Inventory is a critical asset for many businesses, but its value can fluctuate due to obsolescence, damage, or market changes. When inventory loses value and is no longer worth its recorded cost, companies must write down its value to reflect the lower market price. Proper accounting for inventory write-downs and adjustments ensures financial statements remain accurate and transparent.
An inventory write-down occurs when the market value of inventory falls below its recorded cost on the balance sheet. This adjustment recognizes the loss in value and prevents the company from overstating its assets.
Common Reasons for Inventory Write-Downs:
✔ Obsolescence – Items become outdated due to technological advancements or changing consumer preferences.
✔ Physical damage – Goods may be broken, expired, or defective.
✔ Declining market prices – Competition or economic conditions may lower an item’s resale value.
✔ Excess inventory – Overstocking leads to slow-moving items that must be sold at a discount.
Companies must periodically assess whether inventory is carried at a fair value. This involves comparing:
📌 Cost of Inventory (Book Value) – The original purchase cost recorded on the balance sheet.
📌 Net Realizable Value (NRV) – The expected selling price minus any selling costs (e.g., discounts, shipping).
If the NRV is lower than the cost, a write-down is required to reduce inventory to its fair value.
📌 Formula:
Write-Down= Cost−Net Realizable Value (NRV)
Example:
A retailer holds 500 smartphones that cost $200 each.
Due to new models, the selling price drops to $150 each, with an additional $10 in selling costs.
NRV per unit = $150 - $10 = $140.
Since $140 < $200, the company must write down inventory by $60 per unit ($200 - $140).
When inventory is written down, the loss is recorded as an expense on the income statement.
📌 Journal Entry:
Dr. Inventory Write-Down Expense $30,000
Cr. Inventory $30,000
(Assuming 500 smartphones x $60 write-down per unit)
This entry:
✔ Reduces inventory value on the balance sheet.
✔ Records the loss on the income statement, affecting net income.
Under IFRS, if market conditions improve and inventory value recovers, the write-down can be reversed (up to the original cost).
📌 Reversal Entry (IFRS Only):
Dr. Inventory $10,000
Cr. Inventory Recovery Income $10,000
This adjustment increases net income and restores inventory value.
Under GAAP, inventory write-downs cannot be reversed, even if prices recover.
Aside from write-downs, companies regularly adjust inventory balances for:
🔹 Shrinkage – Losses due to theft, errors, or spoilage.
🔹 Revaluation – Adjustments for changing costs or methods (FIFO, LIFO, Weighted Average).
🔹 Physical Counts – Reconciliations between book inventory and actual stock levels.
✔ Ensures financial statements are accurate by preventing inflated asset values.
✔ Reflects real business performance by recognizing losses when they occur.
✔ Complies with accounting standards (GAAP and IFRS) to maintain transparency.
✔ Helps management make better pricing and purchasing decisions.
Inventory write-downs are a necessary accounting process that protects financial integrity and ensures that assets are not overstated. Businesses should regularly review their inventory, apply conservative valuation methods, and stay aware of market trends to avoid large unexpected losses.