Imagine you run a home goods store that’s waiting on a shipment of furniture. But on the way to your location, the delivery truck gets in a minor fender bender. None of the items on the truck are ruined, but several pieces of furniture get banged up enough that you have to mark them down by 50%.
This is also known as a write-down, which is just what the name suggests — lowering the value of an item according to its condition.
Inventory write-downs aim to ensure a company’s inventory account reflects the actual value of its stock for accurate financial recordkeeping. Let’s explore the practice in more detail to keep your business’s finances on track.
What’s an inventory write-down?
An inventory write-down happens when a company’s inventory value falls below its original value. Damage is one potential cause, but there are others, like obsolescence or a decline in market value.
When performing an inventory write-down, you record the new lower market value in your books — also known as the book value — as an expense. For example, if you marked a $100 item as 25% off, you would write down that $25 as an expense. This way, financial records are as accurate as possible, and they account for the money lost.
People sometimes wrongly assume that an inventory write-off is the same as a write-down. Both involve adjusting inventory value, but a write-down is only a partial reduction. A write-off completely removes the value of unsellable inventory from the inventory account.
When you should do an inventory write-down
Let’s take a closer look at some scenarios that might call for an inventory write-down.
Obsolescence
If you make products that become outdated or obsolete due to technological advancements or changes in customer preferences, lean on write-downs to update your records. A smartphone manufacturer, for example, might need to lower the value of older models after releasing a new, higher-tech version of the same phone.
Damage
You can’t sell damaged inventory at its original price because it’s no longer worth that much. Whether the item is damaged in transit or while on display, write it down in your books and sell it for less. For example, write down a shirt that’s missing a button to reflect its new value.
Market decline
Sometimes the market value of inventory falls below its book value due to economic conditions or competitive pricing, resulting in dead stock. Say you have a stock of winter jackets that normally sells at $100 each, but demand decreases because the winter is milder than usual. Selling the jackets at a reduced price of $70 apiece is better than not at all. You still make a profit and clear out inventory.
Expiration
Inventory write-downs are common in the food industry because most edible items don’t have long shelf lives. If a grocery store has a stock of dairy products selling for $5 each, the store might need to reduce the price to $2 to encourage sales before expiration. The price change requires a write-down of $3 per unit.
4 steps to perform an inventory write-down
Here’s how to perform an inventory write-down to ensure accuracy and compliance with accounting standards.
1. Calculate the value difference
First, determine the difference between the original book value of the inventory and its current market value. This involves assessing the goods and evaluating current market prices.
2. Create a journal entry
Next, create a journal entry to record the write-down. This entry will debit an expense account and credit the inventory account. For example:
- Debit: Inventory Write-Down Expense (Expense Account)
- Credit: Inventory (Asset Account)
3. Report the write-down
Report the write-down in your financial statements. On the income statement, the write-down expense should appear under operating expenses. On the balance sheet, the reduced inventory value should be in the inventory asset account.
4. Evaluate circumstances
Write-downs are common, but they aren’t completely unavoidable. Now that you have the data, look at the circumstances that led to the write-down and note whatever could prevent future occurrences. That might mean reviewing inventory management practices, assessing supplier relationships, or analyzing market trends to better forecast sales.
What’s the effect of an inventory write-down?
Here’s a look at how write-downs affect your books so you can report finances more accurately.
Income statement impact
Since write-downs are recorded as an expense that reduces the company’s net income, they directly impact your income statement. You typically record an inventory write-down in the expense account designated for inventory adjustments. The entry on the income statement will reduce the reported profits, reflecting the loss in inventory value.
Balance sheet impact
On the balance sheet, a write-down reduces the inventory asset account, which in turn decreases total asset value. Making this adjustment ensures that the balance sheet presents an accurate picture of your financial position by aligning reported inventory value with its actual market value.
Reversal of inventory write-downs
A write-down isn’t always permanent. Sometimes, the value of something you’d previously written down recovers, prompting you to reverse the change. Here’s how that journal entry might look:
- Debit: Inventory (Asset Account)
- Credit: Inventory Write-Down Reversal (Income Account)
Accounting standards dictate that a reversal shouldn’t exceed the original write-down amount, and the reversal should appear in the same period as the value recovery. To ensure accurate financial reporting, documenting reversals is just as important as recording write-downs.
5 tips for reducing inventory write-downs
Here are some strategies to reduce write-downs and maintain good financial health.
1. Minimize excessive inventory
Aligning stock levels with demand helps you avoid holding excessive inventory, which could lower in value later. Regularly review sales data and trends to make informed purchasing decisions that reduce the risk of inventory impairment — when the market value of your inventory falls below its book value.
Implementing a just-in-time (JIT) inventory system minimizes the amount of stock you hold. It’s also a good idea to collaborate closely with suppliers to ensure timely deliveries that match sales cycles and avoid overstocks.
2. Use inventory management software
A comprehensive inventory management platform tracks inventory levels, automates reordering processes, and provides real-time data on inventory status, reducing the risk of write-downs. A solution like Fishbowl even integrates with your accounting system, offering seamless updates and accurately recording every transaction.
3. Keep inventory safe
You might not have the power to protect suppliers’ delivery trucks from minor accidents. But you can store inventory in conditions that prevent damage and deterioration before they ship out to customers. Invest in climate-controlled storage facilities with proper shelving and strong security measures, and do regular inspections to stay on top of issues like leaks, pest infestations, or lighting that could compromise quality.
4. Monitor sales and demand trends
Keeping a finger on the pulse of sales and trends offers the knowledge needed to adjust inventory levels according to demand. Use data analytics to forecast interest based on historical sales patterns, seasonal trends, and market analysis. Then, regularly review and adjust inventory levels to align with current and projected demand.
5. Track inventory by expiration date
If you sell products that expire, implement a system to track inventory based on expiration dates, shelf life, and other criteria that could lead to write-downs. Proper inventory tracking helps you identify items you may need to sell quickly to prevent the need to write them down (or off).
This process is much easier with inventory management software. You can set up alerts for items nearing expiration or the end of their shelf life so you know to sell them faster. Using a first-in, first-out (FIFO) approach for managing inventory rotation also helps offload older items before the newer, fresher products hit the floor.
Take full control of your inventory with Fishbowl
Minimizing write-downs and maintaining accurate financial records starts with effective inventory management — which means it starts with Fishbowl.
Fishbowl is an all-in-one inventory management solution designed to help you control stock, warehouse operations, and manufacturing workflows in one place. And thanks to the platform’s QuickBooks integration, your financial visibility will be clearer than ever. Schedule a demo to see how managing inventory with Fishbowl can keep your accounts — and your products — healthy.