What is an Inventory Write Down?
An Inventory write down is an accounting process that is used to show the reduction of an inventory’s value, 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 on what it is. Excess, stored inventory will near the end of its lifespan at some point and in turn result in damaged or unsellable goods. In this scenario, write-down happens by either reducing the value of the inventory or removing it entirely.
Goods that are damaged in production or when being delivered also contribute to inventory write-down.
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?
Inventory write-down should be treated as an expense, which will reduce net income. The write-down also reduces the owner’s equity. This will also affect inventory turnover for subsequent periods.
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 include 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, 10% of the total inventory, for example, the accountant will reduce the value of inventory by crediting the inventory account and debiting the account as something like “write-down damaged goods.”
Reversal of Inventory Write Down
In rare cases, it is possible for a company to reverse the inventory write-down. This happens when the 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, 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.
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