Inventory Write-Downs: Understanding & Accounting for Value Reduction

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 TimeJust in Time (JIT) MethodThe Just in Time (JIT) style of inventory management – also sometimes referred to as the Toyota Production System (TPS) – is a strategy of managing” 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 turnoverInventory TurnoverInventory turnover, or the inventory turnover ratio, is the number of times a business sells and replaces its stock of goods during a given period. It considers the cost of goods sold, relative to its average inventory for a year or in any a set period of time. for subsequent periods.

How to Perform an Inventory Write Down?

First, the accountantAccountingPublic accounting firms consist of accountants whose job is serving business, individuals, governments & nonprofit by preparing financial statements, taxes 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 reduces the value of inventory by crediting the inventory account and debiting an account such as “write-down damaged goods.”

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.

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• Inventory TurnoverInventory TurnoverInventory turnover, or the inventory turnover ratio, is the number of times a business sells and replaces its stock of goods during a given period. It considers the cost of goods sold, relative to its average inventory for a year or in any a set period of time.
• Debt ScheduleDebt ScheduleA debt schedule lays out all of the debt a business has in a schedule based on its maturity and interest rate. In financial modeling, interest expense flows
• Days Sales OutstandingDays Sales Outstanding (DSO)Days Sales Outstanding (DSO) represents the average number of days it takes credit sales to be converted into cash, or how long it takes a
• Fixed Asset TurnoverFixed Asset TurnoverFixed Asset Turnover (FAT) is an efficiency ratio that indicates how well or efficiently the business uses fixed assets to generate sales. This ratio divides net sales into net fixed assets, over an annual period. The net fixed assets include the amount of property, plant, and equipment less accumulated depreciation