Businesses may end up with obsolete inventory when they fail to accurately forecast demand based on historical sales data, market trends, and other factors. The allowance for obsolete inventory account is a reserve that is maintained as a contra asset account so that the original cost of the inventory can be held on the inventory account until it is disposed of. When the obsolete inventory is finally disposed of, both the inventory asset and the allowance for obsolete inventory is cleared. This inventory has not been sold or used for a long period of time and is not expected to be sold in the future. This type of inventory has to be written-down or written-off and can cause large losses for a company. If bad buying decisions are made, sellers will end up with products no one wants.
Conversely, if a company is offering items that can be found everywhere else, there’s a chance they could be stuck with them. Inventory control describes having a thorough oversight of each item in the warehouse. https://www.bookstime.com/ It differs from inventory management in that it focuses much more on the actual number of each item held in storage, ensures the right levels are there at all times, and keeps on top of purchase orders.
How to Identify the Obsolete Inventory Problem
Management estimates the obsolete inventory base on the historical data and nature of product. It requires the company to make estimates on inventory obsoletes and record expenses on every accounting period. The main problem with the obsolete inventory percentage is figuring out which inventory to include in the numerator, since it can be difficult to define “recent” usage. Whatever method is chosen to define “recent” usage should be applied in a consistent manner, so that trends in the percentage can be more reliably tracked over time.
Beach toys, Christmas decorations, and Halloween costumes are all examples of seasonal products that will eventually become obsolete. While small businesses could hold onto these items until the season rolls around again, doing so can be costly and limits cash flow. For instance, conducting regular inventory audits can quickly identify obsolete inventory before it eats away at your profits. 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 journal entry removes the value of the obsolete inventory both from the allowance for obsolete inventory account and from the inventory account itself.
The Timing of Obsolete Inventory Recognition
A new brand with a better price or better marketing may be enough to disrupt your market. With so many options for consumers, it’s easy for them to shift away from your product, even if it still meets their needs. 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. We hope this article has given you a better understanding of what obsolete inventory is and why it is essential for a company’s financial health and long-term success.
A robust inventory management system like Cin7 Omni can do the heavy lifting for you. The software produces reports, insights, and advanced analytics you’ll find invaluable when making decisions about buying new inventory. When you base your buying decisions on information like this, you have a much better chance of having best-selling items in stock and avoiding those slow movers that can end up being obsolete.
Benefits of Getting Rid of Obsolete Inventory
It can include outdated parts, components, or materials no longer used in production. Because these products cannot be sold, they can take up valuable space and resources that could otherwise be used to store more profitable items. A final source of information is the preceding period’s obsolete inventory report.
- You can also use automated systems to detect when certain items are becoming obsolete and adjust your inventory accordingly.
- 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.
- Inventory is at the heart of an online business, so it’s important to have access to data that provides insights into how well your supply chain is performing.
- The transaction will not impact the expense account on income statement as the company has already estimated and recorded the expense.
- In the past, if the inventory was held for too long, the goods may have reached the end of their product life and become obsolete.