However, when the write-down is large, it is better to charge the expense to a separate account. In the past, if the inventory was held for too long, the goods may have reached the end of their product life and become obsolete. Currently, with technology, the state of abundance, and customers’ high expectations, the product life cycle has become shorter and inventory becomes obsolete much faster. If the asset sells for exactly the book value, its depreciation expense was estimated perfectly, and there is no gain or loss. If it sells for $29,200 and had a book value of $29,200, its depreciation expense of $28,800 matches the original estimate.

• Not only is this much preferred to disposing of the items, but it can make organizations eligible for a tax deduction equivalent to the cost of those products.
• Obsolescence risk also means that companies wanting to remain competitive and profitable need to be prepared to make large capital expenditures any time a major product, service, or factor of production becomes obsolete.
• They need to get rid of the inventory before it becomes obsolete and worthless to them.
• A write-down occurs if the market value of the inventory falls below the cost reported on the financial statements.
• Since GAAP mandates immediate recognition of any obsolescence as soon as it is detected, you may have a struggle enforcing immediate recognition over the objections of management.

One way companies can beat the inventory odds is by minimizing the volume of unsold or unused goods or raw materials they have on hand, but that requires mastering inventory management. The allowance for obsolete inventory account is a reserve that is maintained as a contra asset account so that the original cost of the inventory can be held on the inventory account until it is disposed of. When the obsolete inventory is finally disposed of, both the inventory asset and the allowance for obsolete inventory is cleared.

Inventory Control System vs. Inventory Management System

These numbers can change quickly, so employees need the most up-to-date information. ERP inventory systems draw on a variety of data sources to help companies better understand the performance history of various SKUs, among other insights. An inventory management system that shows inaccurate numbers or lacks the reporting capabilities to give a comprehensive view of current stock will only exacerbate the obsolete inventory problem.

This inventory has not been sold or used for a long period of time and is not expected to be sold in the future. This type of inventory has to be written-down or written-off and can cause large losses for a company. You can improperly alter a company’s reported financial results by altering the timing of the actual dispositions. Overall, obsolescence can impact several accounting areas, and understanding its implications and trends can inform accounting policies and practices, as well as financial reporting and analysis. The recognition of obsolescence as an expense is important for companies to accurately reflect the true value of their assets in their financial statements.

Description of process costing in accounting

A contra asset account may include an allowance for obsolete inventory and an obsolete inventory reserve. When the inventory write-down is small, companies typically charge the cost of goods sold account. However, when the write-down is large, it is better to charge the expense to an alternate account.

After two quarters with the inventory management software, obsolete inventory costs are down 70%, saving Central City a bundle of money and putting profit back on an upward trajectory. GAAP requires companies to establish an inventory reserve account for obsolete inventory on their balance sheets and expense their obsolete inventory as they dispose of it, which reduces profits or results in losses. Companies report inventory obsolescence by debiting an expense account and crediting a contra asset account. For example, a company what is cash flow and why is it important may use obsolescence calculations to determine when it is time to replace an outdated piece of machinery or technology, or to adjust inventory levels to reflect changes in consumer demand. A retailer may use obsolescence assessments to determine when to discount or liquidate products that are no longer in demand, or to adjust its inventory mix to reflect changing consumer preferences. When the asset was sold for $27,100, the accounting records would show $30,900 in depreciation (cost of $58,000 less the sales price of $27,100).

Accounting for obsolete inventory

Obsolescence concept is an important part of various areas in business, economics, technology, innovation and other.

Obsolescence risk is most significant for technology-based companies or companies with products or services based on technological advantages. There are several types of obsolescence, including functional obsolescence, technological obsolescence, and style obsolescence. They need to understand how long after they place an order they will actually receive products, which could vary among vendors.