Not every product is going to be a bestseller. This is a harsh reality and it comes with the cost of doing business. For whatever reason when inventory does not sell and loses its market value, companies need to report it as an “inventory write off”.
So, let’s see what this phenomenon is in detail.
What is Inventory Write Off?
It is an accounting term that formally recognises a portion of the company’s inventory that no longer has value. You can record it in one of the two ways:
- Directly expensing it to the cost of goods sold (COGS) account, or
- It may offer the inventory asset account in a contra asset account, what you’d call allowance for obsolete inventory reserve.
Since it may lead to a loss and the products are not in use anymore, you would need to resort to it. However, this only happens a few times. Let’s see how to identify the situations which call for inventory write off.
When Should You Write off Inventory?
Both small and large companies that have inventory on hand would have to write-off a portion of it at some point. Here is a list of the most common reasons why companies write off inventory:
1. Inventory Theft
Whether small or large, inventory tends to disappear. It could be stolen in the supply chain process even before it reaches you. Sometimes when your inventory counts do not match what you have at hand, it is likely because of theft.
2. Inventory Damage
There remains the possibility of inventory damage at part of the supply chain. If the inventory wants to retain its value, it must arrive in pristine condition at its selling location. But, of course,the reality differs at times.
The supply chain can malfunction at any point. This may lead to damaged or defective products and become unstable as a result. You are eligible to receive a reimbursement from the supplier. Until you receive it, it is your responsibility to write off the damaged inventory.
3. Inventory Has Lost its Relevance
Another common reason for an inventory write off is the relevance of the market. The market demands to undergo rapid changes. A product that might have been a big seller a year ago, is now obsolete in the market. So, since the inventory has become obsolete, you have nothing to do, but write it off.
4. Inventory Close to Expiring
Businesses in the food and drinks industry will understand this. There is a time limit for these foods- an expiry date. After that, you cannot consume them. So, it is best not to overbuy and cycle through dates properly. You will have to write off any product that has reached its expiration date.
So, considering these criteria, you know when to initiate a write-off. But how do you do it? Shall we find out?
How to Write Off Obsolete Inventory in 5 Steps
Here is how to write off damaged inventory as well as obsolete ones in five steps:
1. Evaluation of Inventory
The first step of inventory write off is to inspect it. This can help you to decide which method is the best to write off the items. For instance, a flood destroys some items that are beyond repair.so, you plan to dispose of those items immediately. For this, you can use the direct method. Identifying the affected inventory gives you a plan to proceed to record different write-offs.
2. Assess the Impact
Once you are aware of the affected inventory, you can assess the impact on your accounting and business records. If the inventory write-off is immaterial or it has little to no impact on your company, you can charge the inventory write off to the cost of goods sold (COGS) expense account.
When you do this, you can increase the cost account without revenue to offset it which may affect gross margin. For material write-offs, you can record these in separate accounts that do not affect gross margin. You can include large write-offs, like if many items had damage in a natural disaster, as a non-recurring loss.
3. Update Financial Records
Recording your inventory write offs is going to be different for each transaction. Consider creating the formal sections on your balance first. For instance, create sections for contra assets, COGS accounts and inventory reserves.
In each case, you remove the value of the asset. You can do dos by crediting and recording cost in an expenses section. This can ensure that you have accurately balanced financial records like:
- Damaged Inventory (Disposed): Record a credit for the asset that indicates the removal of the item and debit the expense indicating the cost of losing the item.
- Damaged Inventory (Not Disposed): Record a credit in a contra asset account and a debit in the expenses category.
- Non Recurring Losses: Record non-recurring losses which include write-downs on an income statement as a footnote. You can exclude them from your expense calculations.
- Immaterial Loses: Keep a record of them in the COGS section of your income statement.
Let’s see the next step of the inventory write off process.
4. Review Removal Options
Usually, you would want to remove this type of inventory from your stock. Consider the various options depending on the situation. For instance, with theft, you will not need to dispose of anything but you can donate damaged merchandise.
Sometimes, you may even keep the damaged item. This could include merch that has lost its market value. Iut is fine, what if the value increases again?
5. Document Inventory
When recording write-offs, it is important to document your inventory before disposing it off. You need the proof to match it to your financial records. For instance, you may take pictures of inventory damaged in a natural disaster. If you happen to donate items to other organisations, you have the receipt to show as proof. In some cases, you may even need to present them for tax purposes.
For such processes, there are quite a few advantages of inventory write offs. Let’s see them, shall we?
Advantages of Inventory Write Offs
Here is how these write-offs can help your business:
- Increase in Financial Documentation Accuracy: Write-offs help you to record the accurate value of your assets and cost of damages.
- Reducing Tax Liability: As you write off inventory, you may be able to reduce the amount of taxes you owe.
- Improving Inventory Management: When you write off items that have lost value, it helps you to better manage your inventory by evaluating your products and their value frequently to see if you might remove anything.
- Updating Products: Sometimes there might be write-offs for items that are obsolete like dated versions of technology. This may help you to identify any costs that are associated with low-value inventory and ensure that the products are current.
- Identify Risks: If you commonly have write-offs due to theft or natural disasters, then you can prepare better to avoid any future losses.
Apart from all this, have you ever wondered how to avoid inventory write off?
3 Ways to Avoid Inventory Write-Offs
- Ensure that your business has a clear Standard Operating Procedure (SOP). It is a written set of instructions that outlines the steps taken in a specific process or activity. An SOp will help team members follow processes which help them avoid stock getting stolen lost or damaged.
- Complete stock takes more frequently. This enables you to spot and address issues promptly instead of waiting until the end of the financial year each time. Remember, stock takes can be time-consuming and costly. Conducting mini-stock takes on different sections of the business during staff downtime is a practical way to manage this expense, considering they are being paid regardless.
- Utilise a robust inventory management system such as Unleashed. An effective inventory system will streamline business operations, reducing fulfilment time and providing greater insight into the numbers for making informed decisions.
The company can also record a goodwill written-off entry to reflect the impairment of intangible assets on its balance sheet.
FAQs: Inventory Write-Off: 5 Steps to Properly Removing Inventory from Your Records
What is an inventory write-down?
This refers to a reduction in the value of inventory due to obsolescence, damage, or other factors, reflecting its decreased worth on the balance sheet.
Is a write-off an expense?
The inventory write-off usually records expenses, but in itself, it is an expense as well. To complete the write-off, employees spend time and effort on it which they could have used on other tasks.
How to reduce inventory?
Optimise demand forecasting, improve supply chain efficiency, implement just-in-time inventory practices, minimise excess stock, and offer promotions to sell slow-moving items.
Conclusion
Inventory write offs are crucial for financial accuracy, tax reduction, and efficient inventory management. To streamline your process, consider Qodenext, a leader in supply chain solutions. Reduce write-offs by optimising operations and adopting best practices.
