An inventory write down is the process of reducing the value of the inventory of a business to record the fact that the inventory is estimated to be worth less than the value currently shown in the accounting records.
As an example, suppose a business has a product in inventory which cost 1,000, and has decided that due to a decline in the market for the product, its value is estimated to be worth 700.
Inventory Write Down Journal Entry
The value of the inventory has fallen from 1,000 to 700, and the reduction in value which needs to be reflected in the accounting records is 1,000 – 700 = 300.
The inventory write down journal entry is as follows:
|Loss on inventory write down||300|
|Allowance for obsolete inventory||300|
The journal entry above shows the inventory write down expense being debited to the Loss on inventory write down account. If the inventory write down is immaterial, then a business will often charge the inventory write down to the Cost of goods sold account. The problem with charging the amount to the cost of goods sold account is that it distorts the gross margin of the business, as there is no corresponding revenue entered for the sale of the product.
The journal entry also shows the inventory write down being credited to the Allowance for obsolete inventory account. In effect, this has crested a reserve against which future inventory write offs can be charged.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business This is true at any time and applies to each transaction. For this transaction the Accounting equation is shown in the following table.
|Allowance for obsolete inventory||=||None||+||Retained earnings|
|– 300||=||0||+||– 300|
In this case the asset of inventory has been decreased by a 300 credit to the contra asset account, Allowance for obsolete inventory. At this stage the inventory write down reflects an estimated reduction in the value of the inventory, and the reduction is reflected in the contra asset account of Allowance for obsolete inventory rather than the Inventory account itself.
The profit and loss has been charged with the 300 as an expense to the Loss on inventory write down account. The charge to the profit and loss reduces the profit which reduces the retained earnings and therefore the owners equity in the business.
The Allowance for obsolete inventory account is included on the balance sheet directly below the Inventory account to show a net value of inventory. In this example, the Inventory account shows a debit balance of 1,000 and the Allowance for obsolete inventory account shows a credit balance a 300, resulting in a net inventory of 700 as required.
The purpose of the Allowance for obsolete inventory account is to allow the original cost of the inventory to be maintained on the Inventory account until disposed of. The use of the Allowance for obsolete inventory account is further explained here.
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