How does obsolete inventory work?
The world is always changing, and other companies are coming out with newer, better versions of the same product. Your products will eventually become obsolete and no longer have a consumer base.
Obsolete inventory accounting
Accounting for obsolete inventory and its value is critical, as it can impact a company’s financial statements. When obsolete inventory benchmarks are reached, the cost of goods sold and the value of total assets will both decrease.
This means that manufacturers must keep track of their inventory to ensure they are not spending too much money on unsellable products.
A write-down is a standard accounting obsolete inventory journal entry used to record the value of the old stock. This write-down is typically done when a company has certain products that are no longer useful and will not be sold.
For example, if the value of 200 units is initially $10,000, but they have become obsolete, the company may write down the value of these units to $5,000. This will then be reflected in their financial statements as a decrease of $5,000 in the cost of goods sold and assets.
A write-off is when a company eliminates an obsolete stock item from its financial statements. This is usually done when a product has become so outdated that it has no value left or is a net negative for the company.
Causes of obsolete inventory
Here are some of the ways that your inventory can become obsolete.
Technology is always changing and improving. This can render a product obsolete as newer products offer more features or better performance at a lower cost.
Consider the example of the VHS tape. Once DVD and Blu-Ray players became popular, VHS tapes were no longer in demand. Now those, too, have been replaced by streaming services.
Innovative companies can cause internal obsolescence by improving and replacing existing products.
Changing customer preferences
You can’t always predict customer preferences. People’s tastes can change quickly, and what was once popular may no longer be in demand.
For example, if your company produces clothing for teens, you must keep up with the trends to remain competitive. If your warehouse consists of items that are no longer in fashion, it could quickly become stale inventory.
Competitors don’t always need to advance the technology to make your product obsolete. A new brand with a better price or better marketing may be enough to disrupt your market. With so many options for consumers, it’s easy for them to shift away from your product, even if it still meets their needs.
Government regulations can also render a product obsolete. If your company manufactures products that are no longer legal or compliant with the law, it will be challenging to sell them.
When the government changes regulations, it is vital to adapt quickly and modify your products to meet the new standards. Compliance is essential, and ignoring new laws could cost your company dearly.