Obsolete Inventory
Candlefocus EditorIn order for a company to keep its records accurate and up-to-date, it must write-down or write-off obsolete inventory. This involves debiting expenses and crediting a contra asset account, such as allowance for obsolete inventory. The contra asset account is netted against the full inventory asset account to arrive at the current market value or book value. The journal entry also requires that both the related amount in the inventory asset account and the contra asset account be removed when obsolete inventory is disposed of.
Under GAAP, a company must review its inventory annually and adjust the value of its inventory to the lower of cost or market in order to remain in compliance. Revaluing inventory is an important step in accounting for obsolete inventory, as it helps to reduce the carrying amount of obsolete inventory and minimize potential write-downs that may be required in future periods.
In addition to revaluing inventory, companies must decide what to do with the obsolete inventory. Options include selling the inventory at a discount, donating it to charity, or scrapping it. It is important to note, however, that when obsolete inventory is sold, it is likely to be recorded as a loss, as the proceeds are likely to be well below the original cost or book value.
In conclusion, obsolete inventory is inventory at the end of its product life cycle that needs to be written-down or written-off the company’s books. For a company to keep its records accurate and up-to-date, it must revalue its inventory annually and decide what to do with its obsolete inventory. Generally speaking, companies face losses when disposing of obsolete inventory, but the process is necessary in order to remain compliant with GAAP.