In this article, we are going to dive deeper into inventory write-off.
- What is inventory write-off?
- Why inventory write-off?
- How to write off inventory with examples
- When should we write off inventory?
- How to write off the inventory damages?
- Impacts of inventory write-off towards income statement
- How to reduce inventory write-off?
Let’s start with no further delay.
What is inventory write-off?
Inventory write-off is just a term used in the accounting process of decreasing the inventory value that has totally lost all of its value. The reason behind the inventory losing its value may be due to misplacements, damage in the transit, other damages, theft losses, and might have market demand changes, and so on.
If there is a case that inventory decreases without any complete loss, it is a write-down instead of a write-off inventory.
Why inventory write-off?
Inventory write-off will help and support the objectives of accounting accuracy. Additionally, it helps to decrease the business owner’s tax liabilities. This is done by balancing the allowances of obsolete inventory or by just modifying it to the COGS (cost of goods sold) in the books.
How to Write-Off Inventory?
If a case, inventory tends to lose all its value, this inventory loss will impact both your income statement and the balance sheet of your business. The cost of written-off inventory is the amount of inventory and cost of cash that can be acquired by disposing of the most superior inventory manner.
If the particular inventory has not been identified, then in such cases, businesses can set up the inventory write-off reserve. One of the alternative approaches, when a specific stock item has not been identified, then just set up a reserve inventory write-off. It is a contra account that is paired with the inventory account. When the inventory is disposed of, the waste/loss will be charged against the account called reserve account.
For inventory write-off, you need to credit the account of inventory and record inventory debit.
You decided to write off $15,000 inventory worth from the $70,000 inventory worth that your organization/business had at the end of the year first, you need to credit the account of inventory with the write-off value to decrease the balance.
The inventory write-off value is,
$15,000-$70,000 = $55,000
Next, in order to reflect the inventory loss, you need to credit the account of inventory shrinkage expense in the income statement. Keep in mind, in any of the cases the expense items will appear as an operating expense.
The impact that reflects from this is,
- A decrease or cut-down in business net income. It results in a reduction in retained earnings.
- As a result of the retained earning reduction, reduces the shareholders’ equity in the balance sheet.
If inventory write-off is negligible, the write-off inventory is charged to the COGS (cost of goods sold) account. The trouble with this is that it falsifies the business gross margin, as there is no corresponding revenue matching entered for the product sale.
When should we write off inventory?
It is very crucial to calculate the gross profit or loss with the exact inventory value. This is the reason, why it is considered important for businesses to account for inventory write-off when the value of inventory significantly changes.
Here are the following reasons that this may happen.
- The inventory/items may be robbed by your employee or shoplifters or shippers.
- Inventory damages due to improper handling or storage.
- Some of the inventory as flowers or fruits may decay or spoil due to their short life span.
- High market value inventory may be outdated or expire after a few months.
Commonly, most businesses do inventory write-off only once in the year. But if you have a large stock, it is preferred to account for once every month.
How to write off the inventory damages?
- Identify which stock arrives and when it arrives. It will help you to identify goods that might be damaged. Place those inventory in the designated area. Prepare and maintain the list of damaged reports for every single damaged item.
- To write off inventory loss, calculate the spoiled inventory value at the end of the accounting cycle.
- The spoiled inventory is valued at a fair market rate. It is nothing but the ongoing purchase price for a similar item. This value may be lesser than the original purchase price.
- Now, to record all your damaged inventory value just set up an expense account for inventory write-off. While you enter an inventory write off the expense account every time, you decrease the inventory value carried on the books.
- Now, credit the inventory write-off expense account and debit COGS (cost of goods sold). As a result, if you haven’t found any frequently damaged items, then you can move forward to choose credit the inventory account to write off the loss and debit the COGS account.
Inventory write off vs Inventory write down
An inventory write-off is closely similar to an inventory write-down. The one huge difference between the inventory write-off and inventory write-down is that it differs from the intensity of the loss.
When an inventory tends to decrease in their value but if they don’t result in loss of all its total worth, it is an inventory write-down. Still, the inventory has the intensity to sell it (but not with the original cost).
Inventory write-off occurs when the item has completely lost its original worth and spoiled totally.
Can an expired inventory be written-off?
Expired inventory is not similar to damaged inventory. Expired inventory typically just means it is no longer useful in its original capacity. Since it no longer exists, it can be written off.
Is an inventory write-off tax deductible?
In some cases, the inventory write-off can be tax-deductible. To evidence IRS (Indian Revenue Service) that your inventory was not in fact to sell, there is the necessity for the company to provide some of the corresponding proof of the following.
A company can sell its written-off inventory and still be eligible for a tax deduction from the IRS. A company would then subtract the profit recovered from the inventory’s original fair market value and could claim any remaining cost as a tax benefit.
The second option is to donate the written-off inventory to a charity. It can make it acceptable for a tax deduction. Additional tax deductions may be attainable if provided items undeviatingly benefit ill, impoverished, or infant populations. If you donate, make sure to arrange a receipt in case you’re audited.
When all other methods are unavailable to use, then destroying inventory can be a temporary solution. Destroying property to take a deduction isn’t something most people would consider, but the tax rules allow it. You can take a deduction for business property that’s lost or destroyed. But you must show that you took substantial steps to limit your loss.
How does inventory write-off impacts income statement?
Take a case that you are writing off small values of inventory. In this situation, you do not have any necessity to hold separate disclosure on the income statement. Alternatively, here is loss the added on with the cost of goods sold value.
But, if you have the case to write off your inventory to a huge dollar amount, then it should be disclosed on the income statement. A separate account similar to the inventory write-off expense account should be included with the other inventory accounts. The loss in this particular account should appear on the income statement whenever you write off inventory.
It is more important to recall that the reduction in the inventory amount can never be the extent and admitted over multiple periods. Because this could mean that there is some extra benefit connected with the inventory item.
This is the reason why the inventory write-off must be admitted and recognized at once.
How to reduce inventory write-off?
Here are some of the tips to reduce your inventory write-off.
Preserve your inventory items:
The inventory write-off requirement can be reduced by protecting your items from theft, damages, and goods misplacements. Make sure to take necessary action in preventing your items. Using security cameras, installing locks, security alarms, and other security-related products will help your more. Additionally, take extra care of the high-valued inventory items and have additional security for those stocks.
Revisit your order cycles and the sizes
Large, infrequent orders can create large amounts of inventory that may not sell before reaching the end of its shelf life. Many companies also find that smaller, more frequent orders help reduce inventory value loss in comparison to larger, less frequent orders. Since inventory value is calculated as the cost price of the inventory less its realizable value, minimizing losses will lower inventory values and reduce costs.
Keep tracking your inventory levels:
Inventory management software helps you to helps you in displaying the real-time inventory levels. It will help you in making better purchasing and management decisions. Inventory Management Software is a data warehouse solution for tracking inventory levels, comparing actual to budgeted inventory values, identifying stock on hand versus the on-order quantities you entered in eSales, and more.
Try to avoid excess inventory
Sometimes excess inventory will lead to an increase in inventory write-off. Store the right amount of product to eliminate wastage and avoid spoilage. Avoid Obsolescence by maintaining quality levels and preventing damage by storing products in the right size cabinet.
Consider having written down first
By executing a write-down, companies can preserve some of the value of their inventories by selling it at a discount, remarketing it, or bundling it with other items.
Keep tracking your market trends and demands
Tracking the market trends and demands is the smarter way to reduce the inventory write-off. Understand inventory trends in your business. Track sales, trends, and order data so you can make better decisions about when to reorder. If the trend data shows that your product is not moving, pause or change the order size on that product. Tracking this information will help you avoid excess on the shelves by telling you when it’s time to halt an existing product line or adjust the size on future orders.
Make sure to implement the inventory management system
With inventory management software, you can reduce your inventory write-off. The right inventory management software can help you save money. For example, if you cycle counts your inventory correctly, you’ll never have to write off obsolete or damaged products.
Inventory management software with myBooks can help you manage the accounting processes behind lost or damaged goods, which assists you to maintain compliance while reducing your overall taxable income. For example, maintaining higher inventory levels can help you decrease material loss through spoilage. And tracking orders and letting customers know about order delays can help prevent stockouts that could cause write-offs because of excess inventory.
Inventory shrinkage is shrinkage refers to inventory that is unaccounted for; it’s missing, stolen, or destroyed. Read more
The beginning inventory is the book value of all company inventory by an organization or a business at the starting accounting period. Read more