Inventory write-offs are unfortunate but necessary when inventory goes missing, is damaged, or loses value on the market. Following a proper accounting process is critical when writing off inventory: otherwise, your balance sheet and income statement will become more and more mismatched with each write-off until you have a major budget problem.
There is a simple write-off process that you can follow to avoid this and ensure your financial statements stay accurate. Furthermore, a 3PL like ShipBob can streamline your inventory management and fulfillment processes to prevent future write-offs and make your capital more productive.
Read on to learn everything you need to know about inventory write-offs:
- Why inventory is written off
- How to account for written off inventory
- How a 3PL can minimize write-offs
What is an inventory write-off?
An inventory write-off is the process of removing or reducing the value of inventory that has no value for businesses from their accounting records. Inventory is written off for various reasons, such as when inventory has lost its value and cannot be sold due to damage, theft, loss, or decline in market value.
Write-down vs write-off
Inventory write-downs are similar, but less drastic than a write-off. A company’s inventory is written down when the valuation of an asset must be reduced in accounting, whereas a write-off is when an asset loses all of its value and must be removed from accounting records entirely. If a company’s inventory still has fair market value but that value is less than its book value, it will get written down, not written off.
When to write off inventory
Both large and small businesses that maintain inventory on hand will have to write-off a portion of it at some point in their journal entry. Here are the most common reasons inventory is written off.
1. Inventory is stolen
Unfortunately, small and large inventory have a tendency to disappear. It may be stolen earlier in the supply chain before it even reaches you, or by shoplifters, or even employees. When your inventory counts don’t match what you have on hand, theft may be the culprit.
2. Inventory has been damaged at any part of the supply chain
For inventory to maintain its value it must arrive in fit condition to be sold. But, of course, this doesn’t always happen. The supply chain can stop functioning at any point, leading to damaged or defective products, and become unsellable as a result. You should be reimbursed by the supplier, but in the meantime, you will have to write-off the damaged inventory.
3. Inventory isn’t relevant to the market anymore
Market demand changes rapidly, and a product that you thought would be a big seller a year ago may have become obsolete in the market (like 3D TVs or hoverboards). Now, with all this obsolete inventory on hand and nothing to do with it, you might have to consider writing it off.
4. Inventory was perishable
Businesses that handle food, drinks, or anything perishable will be all too familiar with this scenario. Do your best to not overbuy and cycle through dates properly, but any products that reach an expiration date will have to be written off.
How to write off inventory in 5 simple steps
Accounting for inventory write-offs and inventory reserves are just a matter of accurately assessing damage/losses and charging them to the right account. Then, you need to trace the source of the damage or inventory losses to prevent it from happening again.
1. Assess your damage
The first step is to determine how much inventory is damaged and must be written off from the gross inventory. For instance, if you receive a shipment with damaged or defective product, first separate the damaged inventory from any that might still be sellable.
2. Calculate losses
Now that you know exactly how many inventory items are damaged, calculate the losses by multiplying the cost-per-unit by the number of damaged units.
3. Account it as an expense
Businesses typically set up an inventory write-off expense account to record the value of inventory written off from the current assets. When you add to the inventory expense account, you must reduce the amount of inventory. In some cases, inventory write off can be accounted as tax deductible but the IRS is very strict about the criteria.
4. Debit COGS while crediting inventory-write off
On your balance sheet, debit cost of goods sold (COGS) and credit your inventory write-off expense account. If you’re only writing off small amounts of inventory, you can also just debit your COGS account and credit your inventory account.
5. Assess the error
Finally, you need to get to the bottom of the write-off to prevent it from happening in the future. If inventory was damaged, how did the damage occur? If counts are off and inventory disappeared, trace it through the supply chain and figure out where it went missing.
Inventory write-offs and ecommerce
Ecommerce businesses often see inventory and fulfillment as a cost center, but what if, with the right inventory solutions, it could actually drive revenue? Holding more inventory than you can sell is an unproductive use of capital and also leads to write-offs.
Minimizing inventory write offs with a 3PL
In a traditional supply chain the upstream activities of purchasing and manufacturing are disconnected from actual demand for the product. This is a chief cause of inventory write-offs, as sales and demand aren’t feeding back into purchasing decisions.
A 3PL like ShipBob, on the other hand, integrates with your sales and distribution processes as well as upstream purchasing and manufacturing. This makes the supply chain more agile and responsive, and minimizes inventory build-up. For instance, ShipBob allows you to set reorder points, so inventory is ordered automatically in the right amounts to meet demand when you need it most.
The accounting terms and processes of writing off inventory are a generally accepted accounting principle, but preventing inventory write-offs is much trickier. It requires accurately forecasting demand, accurately accounting for the value of the inventory, current inventory market prices and strategically placing orders at the right time and in the right amount.
ShipBob’s inventory management software can help prevent write-offs by centralizing your data in one place and automating the reorder process. Learn more about our fulfillment services and more by speaking with a fulfillment expert and requesting a pricing quote below.
Inventory write-off FAQs
What is inventory write-off?
Inventory write-off is the process of removing inventory that has no value for businesses from their accounting records.
What happens when you write-off inventory?
Companies often charge written-off inventory to their cost of sold goods (COGS) at the end of the year, then they take the loss and continue with business as usual.
What is the difference between inventory write-down and inventory write-off?
A write-down reduces the value of something for account and tax purposes, while leaving some value to the asset. Write-off reduces the value to zero.
What are the advantages of inventory write-off?
The two main advantages of inventory write-off is to support accounting accuracy and reduce the tax liability for business owners.