Inventory Write Down | Inventory Write Down vs Write Off

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Inventory Write Down | Inventory Write Down vs Write Off

Inventory Write Down | Inventory Write Down vs Write Off

Definition of Inventory Write Down

Inventory is to be valued at lower of cost or Net Realisable Value as per Generally Accepted Accounting Principles, so whenever the value of inventory gets affected due to several factors, then it is to be write down to the actual realizable value and at every balance sheet date, the assessment of the valuation of inventory is to be done so as to reflect the correct value.

Explanation

Inventory is a major part of every business organization. The valuation of inventory also plays a major role in determining the profit of the company. The expenses related to inventory depends upon the nature of goods, storage period, etc. With the passage of time and change in market situations, the value of inventory gets affected, so at every balance sheet date, the valuation of inventory is to be done, and if the net realizable value of inventory is less than the value shown in the accounts, then inventory valuation is to be write down to its net realizable value so as to reflect the true and fair view in the accounts.

How to Perform Inventory Write Down?

Inventory is to be valued at lower of cost or net realizable value, and this assessment is to be done at every balance sheet date. Net realizable value is to be assessed on the basis of market value, i.e. what will be the value of inventory if it is sold on the date of the balance sheet. Suppose the net realizable value is more than the value recognized in the balance sheet (i.e., its cost). In that case, inventory is to be valued at cost only, which means there is no need to revalue the inventory as per generally accepted accounting policies. If the net realizable value of inventory is less than the cost shown in the balance sheet, then the value of inventory is to be reduced to net realizable value, i.e., inventory is to be written down. If the difference between cost and net realizable value is low, then the difference is debited to the cost of goods sold, i.e., inventory is to be reduced, and the cost of goods sold is to be increased. On the other side, if the difference between cost and net realizable value is high, then the difference is debited to the profit and loss account as inventory writes off.

Example of Inventory Write down

An Ltd. valued its inventory amounting to $ 35,000 at the end of February 2020. In 2020 due to change in the market situations, A Ltd. realized that the selling price of goods reduced to below the cost so A Ltd decides to revalue the inventory as on March 2020, and on assessment, it had found that the inventory has a realizable value of $ 30,000 only. Give the accounting treatment and journal entries in the books of A Ltd by both methods, i.e., reducing the cost of goods sold and write off as expenses. Also, what will be the value of inventory if further in March 2021 the same inventory is in stock and has a realizable value of $ 32,000

Solution:

As of March 2020, inventory is to be valued at lower of cost or net realizable value, i.e. $ 30,000, i.e. inventory is to be written down by $ 5000.

1. Journal Entry for reducing the inventory through increase the cost of goods sold

Date Particulars Debit($)Credit($)
20-MarCost of Goods Sold A/c          Dr.5,000
    To Inventory A/c5,000
(Being Inventory is to be written down to Net Realizable value and the difference is added to the cost of goods sold)

2. Journal Entry for Reducing the inventory by debiting as expenses

Date Particulars Debit ($)Credit($)
20-MarInventory write off Expenses A/c  Dr.5,000
    To Inventory A/c5,000
(Being Inventory is to be written down to Net Realizable value by debiting the loss to P&L)
Date Particulars Debit ($)Credit($)
20-MarProfit and Loss A/c                    Dr.5,000
   To Inventory write off Expenses A/c5,000
(Being Inventory is to be written down to Net Realizable value by debiting the loss to P&L)

As of March 2021, As the Net Realizable value of inventory is increased and below the cost, the write down is to be reversed. The value of Inventory is $ 32,000, i.e. $ 2,000 written off is to be reversed.

1. Journal Entry for reversal of write down of the inventory through decrease the cost of goods sold

Date Particulars Debit ($)Credit($)
21-MarInventory A/c                            Dr.2,000
    To Cost of Goods sold A/c.2,000
(Being write down of inventory is to be reversed by decreasing the cost of goods sold as used earlier for the write down of inventory)

2. Journal Entry for Reversal of the inventory by crediting the profit and loss account

Date Particulars Debit ($)Credit($)
21-MarInventory A/c                              Dr.2,000
    To Inventory W/o Expenses A/c2,000
(Being Inventory valuation reversed due to increase in the net realizable value below the cost by crediting w/o expenses)
Date Particulars Debit ($)Credit($)
21-MarInventory write off Expenses A/c       Dr.2,000
   To Profit and Loss A/c2,000
(Being write off of Inventory is reversed by crediting profit and loss account)

Tax Deduction for Inventory Write Down

It is considered expenses that are allowable business expenditure as per generally accepted accounting principles, and the income is reduced to the extent of the inventory’s write down. Hence the tax benefit is available as the income is reduced and expense is increased.

Inventory Write Down vs Write Off

  • Inventory is to be written down when there is a reduction in the valuation of inventory, whereas inventory is to be written off when the inventory becomes absolute and the same is of no use.
  • Inventory is to be written down because of reasons like the decline in the sale price or adverse market conditions, whereas inventory is to be written off in case inventory is burned due to fire or due to storage or bad conditions making its resale value as zero.
  • In inventory written down, inventory is to be valued at lower of cost or net realizable value, whereas in inventory write off, inventory is to be written off completely from the profit and loss account and valued at nil.

Why Is Inventory Write Down Happening?

It happens due to the following reasons:

  • Adverse market conditions like lower cost of raw materials, availability of substitutes etc.
  • Due to declining in the sale price, of final product inventory is to be written down.
  • When the part of inventory has no realizable value.

Effect of Inventory Write Down

Following are the effect of inventory write down:

  • Inventory is to be re-valued at net realizable value after write down.
  • The loss on write down of inventory is to be reduced from the net income.
  • The tax benefit is to be availed from inventory write down as income decreases.

Conclusion

Inventory is to written down to net realizable value when the cost of inventory is reduced due to several conditions like adverse market situations, lowering the sale price, substitutes available, etc. If after write down of inventory further the net realizable value increases but the same is below the cost, then they write down is to be reversed. It is different from inventory written off as inventory is written off the complete inventory cost is to be debited to profit and loss account due to non-saleable condition.

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This is a guide to Inventory Write Down. Here we also discuss the definition and how to perform inventory write down? Along with an example. You may also have a look at the following articles to learn more –

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