Obsolete and slow-moving inventory

An obsolete inventory write-down example

The rates come from what the manufacturer has achieved when selling aged stock in the past, through discounting, sales to clearance channels or scrap, compared with its cost. Items over 24 months old have historically sold for about 20% of cost, so they are written down by 80%. The discontinued line has no buyers and will be scrapped.

What evidence supports an ageing-based write-down?

IAS 2 requires inventory to be written down item by item, or by groups of similar items, to net realisable value; a general provision is acceptable only if it is a reasonable estimate of that. Good evidence includes recent sales prices of aged stock, the scrap rate, demand forecasts, and stock held compared with expected usage. A blanket percentage with no link to actual recoveries is not enough, and neither is waiting until stock is physically scrapped.

When are raw materials written down?

Only when a decline in their price indicates that the cost of the finished products will exceed their net realisable value, in which case replacement cost may be the best measure. Raw materials held for discontinued products, or excess quantities that will never be used, are written down to their scrap or resale value.

What about spare parts?

Spare parts held for sale to customers are inventory and are written down when slow-moving. Major spare parts held for the manufacturer's own plant and expected to be used for more than a year are property, plant and equipment under IAS 16, depreciated rather than written down for ageing.

What about components for superseded designs?

When a product is redesigned, components used only in the old design can become obsolete overnight. Manufacturers review the bill of materials when designs change, identifying parts no longer needed and writing them down to their scrap or resale value at that point, rather than waiting for them to age.

How do auditors test obsolescence write-downs?

By checking the ageing report against movement data, comparing the write-down rates with actual sales of aged stock after the year end, reviewing slow-moving items during the stock count, and looking at items with no movement that carry no write-down. Large write-backs in the following year suggest the write-down was too high.

Can write-downs be reversed?

Yes. If stock written down is later sold for more, or circumstances change, the write-down is reversed, limited to the original write-down, so the stock never exceeds cost. US GAAP does not allow reversals. Write-downs and reversals are recognised in cost of sales and disclosed.

Disclosure should also explain the circumstances behind any significant write-down or reversal, such as a product being discontinued or an unexpected sale of old stock.

What are common mistakes with obsolete inventory?

Using the same ageing rates for years without checking them against actual recoveries, ageing stock from the date it was made rather than its last movement, and treating a write-down as a reserve to smooth profits. See net realisable value, retail inventory and manufacturing accounting.

This guide is general information. It is not tax or legal advice for your situation.