What Is Obsolete Inventory and How Is It Accounted For?

Due to poor inventory management, a batch of vaccines was forgotten in storage and not used before their expiration date. Since expired medical products cannot be legally sold, the entire batch must be written off as obsolete inventory, resulting in both financial loss and additional disposal costs. Obsolete inventory works as a warning sign for businesses to take action by either liquidating or recycling products that no longer serve a purpose.

Negative feedback from customers about a product’s performance or quality can be an early warning sign of obsolescence. If the product consistently underperforms, consider removing it from your inventory. If your company manufactures products that are no longer legal or compliant with the law, it will be challenging to sell them. 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. This means that manufacturers must keep track of their inventory to ensure they are not spending too much money on unsellable products.

• Write-offs and write-downs are considered non-cash expenses and thus need to be debited to an expense account, such as the cost of goods sold (COGS) or obsolete inventory account.
• This can lead to a strain on the company’s financial liquidity, impacting the ability to invest in profitable ventures or meet operational expenses.
• However, deductions must align with the lower of cost or market (LCM) rule, and businesses must provide documentation, such as inventory aging reports or evidence of market conditions, to substantiate the obsolescence.
• It is important for businesses to dispose of obsolete inventory responsibly, in compliance with relevant laws and regulations.
• Investing in advanced inventory management software can significantly enhance a company’s ability to prevent obsolete inventory.
• For example, MRPeasy integrates all of the above functionalities to support businesses in maintaining a streamlined and profitable inventory management process.
• By leveraging historical sales data and market trends, these systems allow businesses to predict future demand more precisely, helping to avoid the pitfalls of misaligned procurements.

Changing customer preferences

Generally accepted accounting principles require that estimates for obsolete inventory are reviewed on a regular basis. 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. While the annual review is required for accounting compliance, the quarterly review can help management identify ordering issues that increase the chance of products becoming obsolete. This is an example where, even though GAAP does not require more frequent analysis, it may be good for the company to address this issue more often than required.

Inaccurate inventory forecasting

Businesses should spend time closely studying historical demand, including seasonal trends for certain products, as they build forecasts. 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. If they walk into a store filled with too many different products, they might walk right back out. It is a delicate balance between having enough stock to satisfy customers and not having too much of it.

How to Identify Obsolete Inventory

Identifying obsolete inventory begins with analyzing sales trends and inventory turnover ratios. Inventory management software can track these metrics, flagging items that haven’t moved within a specific timeframe. This data-driven approach allows businesses to address potential obsolescence proactively. Obsolete inventory is a significant issue for businesses as it ties up valuable warehouse space and days in inventory capital that could be used for more profitable products. It often arises when products become outdated, discontinued, or replaced by newer versions.

How ShipBob ensures inventory obsolescence is a problem of the past

This strategy can be particularly useful for items that may not be attractive as standalone products but could serve as valuable add-ons or accessories. There are several ways a small-business owner may choose to handle obsolete inventory. The products may be remarketed by bundling them with other products, selling them to different audiences, or by selling them via new business channels. They could also be sold at a discount, liquidated, donated, or written off as a loss. Obsolete inventory can result from many issues, from poor inventory management and a lack of traceability to unexpected market dynamics, supply chain issues, or even bad luck. By taking a look at historical data, you can predict future demand for each SKU and make informed decisions to avoid purchasing too much of an item that might become obsolete faster than it can be sold.

Communicate with Suppliers and Customers:

If you’ve determined there’s simply not enough demand to run 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.

• In the U.S., inventory write-downs due to obsolescence are generally deductible as ordinary business expenses under IRS rules.
• This can pose a challenge for businesses as it ties up valuable resources that could be used for more profitable ventures.
• Consider repair options, discounts for minor flaws, or proper disposal methods to prevent them from taking up valuable space.
• Accumulating obsolete inventory can occur for several reasons, from inaccurately forecasting demand to a lack of proper inventory management.
• These items may remain in storage for extended periods, gradually losing their value and becoming increasingly difficult to sell or repurpose.
• Inventory management software can automatically track inventory-relevant KPIs like reorder point, days of inventory on hand and inventory turn and deliver daily reports with key numbers.
• 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).

Excess obsolete inventory can lead to cluttered warehouses, making it difficult to locate and retrieve items efficiently, resulting in longer lead times and potential customer dissatisfaction. Obsolete inventory often also requires additional handling, such as relocation or special storage arrangements, which can increase operational costs. At the same time, the presence of obsolete inventory can hinder the efficient flow of materials and products, leading to delays, disruptions, and decreased simple invoices in 9 steps productivity. Resources tied up in obsolete inventory can limit a company’s ability to respond quickly to changes in market demand, potentially causing them to miss out on lucrative opportunities.

This means you’ll always know what you’ve got in stock and where it is, even if you stock inventory across multiple locations. This should help your team order confidently, practice tighter inventory control, and quickly estimate the value of inventory you have on hand. If that’s the case, you can avoid over-ordering by buying less inventory more often rather than purchasing inventory for an entire year. Led by Mohammad Ali (15+ years in inventory management software), the Cash Flow Inventory Content Team empowers SMBs with clear financial strategies. We translate complex financial concepts into clear, actionable strategies through a rigorous editorial process.

One way is to use an inventory management system that helps track inventory throughout its lifecycle. This way, you have data to calculate inventory days on hand and inventory turnover rate, which are key inventory metrics to track. Visibility into real-time beginning inventory definition inventory levels is critical in enabling organizations to optimize purchasing and inventory management, which will minimize obsolete stock. Supply chain employees need constant access to their inventory positions for every SKU so they can place purchase orders or promote products when stock is low or high, respectively.