First, when inventory becomes obsolete, it must be written down or written off. This adjustment is recognized as a loss on the income statement, directly reducing net income. The write-down or write-off is recorded as an expense, meaning the loss is recognized in the current period.
On your balance sheet, debit your cost of goods sold (COGS) and credit your inventory write-off expense account. If the amount of loss is material, it should be identified separately in the income statement. Add comments justifying the write-off (e.g., explaining that the inventory was damaged, stolen, spoiled, etc.).
This can be done through various methods, such as reselling it online or in your local community, giving it away for free, or sending it back to the manufacturer. It is also possible to hold an auction and sell items on eBay or Craigslist.
Treating inventory as non-incidental materials and supplies means that you can deduct your cost at the later of: when you bought the product or when it's used or consumed. This is the exact opposite of *incidental* materials and supplies which allows you to write everything off immediately.
So how do you account for obsolete inventory? There are different rules that need to be considered for Generally Accepted Accounting Principles (GAAP) vs. tax methods. In regards to GAAP, once you have identified inventory that you cannot sell, you must write this inventory off as an expense.
By donating that new, idle merchandise to charity, your business can earn a federal income tax deduction under Section 170 ( e )(3) of the U.S. Internal Revenue Code. The IRS Code says that regular C corporations may deduct the cost of the inventory donated, plus half the difference between cost and fair market value.
Obsolete inventory refers to a product that has reached the end of its lifecycle. It happens when a business considers it to be no longer sellable or usable and most likely will not sell in the future due to a lack of market value and demand.
Make a journal entry that credits the inventory asset account with the value of the write-off. Then, debit the inventory write-off expense account the same value. The change to the expense account reduces your company's net income on its income statement and decreases shareholder equity in the balance sheet.
Liquidating inventory can be done through various channels such as auctions, online marketplaces, or through third-party liquidation companies. By liquidating inventory, businesses can avoid the costs associated with storing and maintaining excess goods while generating immediate cash to reinvest in the business.
In many states, unsold inventory can reduce the amount of taxable income for the year, but there are multiple ways of valuing inventory for tax purposes. In addition, it's an income adjustment, not a line item, making accounting for it a lot more difficult.
Obsolete inventory examples
Here are some common examples of obsolete items: Outdated parts or components. Excess inventory from discontinued products. Unsellable dead stock due to a change in customer preferences.
Subtract the loss from your previous inventory balance and report the new amount on your balance sheet. Continuing the example, assume the expired food was your only inventory and your previous balance was $500. Subtract $450 from $500 to get $50. Report "Inventory $50" on your balance sheet.
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.
Dead stock, also known as excess inventory, is inventory that is no longer wanted or needed by a company. It is typically sold to a liquidator or wholesaler at a discounted price, or donated to a charity. It can also be recycled, resold, returned to the manufacturer, or broken down for parts.
Summary: Common SCM inventory golden rules are: (a) avoid situations where inventory and demand are out of balance, those slow-moving low margin products add no value to the firm and (b) production campaigns result in unnecessary inventory.
To manage obsolete inventory, businesses can consider liquidation, repurposing, donation, or recycling. To avoid obsolete inventory, businesses should implement accurate demand forecasting, lean manufacturing practices, regularly review inventory levels, and keep up with market trends.
What are the GAAP rules for obsolete inventory? GAAP requires that obsolete inventory be accounted for as soon as it's identified. This typically involves either writing down the inventory to its net realizable value or writing it off entirely if it has no value.
If you're going to write-off inventory on your taxes, you'll need to complete a valuation first. You can opt for the cost method, which involves calculating all the direct and indirect costs associated with the inventory you plan to write-off (purchase price, associated costs of transporting the items, etc.).
For calculation of the amount of provision to be recorded, consideration has to be given for expired goods, the possibility of extension of the shelf life or the goods which are near expiry and the possibility of sale of those goods before they expire.
You can take a deduction for a contribution of an item of clothing or a household item that isn't in good used condition or better if you deduct more than $500 for it and include a qualified appraisal of it with your return.
On your balance sheet, debit cost of goods sold (COGS) and credit your inventory write-off expense account. If you're only writing off small amounts of inventory, you can also just debit your COGS account and credit your inventory account.