The Difference Between Write-Offs and Write-Downs

An inventory write down is an accounting process used to record the reduction of an inventory’s value and is required when the inventory’s market value drops below its book value on the balance sheet. Loss on inventory write-off is an expense account on the income statement, in which its normal balance is on the debit side. Likewise, in this journal entry, the write-off expense will increase in the same amount of the inventory loss.

  • In this scenario, a write-down is recorded by either reducing the value of the inventory or removing it entirely.
  • An inventory write-down lowers the value of the goods, while a write-off removes the value completely from the company’s financial records.
  • Apart from inaccurate demand forecasting, poor sales efforts can also result in a stockpile of dead stock.
  • The amount to be written down is the difference between the book value of the asset and the amount of cash that the business can obtain by disposing of it in the most optimal manner.

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. A write down is similar to a write off, except that with a write down, the asset is still left with a book value whereas with a write off the value of the asset is reduced to zero. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support.

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This is done by crediting the inventory account and debiting the cost of goods sold. An ending inventory balance is reported as a current asset on the balance sheet at the end of an accounting period. The write down of inventory involves charging a portion of the inventory asset to expense in the current period. Inventory is written down when goods are lost or stolen, or their value has declined. This should be done at once, so that the financial statements immediately reflect the reduced value of the inventory. Otherwise, the inventory asset will be too high, and so is misleading to the readers of a company’s financial statements.

Goods that are damaged in production or when in transit also contribute to inventory write-downs. Other common causes of inventory write-downs are stolen goods and inventory used as in-store displays (goods put on display are not fit for consumption). If you have items stored in different bins — one with no lot date and one with a lot date — we will always ship the one updated with a lot date. It’s worth noting that smaller write-offs can be reported as COGS, rather than a write-down. But larger amounts must always be entered as a separate line on the income statement.

  • Treating the write-down as an expense means the company’s reported profit and the amount it needs to
    pay in taxes both decrease.
  • The accounts receivable on the company’s balance sheet is written off by the amount of the bad debt, which effectively reduces the accounts receivable balance by the amount of the write-off.
  • From ordering too much inventory to begin with, to a decline in demand, there are several reasons why inventory can lose its value.
  • This is useful in preserving the historical cost in the original inventory account.

This would be a debit to the cost of goods sold expense and a credit to the reserve for obsolete inventory account. The reserve would appear on the balance sheet as an offset to the inventory line item. Then, as items are actually disposed of, the reserve would be debited and the inventory account credited. This approach immediately recognizes the full amount of the loss, even if the related inventory has not yet been disposed of. Inventory write-downs are an essential accounting process for businesses to accurately reflect the value of their inventory assets. By understanding the reasons for write-downs, the impact on financial statements, and the process involved, companies can better manage their inventory and minimize the need for write-downs.

Write-Off vs. Write-Down Example

This method involves creating a special account to predict how much value might drop (inventory reversal). Items are eligible for a write-down when they become less valuable, like the materials you’re using, the half-done goods, or the finished products. An inventory write-down occurs when the original cost of the inventory exceeds its net realizable value, which can happen for several reasons. For this reason, it’s important to be diligent when processing inventory write-offs because it has a real impact on your tax implications. This means any increase to our cost of goods sold reduces our profit, and therefore the amount of tax we need to pay.

In this case, as the inventory is initially measured at cost, if its net realizable value is lower than the cost later, the loss will occur and the value of inventory should be written down accordingly. When a business writes inventory off, it creates an entry to cost of goods sold, which reduces its profit, and therefore the amount of tax it needs to pay. We have a debit to our Cash on hand for $300 (an increase to our assets), and a credit to our Sales Revenue for $300 (an increase to our revenue).

Why does an inventory write-down increase the COGS?

In addition, changes in market conditions, such as a decline in demand or increased competition, may result in a reduction in the market value of inventory, which can also trigger an inventory write-down. An inventory write-off is the process of removing inventory items from your stock on hand list. This is done when items are no longer saleable due to being damaged, spoiled, stolen or becoming otherwise obsolete. The amount to be written down is the difference between the book value of the inventory and the amount of cash that the business can obtain by disposing of the inventory in the most optimal manner. Write-downs are reported in the same way as write-offs, but instead of debiting an inventory write-off expense account, an inventory write-down expense account is debited. Since the amount of the write-down of inventory reduces net income, it will also reduce the amount reported on the balance sheet for owner’s equity or stockholders’ equity.

Direct write-off method

If SKUs are left unsold in your warehouse for too long, they cross the expiry date and completely lose value. At this point, the expired inventory can no longer be written down but rather “written-off” and counted as a complete loss. From ordering too much inventory to begin with, to a decline in demand, there are several reasons why inventory can lose its value.

Consequences & legal implications of an inventory write-off

Shareholders’ equity on the balance sheet is reduced as a result of the impairment loss on the income statement. An impairment may also create a deferred tax asset or reduce a deferred tax liability because the write-down is not tax deductible until the affected assets are physically sold or disposed. The company can make the inventory write-down journal entry by debiting the loss on inventory write-down account and crediting the inventory account.

If you know a new version of a product is coming out, you can adjust your inventory accordingly. Look at what the company says its inventory is worth and what it’s actually worth. Now let’s look at the situation where we have to write the inventory off, rather than sell it. Note, that GAAP does not allow for the reversal of write downs, while IFRS does allow reversals (except for goodwill). Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

Damage, spoilage, theft, obsolescence, defects and a number of other problems can crop up at any time. If you use cash accounting, you write down the value of inventory when you discover the problem. Under accrual accounting, you may choose to set up an inventory reserve to anticipate future losses. Using TranZact’s inventory management software can make managing inventory write-downs easier. By following the tips mentioned earlier, like avoiding excessive inventory, tracking demand, and protecting your inventory, our software features can help keep your inventory in check.

This entry means we are increasing our cost of goods sold by $100 and reducing our stock on hand by $100. If we had 100 coffee mugs for sale, and we broke 5 of them, we would need to write off this stock, so we only show 95 available for sale. Without an inventory write-off, we could end up in a situation where we sell 100 but are only able to deliver 95. Link Reporting Co-founder and all-round accounting expert, Will McTavish, explains what inventory write-offs are, why they matter, and how to conduct one. Another possible scenario for reversal is when there is an increase in the inventory’s market value.

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