May 15, 2024

What Is Obsolete Inventory and How Is It Accounted For?

If you’ve determined there’s simply not enough demand to run what is net 30 understanding net 30 payment terms a sale or bundle inventory, you might need to consider liquidation. Inventory liquidation is the process of selling off undesirable inventory at a significant discount in exchange for cash. Flash sales, buy-one-get-one offers, and other promotions can also help your company move obsolete inventory before losing its value. Below, we’ll look at an obsolete inventory definition, the causes of obsolete inventory, and strategies for managing it.

To learn more about how ShipBob can help you optimize your supply chain, click the button below to start the conversation. By performing regular audits, you can quickly remove inventory that is unsellable or unlikely to sell. According to a study of Avery Dennison, On average 8% of stock perishes or is discarded annually, which is worth approximately $163 billion worth of inventory.

How to reduce obsolete inventory

A contra asset account is reported on the balance sheet immediately below the asset account to which it relates, and it reduces the net reported value of the asset account. While writing off small amounts of inventory is often unavoidable, obsolete stock doesn’t need to be such a big contributor to liabilities on the balance sheet. Not only is this much preferred to disposing of the items, but it can make organizations eligible for a tax deduction equivalent to the cost of those products. This option is more relevant for retailers and distributors that sell finished goods, rather than manufacturers or suppliers that work with raw materials. Excessive inventory of any product, regardless of its current demand, can indicate potential obsolescence.

Financial Impact

Slow-moving items and dead stock can take up valuable storage space that could be used to store a higher volume of faster-selling products. Though there are several ways to help avoid accumulating obsolete inventory, carrying any type of dead stock is inevitable. Supply chain forecasting involves using data and research to make predictions on all aspects of the supply chain to ensure a business runs smoothly and continues to grow. This includes having insights into production lead times, labor needs, warehousing, order fulfillment, and shipping. In this article, we discuss how to avoid, identify, reduce, and royalty disbursement or suspense account definition manage obsolete inventory to ensure a more profitable business.

How ShipBob ensures inventory obsolescence is a problem of the past

Conversely, underestimating demand can lead to stockouts, prompting companies to overcompensate by ordering too much inventory, which may eventually become obsolete. Companies can avoid obsolete inventory by improving forecasting techniques, using a what is the difference between adjusting entries and correcting entries more adequate inventory management system, making smart purchasing decisions, and accurately predicting lead times. A business may purchase too much of a product due to poor company forecasting, an inefficient inventory management system, or inaccurate lead times.

Sudden changes in consumer preferences, economic downturns, or the introduction of new technology can render existing products obsolete almost overnight.
This technique is crucial for accurately reflecting the true value of inventory on a company’s financial statements.
A purchasing manager made matters worse by buying 200 more 1080p sets than the forecast called for in exchange for a lower price per TV.
This surplus stock can tie up valuable capital and warehouse space, impacting the company’s profitability.
For example, if your company produces clothing for teens, you must keep up with the trends to remain competitive.
Modern inventory management software can automate many of the tasks involved in identifying obsolete inventory.
In the fast-paced and ever-evolving landscape of modern business, effectively managing obsolete inventory is crucial for maintaining a competitive edge and ensuring long-term sustainability.

Reasons to avoid obsolete inventory

Manufacturing companies understand this all too well, as they must keep track of the inventory in their warehouses. By choosing a more accurate way to predict demand, you could save your business time, stress, and money. These industries are at high risk of obsolescence because demand for them is often seasonal and/or trend based.

Storage and Disposal Costs

The amount in this reserve should be the estimated amount by which the inventory asset will be written down, once specific inventory items have been identified as obsolete. Damaged or defective products are not only unsaleable but also create a negative perception of your brand. Consider repair options, discounts for minor flaws, or proper disposal methods to prevent them from taking up valuable space. Implement an efficient system to track product expiration dates and remove them from shelves before they become obsolete.

This data can be used to identify potential risks to product quality or shelf life, allowing businesses to take proactive measures to prevent inventory from becoming obsolete due to environmental factors. Liquidation involves selling obsolete inventory in bulk to liquidators or through special liquidation sales. These channels typically offer a quick and efficient way to dispose of excess stock, although the return on investment may be lower than other disposal methods. Obsolete inventory is any excess products or stock a small business has and doesn’t expect will sell, usually due to lack of demand. Also known as dead inventory, obsolete inventory is at the end of its product life cycle—often because it has been replaced in the market by newer, updated versions of the product. Small-business owners should do everything they can to avoid high levels of obsolete inventory.

However, manufacturing companies and companies that are in industries prone to obsolescence, such as technology or food service, may wish to re-evaluate this reserve on a quarterly basis.
Not wasting money on obsolete inventory frees up cash the company can invest in other areas to help it succeed.
Products that become obsolete or dead go through multiple steps before they become unsellable.
These items have typically been replaced in the marketplace by more advanced or inexpensive goods, so there is no longer any demand for them.
Identifying obsolete inventory begins with analyzing sales trends and inventory turnover ratios.
When it’s not, and the purchasing team is buying based on anecdotal knowledge or other unreliable factors, it leads to problems.
For instance, new environmental regulations could render certain products unsellable.

From there, you can make a decision on when to run a flash sale or donate items so you’re not overpaying in storage fees. The best way to identify obsolete inventory is by implementing the right tools, technology, and processes to identify slow-moving inventory on hand. Along with inventory management, having visibility over your inventory at all times is key. Without inventory visibility, it will be hard to understand how much of each product you need to restock and when (and what product(s) might be worth discontinuing).

Not only can a lack of visibility cause obsolete inventory to go unseen (and therefore increase carrying costs), you also risk stockouts of your high-demand products. It happens when a business considers it to be no longer sellable or usable and most likely will not sell in the future due to a lack of market value and demand. Usually, inventory items become obsolete stock after a certain time period has passed and after they reach the end of their lifecycle. The disposal of obsolete inventory occurs when it cannot be repurposed, kitted, donated, or discounted.