Obsolete Inventory

Business Corporate Finance and Accounting

What Is Obsolete Inventory?

Obsolete inventory is a term that alludes to inventory that is toward the finish of its product life cycle. This inventory has not been sold or utilized for a long period of time and isn't expected to be sold from here on out. This type of inventory must be written-down or written-off and can cause large losses for a company.

Obsolete inventory is likewise alluded to as dead inventory or excess inventory.

Grasping Obsolete Inventory

Inventory alludes to the goods and materials in a company's possession that are ready to be sold. It is one of the main assets of a business activity, as it accounts for an immense percentage of a sales company's incomes.

In the past, assuming the inventory was held for a really long time, the goods might have arrived at the finish of their product life and become obsolete. Currently, with technology, the state of overflow, and clients' high expectations, the product life cycle has become more limited and inventory becomes obsolete a lot quicker.

Obsolete inventory will be inventory that a company actually has close by after it ought to have been sold. At the point when inventory can't be sold in the markets, it declines essentially in value and could be considered futile to the company. To perceive the fall in value, obsolete inventory must be written-down or written-off in the financial statements as per generally accepted accounting principles (GAAP).

A write-down happens in the event that the market value of the inventory falls below the cost reported on the financial statements. A write-off includes totally taking the inventory off the books when it is recognized to have no value and, in this way, can't be sold.

Accounting for Obsolete Inventory

GAAP expects companies to lay out a inventory reserve account for obsolete inventory on their balance sheets and expense their obsolete inventory as they discard it, which decreases profits or results in losses. Companies report inventory obsolescence by charging an expense account and crediting a contra asset account.

At the point when an expense account is charged, this distinguishes that the money spent on the inventory, presently obsolete, is an expense. A contra asset account is reported on the balance sheet quickly below the asset account to which it relates, and it decreases the net reported value of the asset account.

Instances of expense accounts incorporate cost of goods sold, inventory obsolescence accounts, and loss on inventory write-down. A contra asset account might incorporate an allowance for obsolete inventory and an obsolete inventory reserve. At the point when the inventory write-down is small, companies regularly charge the cost of goods sold account. Notwithstanding, when the write-down is large, charging the expense to an alternate account is better.

Illustration of Obsolete Inventory

For instance, a company recognizes $8,000 worth of obsolete inventory. It then assesses that the inventory can in any case be sold in the market for $1,500 and proceeds to write-down the inventory value. Since the value of inventory has fallen from $8,000 to $1,500, the difference addresses the reduction in value that should be reported in the accounting journal, or at least, $8,000 - $1,500 = $6,500.

Provision for Obsolete Inventory
Account	Debit	Credit
Inventory Obsolescence	$6,500
Allowance for Obsolete Inventory		$6,500

The allowance for obsolete inventory account is a reserve that is kept up with as a contra asset account so the original cost of the inventory can be held on the inventory account until it is discarded. At the point when the obsolete inventory is at last discarded, both the inventory asset and the allowance for obsolete inventory is cleared.

For instance, assuming that the company discards its obsolete inventory by discarding it, it wouldn't receive the sales value of $1,500. Hence, as well as discounting the inventory, the company likewise needs to perceive an extra expense of $1,500. The allowance for obsolete inventory will be delivered by making this [journal entry](/changing journal-entry):

Account	Debit	Credit
Allowance for Obsolete Inventory	$6,500
Inventory Obsolescence	$1,500
Inventory		$8,000

The journal entry eliminates the value of the obsolete inventory both from the allowance for obsolete inventory account and from the inventory account itself.

On the other hand, the company might have discarded the inventory for some money, say through an auction for $800. In this case, the proceeds of $800 from the auction is $700 not exactly the book value of $1,500. The amount of $700 will be charged to an expense account, and the journal entry will record the disposal of the inventory and receipt of $800 in proceeds from the auction:

Account	Debit	Credit
Cash	$800
Allowance for Obsolete Inventory	$6,500
Cost of Goods Sold	$700
Inventory		$8,000

The $1,500 net value of the inventory less the $800 proceeds from the deal has made an extra loss on disposal of $700, which is charged to the cost of goods sold account.

A large amount of obsolete inventory is a warning sign for investors. It very well may be indicative of poor products, poor management figures of demand, and additionally poor inventory management. Taking a gander at the amount of obsolete inventory a company makes will provide investors with a thought of how well the product is selling and the way in which effective the company's inventory cycle is.

Highlights

Obsolete inventory will be inventory toward the finish of its product life cycle that should be either written-down or written-off the company's books.
Obsolete inventory is written-down by charging expenses and crediting a contra asset account, like allowance for obsolete inventory.
At the point when obsolete inventory is discarded, both the connected amount in the inventory asset account and the contra asset account are taken out in the disposal journal entry.
The contra asset account is netted against the full inventory asset account to show up at the current market value or book value.