In this article, we explain what an inventory write down is and why it happens. We also share our simple framework with examples on how to record it accurately. Read on to learn more.
An inventory write down is an accounting procedure in which a company reduces the reported value of its inventory to reflect its actual market value.
Example: Tech Gadget Inc. initially recorded 10,000 tablets at $300 each, but due to rapid technology changes, their market value dropped to $250 each.
Inventory write downs are necessary when the market value of inventory is less than its recorded cost. Reasons include:
Market Oversaturation: High supply and low demand for a product can reduce its market value.
Product Obsolescence: Advances in technology or changes in consumer preference can make older products less valuable.
Damage or Spoilage: Physical damage or expiration can render products unsellable at their recorded value.
Economic Factors: Recessions or downturns can lead to decreased demand and lower product values.
Shifts in Consumer Behavior: Rapid changes in what consumers desire can devalue existing inventory.
When a company writes down its inventory, there may be several consequences:
Reduced Asset Value: The total assets on the balance sheet decrease as inventory values are reduced.
Lowered Net Income: The write down is an expense, reducing the company's income for the period.
Impaired Cash Flow: Less revenue from liquidating the inventory can harm cash flows.
Stock Price Impact: Investors may perceive the write down negatively, potentially affecting stock prices.
Supplier Relations: Frequent write downs might cause suppliers to question a company's product management or forecast accuracy.
Here's our step-by-step process for recording an inventory write down with examples:
Engage in market research, evaluate prices of similar products, or assess the expected selling price in the present market.
Example: FashionFlow Inc. purchased designer handbags at $250 each. After market analysis, they discover that similar handbags are now trending at $230.
Check if the current market value is lower than the recorded book value (cost) of the inventory.
Example: AutoEdge Motors has a new sedan model with a book value of $20,000. However, competitive market pricing for similar sedans is currently around $18,500.
Make a journal entry to debit an expense account and credit the inventory account.
Example: SweetDelight Bakeries initially recorded its gourmet cake inventory at $30 per cake. Due to a shift in consumer preferences, they need to reduce the price to $25. With 1,000 cakes unsold, they have to write down $5,000. They debit "Loss on Inventory Write Down" by $5,000 and credit their "Inventory" account by the same amount.
Ensure transparency by providing notes in the company's financial statements about the write-down.
Example: In TechGiant Electronics' financial report, there's a note detailing: "A write-down of $15,000 was taken on our tablet inventory this year due to the introduction of newer models and subsequent reduced demand for older versions."
Supreme Shoes Inc. has noticed a significant drop in the demand for one of its older shoe designs. After assessing the market, they decide to write down their inventory:
Supreme Shoes Inc. engages in extensive market research. They determine that the current market value of the older shoe design is now $70, whereas it was previously priced at $100 in their inventory.
Comparing the discovered market value with their book value, Supreme Shoes Inc. realizes there's a $30 disparity per shoe. The shoes are now worth only $70 in the current market.
Given the difference of $30 per shoe and with 2,000 pairs of these shoes unsold in their inventory, Supreme Shoes Inc. calculates a total write down of $60,000. They debit "Loss on Inventory Write Down" and credit the "Inventory" account by the same amount.
In Supreme Shoes Inc.'s subsequent financial report, a note is added for stakeholders' clarity: "An inventory write-down of $60,000 was made this quarter due to reduced market demand for one of our older shoe designs, resulting in its market value dropping to $70 per pair."
Inventory write downs are essential adjustments ensuring that a company's financial statements reflect the current market realities. We hope this article has given you a better understanding of what an inventory write down is and how to record it properly.
If you enjoyed this article, you might also like our article on what work in process inventory is or our article on how to write off damaged inventory.
