take in the long term to protect your investment.
How to Reduce Inventory Devaluation?
These measures can help a corporation reduce inventory depreciation:
Avoid Excess Inventory
The corporation should hold a reasonable number of shares. Significant inventory levels might put the company at risk of destruction, obsolescence, and spoilage. To establish the appropriate inventory amount to maintain, use EOQ, LIFO, and FIFO tools.
Review The Frequency Of Your Orders
Orders should be placed more frequently and in lesser amounts. These methods can help you determine the appropriate inventory size. If you purchase them regularly, you may also maintain your inventory current.
Keep Track Of Sales And Demand Patterns
Sales and demand trends predict the amount of inventory to keep on hand. To avoid wasting products, store less of them in quantities that correspond to strong seasonal fluctuations. Keep up with the market news to learn about changes or alternatives that could make your list outdated.
Keep The Inventory Safe
Inventory degradation is frequently caused by theft or damage. Protect your goods by installing locks, video cameras, alarm systems, safety enclosures, smoke alarms, and movement sensors. To detect and combat theft and fraud, maintain inventory control procedures, and conduct frequent audits.
Make Use Of Inventory Management Software
An inventory management system can aid in implementing various inventory control tactics in your company. Use it to keep track of inventory across many regions, cycle count, and forecast demand. The application has a user-friendly interface and provides valuable information.
Accounting Methods for Writing Down Inventory
There are two basic inventory accounting procedures for inventory write-downs: allowance and direct write-off.
The magnitude of the inventory write-down determines the inventory method of accounting you select. Here’s a more in-depth look at the two approaches.
Allowance Method
Because some revenue is set aside to cover inventory that may lose all or most of its value in the future and the allowance method is a much more complicated process.
Unlike the direct write-down approach, the allowance technique requires you to declare doubtful debt expenses every financial period.
This approach accounts for the entire amount of the write-down and the original stock account’s accumulated depreciation.
This anticipated decrease in stock is credited to a separate counter investment account used to counterbalance the stock line item on the financial statements. It’s deducted from the expense report as well.
A mobile phone retailer, for instance, possesses property worth $20,000 and marks products worth $2,000 for disposal. They then construct an asset reserve fund to which they instantly add $2,000 and subtract the same sum as an expenditure.
You can debit the stock allocation and credit the stock on hand whenever the stock is sold.
Direct Write-Off Method
The direct write-off approach entails deducting as a “bad debt expenditure” unwanted merchandise that has lost its value.
For instance, a company selling cellphones has $50,000 in stock at the start of the year. By the end of the year, $5,000 worth of merchandise has become obsolete. As a result, the company’s auditor will deduct the write-off value from the accounting system, increasing COGS.
Rather than being declared a write-down, minor write-offs can be recorded as COGS. On the other hand, larger quantities must always be recorded in a different section of the financial statements.
However, because there is no corresponding record for the income generated by the sale of the SKU, adjusting the write-off sum to the COGS category can produce a deceptive impression of your business’s net income.
Reversal of Inventory Write Down
A company may need to recover an inventory write-down in particular circumstances. Reversal can happen when the expected loss from the original write-down is greater than the inventory’s recoverable amount. An evaluation is done through every reporting period, and if clear proof of a value difference is found, the inventory write-down is reversed.
Another scenario in which reversal is likely is when the inventory’s marketplace value rises.
Inventory Write-Off Vs. Write-Down
A write-off is a form of write-down in which the asset’s book value is decreased well below market value. Damaged gear, for instance, may be written down to a low value if it is still useable in parts, and businesses may write down debts if the borrowers can only repay a portion of the loan amount.
It’s a distinction of degree between a write-off and a write-down. A write-off occurs once a commodity has been damaged to the point where it is no longer usable or economical to the owners. A write-off shows that an object is no longer projected to yield any revenue, whereas a write-down is a fractional decrease of a stock’s valuation.
What Are the Benefits of Inventory Write-Off?
You can do an inventory write-off for a variety of reasons. Some of the reasons are listed below:
Increasing The Accuracy Of Financial Documents
Inventory write-offs allow you to accurately track the worth of your assets and the costs of damages or other declines in value.
Reducing Tax Burden
Writing off inventories lowers your tax burden by reducing the amount of money you have on your balance sheets.
Improving Inventory Control
Regularly analyzing your goods and their value to determine if you can discard anything can help control your inventories by writing off goods that fall in value.
Updating Merchandise
You may be able to deduct goods that are no longer in use, such as outdated versions of technologies. Updating merchandise can assist you in identifying any costs related to low-value stock and ensure that your commodities are up to date.
Updating Merchandise
You can start taking steps to prevent future liabilities if you have a history of write-offs due to natural calamities or thefts.
How Can You Write Off Inventory?
You can write off using the following ways:
- When the stock arrives, inspect it for any items that may have been compromised and store it in a specified place. Generate a detailed report for each item in your inventory that has been damaged.
- To write off the loss, compute the amount of the destroyed goods after the accounting cycle process.
- The damaged inventory is assessed at market price, the present purchase cost for identical inventory goods. This amount may be less than the initial purchase price.
- Create an inventory write-off account balance to track the worth of the product damage. You reduce the quantity of inventory carried on the books each time you create a statement in the inventory write-off expense report.
- Charge the stock write-off expense report to the cost of goods sold department. You can write off the loss by debiting the price of goods sold accounts and crediting the inventory account if you don’t often have damaged merchandise.
Conclusion
If the stock loses its value, an inventory write-down is needed to reflect on the accounting information that the recoverable amount is less than expected. Inventory is frequently deteriorated due to depreciation, loss, a drop in customer needs, damages, wastage, accidental loss, and market shifts. An inventory write-down reduces net revenue, stock dividends, and owner’s equity on the income statements sheet.
Effective inventory management tactics such as avoiding excess inventories, evaluating order frequencies, watching demand patterns, and adopting preventive steps to minimize theft or damage can help companies prevent write-downs.
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FAQs
If the write-down is relatively tiny, debit the COGS account and credit the inventory account for the difference in valuation. If the write-down is deemed significant, debit the inventory write-down line item and credit the inventory account for the difference in valuation.
A write-down of inventory entails allocating a part of the asset account to expenditures. Inventory is written down when things are lost or stolen or their worth decreases. The stock should be written down as soon as possible so that the annual reporting reflects the lower value of the stock right away.
In business, writing an asset off means declaring it no longer plays an important role and has no positive future. You’re essentially informing the authorities that an asset’s worth has been substantially reduced. Even if it still has any future usefulness, old merchandise can be written off.
A write-down is a reduction in inventory reported as an adjustment to the current stock.
Businesses might record an inventory write-off in one of two distinct ways. It can be recognized as an expense straight to COGS or balance the inventory account balance in a contra accounting system, also known as the provision for excess stock or inventory reserves.
A computer monitor manufacturer sells monitors online, and the most popular monitor manufacturer has released a new version. The monitors in the manufacturer’s existing inventory will not match the new demand. Because the stock is becoming outdated, its value has dropped from $250 to $225, a $25 difference.