When the inventory’s market value drops below its book value.
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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.
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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