When the inventory write-down is small, companies typically charge the cost of goods sold account. However, when the write-down is large, it is better to charge the expense to an alternate account. By keeping up with market trends, businesses can adjust their production levels and inventory orders to match anticipated demand, reducing the risk of overproduction and excess inventory. This can help to minimize storage and handling costs, improve cash flow, and optimize profitability, while ensuring that the business remains competitive in the market.
What inventory and how much are key inventory decisions, informed by demand forecasting. But factors like suboptimal inventory control, supply chain snags, and unexpected demand fluctuations can cause more products to sit on the shelves with little or no chance of selling. Inventory obsolescence occurs when a company determines that certain products can no longer be used or sold because demand is so low. Once an item reaches the end of its product lifecycle and a company feels certain that it will never be used or sold, a business will usually write down or write off that inventory as a loss. Consistent and accurate inventory audits can also help you avoid and reduce obsolete inventory by understanding how much you’re paying in holdings costs to store slow-moving items that are at risk of going obsolete. Though obsolete inventory can still impact ideal profit margins, putting items on sale can help replenish some of the costs by attracting bargain shoppers.
Review the Prior Obsolete Inventory Report
By switching to inventory management software, your business can automate every aspect of tracking inventory. If a product is no longer in high demand but obsolete inventory accounting still has some value, there’s a good chance you can sell it. In general, a business has a supply of inventory on hand that’s ready to be consumed or sold.
By soliciting feedback from customers and staying attuned to their needs, businesses can better manage their inventory levels and prevent the accumulation of obsolete inventory. By monitoring the product life cycle, businesses can identify when a product is approaching the decline stage and take proactive steps to prevent the accumulation of obsolete inventory. They can adjust their inventory levels, implement promotional strategies to boost sales, or even phase out the product if necessary.
How to Adjust Entries for a Merchandise Inventory
If the inventory still has some fair market value, but its fair market value is found to be less than its book value, it will be written down instead of written off. When the market price of the inventory falls below its cost, accounting rules require that a company write down or reduce the reported value of the inventory on the financial statement to the market value. If the inventory write-off is immaterial, a business will often charge the inventory write-off to the cost of goods sold (COGS) account. The problem with charging the amount to the COGS account is that it distorts the gross margin of the business, as there is no corresponding revenue entered for the sale of the product.
At this point, it will be written off as a total loss on the company’s financial statements. The upper boundary, called the ceiling, is in place to remove the opportunity for a company to overstate the value of its inventoried assets. The amount to be written down is the difference between the book value of the inventory and the amount of cash that the business can obtain by disposing of the inventory in the most optimal manner. 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.
Obsolete inventory percentage
But to move the product faster and get more cash for it, the company decided to bundle the product with two best-selling wines, a red and a white. The store is able to charge more for the set once they add champagne—and customers continue to purchase the bundle. Best of all, the company is now covering its costs and has avoided a write-off altogether. Most business owners know that too much inventory on hand is a losing proposition, especially if that inventory has a low inventory turnover rate. And when a company’s inventory sits on shelves for too long, it can waste costly storage space and ties up cash that could’ve been better spent elsewhere. Slow-moving items and dead stock can take up valuable storage space that could be used to store a higher volume of faster-selling products.
It is a delicate balance between having enough stock to satisfy customers and not having too much of it. Manufacturing companies understand this all too well, as they must keep track of the inventory in their warehouses. Generally accepted accounting principles (GAAP) require that all inventory reserves be stated and valued using either the cost or the market value method, whichever is lower. However, accountants who apply GAAP to inventory reserves often use a significant amount of personal judgment. If a computer system includes a bill of materials, there is a strong likelihood that it also generates a “where used” report, listing all the bills of material for which an inventory item is used.