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Any business owner who maintains inventory knows that a certain portion of that inventory probably won't be sold, and thus won't produce revenue.
The reasons are many: Technology becomes obsolete, perishable goods spoil, items get damaged or stolen. Accountants use "inventory reserves" and "inventory write-offs" to recognize this reality.
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The difference between them is one of timing: An inventory reserve anticipates inventory continue reading, while a write-off makes them official. Inventories as Assets A company's inventories count as assets on its balance sheet. Since inventories are made up of goods that can be sold to produce revenue -- or materials that will be turned into such goods -- they represent future economic value and therefore meet the accounting definition of assets.
Accounting for a Write-Off Writing off an asset is the same as claiming the asset no longer serves a purpose and has no future value. A write-off may usually be deducted from one's taxable income. In commercial or industrial settings, a productive asset may be subject to write-off if it suffers failure or accident damage that is infeasible to repair, leaving the asset unusable for its intended purpose. Because write off impacts Net income, therefore, the action also lowers dividends and retained earnings on the Statement of retained earnings. Writing off debt in this way therefore directly impacts two accounting system accounts:
The principles of conservative accounting require companies to report their assets as close to their current value as possible. With inventories, this involves making some estimates.
What is the difference between a write-off and a writedown? In this case, the fluctuating values of marketable securities in trading accounts are adjusted daily, writing them up if they have increased in value or writing them down if they have wrife value. Let our CV writing experts help you. A credit transaction lowers the value of an asset account. Statement of retained earnings Net income Net profit from the Income statement impacts the Statement of retained earnings in two ways. The write off, in other words means that Net Accounts receivable is less than Accounts receivable. Write-offs are common among businesses and individuals, who perform write-offs to reduce their personal taxable income. Printed magazines and other dated publications may have high value for no more than a few days.
Inventory Reserve A company estimates how much of its inventory will "go bad" based on its past experience, its assessment of current conditions in its industry and its knowledge of its customers' tastes. It's important qrite note that, at this point, the company has not actually identified any specific items in inventory as having gone bad.
- An inventory reserve anticipates inventory losses, while a write-off makes them official.
- Because write off impacts Net income, therefore, the action also lowers dividends and retained earnings on the Statement of retained earnings.
- Write downs may also be required to acknowledge that the prices at which securities are recorded on a firm's books exceed the amount they could be sold for, assuming they could be sold at all.
The inventory reserve is simply dofference allowance, an amount set aside and already accounted for in anticipation of inventory's going bad. Inventory Write-Offs At some point, a company will identify inventory that it can't sell -- a crate of rotten bananas in a grocer's warehouse, for example, or a pallet of outdated computer peripherals for an electronics retailer.
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When that happens, the company "writes off" those items -- meaning, it takes them off the books and "eats" the cost. Note that the company's net inventory remains the same as before: The company doesn't have to report the write-off as an expense on its income statement; it already did that, back when it created the reserve.
A write-off simply "uses up" a portion of the reserve. Write-Downs Inventory can lose value without having to be written off entirely.
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A business reports its inventory "at cost," meaning that the value it reports for inventory assets is what the company spent to obtain the items in the inventory -- not the retail price at which it will ultimately sell those items. Sometimes, though, the market price for an item in inventory falls below its cost.
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An example is a computer one or two generations behind the state of the art. That computer isn't worthless, but the demand for it may be so low that to sell it, the company has to price it for less than cost.
In such situations, accounting rules require a company to "write down" the value of the item to the market price. Write-downs are handled just like write-offs: The value of the write-down is taken out of both gross inventory and the inventory reserve.