Inventory write-down and inventory write-off explained

Write down, right hand. Write off, left hand. Just as Mr. Miyagi taught us, the journey to success includes some situations, tasks, and chores that we would probably prefer to skip, but that are also important to the quality of our overall effort. Every journey faces adjustments along the way, for various reasons, and inventory management is no different! 

Although unfortunate, writing down or writing off inventory is unavoidable. In fact, you’ll find that you’re likely to come across situations in which either one or both adjustments might be your smartest option. And that is truly the best way to think about them — adjustments that you can make to ensure that the accounting of your balance sheet and your income statement truly match. Let’s dig into the details of an inventory write-down, a write-off, and how each one works, specifically. 

What is inventory write-down?

This accounting adjustment is what you would use to reduce the value of certain inventory on your balance sheet. Also sometimes referred to as “inventory impairment,” what you need it for is to formally acknowledge when the market value of some inventory has dropped below its value on your books. The key factor in this scenario is that the inventory in question is still sellable. 

Benefits of inventory write-down

While it’s understandable that you might think of this adjustment as a negative, it’s important to consider the benefits of inventory write-down to your business:

• Fact-based decision making — Maintaining an accurate valuation of your inventory helps you better adjust your production, purchasing, and pricing strategies.
• Prevent future losses — Recognizing inventory devaluation early helps you prevent total inventory loss later, such as forced liquidation of damaged or obsolete inventory.
• Correct financial reporting — Legitimate write-downs ensure that your financial statements reflect your company’s financial health.
• Tax benefit — Check if write-downs can translate to tax savings in your jurisdiction.

Challenges of inventory write-down

Maintaining a healthy financial situation is essential to any business, and an inventory write-down is an important element of that. It can, however, present challenges:

• Valuation — It can be difficult to accurately estimate the market value of certain inventory, depending on how fast prices vary for it or how active the market is.
• Judgment call — Similarly, estimating the devaluation you should write down might be subjective.
• Timing — The best timing for an inventory write-down can also be challenging to pin down — waiting too long could distort your financial statements, but writing down too soon might reduce reported profits unnecessarily. 
• Profitability — Since write-downs reduce net income, this adjustment reflects on profits and earnings per share, which investors tend to keep an eye on.

How to write down inventory

There are multiple ways you could adjust your inventory value on the balance sheet to reflect either the current market value or its lower of cost or market (LCM) value. It is also important to note that the specific accounting treatment you choose for inventory write-downs can vary depending on your company’s internal policies and accounting standards (GAAP or IFRS).

Making this adjustment can be broken down into three main steps:

• Establishing the impairment means you calculate the estimated difference between the original cost of the inventory (let’s say $10,000) and the current market value (let’s say $8,000).
• Recording the write-down, you make a note to reduce the inventory account and recognize the loss — in this case, $2,000 — on the income statement.
• Updating your records to appropriately reflect the new value for the written-down inventory. 

What is inventory write-off?

The inventory write-off is an accounting adjustment that takes it one step further. Specifically, it is a formal recognition of inventory that can no longer be sold and has completely lost its value. A write-off removes the inventory from your company’s accounting records. 

Benefits of inventory write-off

Even though, in many ways, this represents a loss for your company, you should know that it also offers some benefits:

• Free capital — Clearing your balance sheet of inventory you can no longer sell can free up capital that you can direct elsewhere in your operations.
• Tax benefits — Depending on the accounting standards applicable to your business or in your area, inventory write-offs can be tax-deductible.
• Improved inventory management — Going through this experience a few times can be very informative about how to better manage your inventory to avoid overstocking, damage, or other issues.

Challenges of inventory write-off

Although it does happen as the result of circumstances that you could not have accounted for or sheer bad luck, inventory write-offs are a “fix” that can come with some challenges:

• Complicated taxes — Depending on where you are, the tax implications of an inventory write-off can be complicated and difficult to navigate without professional guidance.
• Brand image — One too many write-offs can affect the perception of your business, as it affects profitability and can be an indication of persistent inventory management issues.
• Subjectivity stress — If you are dealing with items in various states of damage or obsolescence, it can be challenging to be accurate with the value and the timing of your write-off.

How to write off inventory

It’s important to note from the get-go that inventory write-offs should first be carefully evaluated and documented so that you comply with the appropriate accounting standards and tax regulations that apply to your business in your location. 

There are a few general steps to the formal acknowledgment that certain inventory items are no longer assets and have become expenses, instead:

• Identify the inventory that has lost its value due to damage, obsolescence, theft, or other reasons
• Do a valuation by which you estimate the cost of the inventory that you are writing off
• Document the write-off process as support for your financial statements

Take charge of inventory write-downs and write-offs with Katana

The base layer of your success in catching any inventory issues is to have real-time visibility and tracking for your products. With Katana Cloud inventory solutions, you can track raw materials, work-in-progress inventory, as well as finished goods in real time, allowing you to catch any issues as early as possible. 

What’s more, the data you collect in real time empowers you to adjust not just your accounting records, but also your inventory management strategy so that you can avoid experiencing the same issues in the future. 

Additionally, Katana Insights makes financial visibility easy, allowing you to track your inventory valuations and costs. Katana also keeps bookkeeping convenient with easy accounting integrations with Xero and QuickBooks Online. 

Reach out for a demo to see how our solutions can add value to your business.

FAQ

Ioana Neamt

Contributing Writer

With more than 10 years of copywriting experience, Ioana has a fondness for longform writing, investigative journalism, cats, and Victorian-style mansions.