Obsolete inventory definition

obsolete inventory accounting

For instance, if you don’t have any insight into what items are slow-moving and taking up storage space, then it will be harder to identify how much obsolete inventory you’re accumulating. It can be difficult to move obsolete inventory, but consider repurposing, donating, or discounting the products. You can also use automated systems to detect when certain items are becoming obsolete and adjust your inventory accordingly. But with a bit of planning, you can reduce its impact on your business and ensure that only profitable products remain in stock. Likewise, if a company produces a product that is no longer in demand, its inventory of it becomes obsolete and must be cleared out. This can happen with technology products such as laptops or smartphones, where newer models come out every few months.

Whether you are in retail, the supply chain, or are a manufacturer you have inventory. Today we are discussing how to analyze the various inventory phases to eliminate or reduce your obsolete inventory. https://investrecords.com/the-importance-of-accurate-bookkeeping-for-law-firms-a-comprehensive-guide/ Selling it – This does not mean selling the inventory at a reduced price to your existing customer base. Rather, this is the sale of inventory to a place such as a liquidator or junkyard.

Related IFRS Standards

Put simply; the term refers to items that are either impossible or very difficult to sell. Once inventory becomes obsolete, your options for disposal become very limited so catching an inventory problem when it still has some value is very important. A typical calculation of Months on Hand (MOH) or Days on Hand (DOH) for Total Year Usage, indicates that both items are both at 4.4 months on hand (MOH). Whatever system you rely on proper maintenance of data to ensure the validity of the analysis will be required.

  • This occurs when inventory or equipment is no longer useful due to changes in technology or consumer preferences.
  • Selling it – This does not mean selling the inventory at a reduced price to your existing customer base.
  • The percentage of sales is then multiplied by the total sales revenue to arrive at the amount of the inventory obsolescence reserve.
  • With so many options for consumers, it’s easy for them to shift away from your product, even if it still meets their needs.

Inventory account’s balance is netted with this contra account’s balance, and net amount is presented in the balance sheet as inventory. By doing so, loss due to inventory obsolescence is recorded in a timely manner as per prudence principle. When that obsolete inventory is disposed, either sold or scrapped, balance of that inventory item is removed from the inventory account and contra account. Perhaps the most impactful way to increase sold cost recovery is by selling product with as much shelf life as possible, and as part of this, working through cycles more quickly. By increasing your speed to market and sales efficiency, you can get items communicated, negotiated and sold faster – farther from any potential expiration dates and therefore worth more to your customers.

Accounting Methods for Obsolete Inventory by GAAP

The business is concerned that these t-shirts may have lost their value and no longer be sellable. Even though inventory costs must be adjusted down to the lower of cost or market, this does not mean that inventory costs are adjusted upward if the price recovers. GAAP specifically prohibits companies from writing up the cost of inventory in almost all circumstances. For companies with high Navigating Law Firm Bookkeeping: Exploring Industry-Specific Insights turnover rates or those operating in fast-paced industries like electronics, obsolescence can pose an even greater risk. In such cases, it’s essential to stay ahead of market changes by forecasting demand accurately and adapting production schedules accordingly. Inventory write-off refers to the accounting process of reducing the value of the inventory that has lost all of its value.

obsolete inventory accounting

Inventory overage occurs when there are more items on hand than your records indicate, and you have charged too much to the operating account through cost of goods sold. Inventory shortage occurs when there are fewer items on hand than your records indicate, and/or you have not charged enough to the operating account through cost of goods sold. Limit access to inventory supply and implement procedures for receiving and shipping. Ensure that all employees responsible for inventory control and accounting entries are knowledgeable about the products and items inventoried. If you are considering creating an inventory reserve, it is important to consult with an accountant or financial advisor to determine the best approach for your business. Let’s assume that a business is engaged in clothing production and has an inventory of t-shirts that have been in stock for over six months.

What is Obsolete Inventory Accounting?

Sell through rate is a great metric to measure the effectiveness of your sales process and robustness of your sales network. Generally speaking, the more cases you sell, the fewer cases that get written off, and this KPI measures that. We’ve also outlined the differences between obsolete, slow-moving and short-dated inventory. The food or beverage itself might be perfectly good and far from its customer guarantee date, but it still qualifies as excess inventory. Process the transaction on an Internal Billing (IB) e-doc to credit interdepartmental income on your operating account and debit an interdepartmental expense in the purchasing department’s account.

obsolete inventory accounting

The disposal of obsolete inventory occurs when it cannot be repurposed, kitted, donated, or discounted. Depending on the type of product, this could be done through recycling programs or other disposal methods. At this point, it will be written off as a total loss on the company’s financial statements. IAS 2 provides guidance for determining the cost of inventories and the subsequent recognition of the cost as an expense, including any write-down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.


The cost of holding on to obsolete Inventory is another factor we need to consider when analyzing our stock and preparing our action plan to decrease obsolescence. These consist mostly of warehousing expenses like rent (or depreciation if we use our premises) and include other relevant costs like equipment depreciation, salaries, and utilities. It isn’t uncommon for businesses to hold excess inventory in the case of emergencies. One of the biggest reasons why companies experience costly annual write-offs is because they don’t have a realistic look at where their money is flowing. This is yet another reason why gaining visibility into your obsolete inventory is critical. It gives you a holistic view of where your inventory moves and where it doesn’t so you can adjust and optimize where needed.

These items have typically been replaced in the marketplace by more advanced or inexpensive goods, so there is no longer any demand for them. Since these goods cannot be used, their cost is either written off or written down. A write off completely eliminates the inventory asset from the accounting records, while a write down reduces the amount of the recorded asset to the price at which it can still be sold. Generally accepted accounting principles require that companies periodically examine their inventory balance for inventory that is no longer able to be sold for as much as the company paid for the goods.

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