What is Obsolete Inventory?

Obsolete inventory, also known as the excess inventory or dead inventory, refers to such an inventory that is toward the end of the product life cycle. For a long period of time, neither this inventory has been used nor sold.

Moreover, there are no expectations of selling anything from the inventory in the future. An obsolete inventory should be written-off or written-down since it can cause huge losses.

Explaining Obsolete Inventory

In simple words, inventory is known as the materials or products that a company possesses and are ready to be sold. An inventory, undoubtedly, is one of the most important assets of a firm as it is obligated for a huge percentage of the sales revenues of a company.

However, if a specific company holds the inventory for too long, there are chances for the products to reach the end of their life and turn obsolete. On top of that, with an abundance of products, latest technology and higher expectations of customers, the life cycle of a product becomes shorter, and inventory goes obsolete faster.

When an inventory cannot be sold, it decreases substantially in value and could be regarded as useless for the company. Therefore, an obsolete inventory should be written-off or written-down, to identify the value decline, in the financial statements.

A write-down takes place if the inventory’s Market value goes below the cost that has been reported on the financial statement. And, a write-off comprises taking the inventory completely off the books when it is recognized to have zero value; hence, cannot be put in the market for sale.

Example of Obsolete Inventory

Let’s go in-depth with an obsolete inventory example here. Suppose a company recognizes Rs. 8,000 worth of the obsolete inventory. Then, the company estimates that there are chances of selling the inventory for Rs. 1500 and goes ahead to write-down the value.

Considering that the value has declined from Rs. 8000 to Rs. 1500; the difference signifies the value decrease that has to be reported in the sheets, which will be:

Rs. 8000 – Rs. 1500 = Rs. 6500

The allowance for the obsolete inventory account is the reserve that is preserved as a contra asset to hold the original cost of the inventory on its account until it can be disposed of. Once the obsolete inventory is disposed of, both the allowance and the inventory asset get cleared.