obsolescence in accounting

The push to make equipment better, cheaper and faster can render an asset obsolete in a short period of time – especially when trying to keep up with technology in a competitive marketplace. The different types of obsolescence require unique solutions, but there are some universal strategies that businesses can adopt. These include regularly reviewing inventory levels, forecasting demand accurately, working closely with suppliers, and implementing efficient storage systems. A write-down occurs if the market value of the inventory falls below the cost reported on the financial statements. A write-off involves completely taking the inventory off the books when it is identified to have no value and, thus, cannot be sold. Overall, obsolescence can have a range of negative impacts on the environment, consumers, businesses, and society as a whole.

obsolescence in accounting

Obsolete stock takes up valuable space that could instead be used for more profitable products; it also requires additional costs such as storage fees and increased insurance premiums. Technological obsolescence occurs when newer products replace existing ones, rendering them obsolete. Economic obsolescence happens when market conditions change, causing demand for certain products to drop. Functional obsolescence is caused by changes in customer preferences or needs. Obsolete inventory is inventory that a company still has on hand after it should have been sold. When inventory can’t be sold in the markets, it declines significantly in value and could be deemed useless to the company.

What is inventory obsolescence, Accounting Basics

Holding inventory of electronic components will often result in losses because of obsolescence. Manufacturers main concern with obsolescence is in their fixed assets or plant assets. Manufacturers spend large amounts of their budgets on machinery and equipment to help produce products. When

the inventory write-down is small, companies usually charge the cost of goods

sold account. However, when the write-down is large, it is better to charge the

expense to a separate account. For companies with high turnover rates or those operating in fast-paced industries like electronics, obsolescence can pose an even greater risk.

A prudent investor will either implicitly or explicitly consider FO in the determination of a purchase price for the entire business. If that same line should have a bottle-capping machine with a capacity to cap 2,000 bottles per minute, the capping machine suffers from a loss in value due to FO. This component of the production line is not used to its full capacity, and therefore no prudent investor would pay for its rated capacity. Today one can find laser-based equipment offering the same (or better) utility in a big box hardware store for several hundred dollars. The value of the older equipment has suffered a loss in value due to FO from excess capital cost. A key factor that causes obsolescence is a shift in technology or product design.


Obsolescence can arise when there are less expensive alternatives in the marketplace, or when customer preferences change. To monitor inventory obsolescence reserve, it is important to track and analyze inventory movements and transactions regularly, as well as perform physical inventory counts and reconciliations periodically. You should also monitor key indicators and metrics, such as the inventory turnover ratio, inventory days, inventory obsolescence rate, and inventory obsolescence reserve ratio.

It also helps management make informed decisions about when to retire or replace assets that are no longer contributing to the company’s operations or profitability. Obsolescence is a notable reduction in the utility of an inventory item or fixed asset. The determination of obsolescence typically results in a write-down of the inventory item or asset to reflect its reduced value.

A good example of machinery becoming obsolete is the manual drive press. Instead, modern manufacturers use CNC or computer navigated machines to drive and shape products. Once a manufacturer has a CNC machine, the stand-alone drill press is pretty useless. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. Companies can commit fraud by incorrectly reporting the value of their inventory reserve. There are at least two reasons why the consideration of functional obsolescence is important.

What Is an Inventory Reserve in Accounting?

It is one of the most important assets of a business operation, as it accounts for a huge percentage of a sales company’s revenues. The specific process for determining, calculating, and accounting for obsolescence may vary depending on the industry, company, or asset in question. It is important to follow generally accepted accounting principles and to consult with accounting and industry experts as needed to ensure accurate and appropriate accounting treatment. The process of becoming outdated or no longer being economically feasible (often caused by technology advances). For example, personal computers and computer chips from 1990 are obsolete even though they can be operated.



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The cost of extracting the mineral is spread between the number of years it is expected to last. Depletion is a systematic reduction in the value of a natural resource. Obsolete inventory is also referred to as dead inventory or excess inventory. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers.

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As a result, there is growing interest in sustainable consumption practices, product longevity, and circular economy models that aim to reduce waste and promote a more sustainable approach to production and consumption. In the context of business, that printer I mentioned above is an obsolete asset. Business assets can be anything from a desk to computers to inventory to machinery and equipment to a company vehicle.

  • By identifying the factors that can lead to obsolescence, such as changes in technology, consumer preferences, or economic conditions, individuals and businesses can better manage their resources and investments.
  • There are at least two reasons why the consideration of functional obsolescence is important.
  • Obsolete inventory is inventory that a company still has on hand after it should have been sold.
  • Second, it helps you plan for future inventory purchases and avoid excess or insufficient stock levels.
  • Inventory refers to the goods and materials in a company’s possession that are ready to be sold.


we can see from this example, the valuation of inventory as obsolete affects

both balance sheet (through the allowance for obsolete inventory account) and

income statement (through an expense account). This practice is not appropriate and

auditors usually watch out for it. For instance, a company might recognize

excessive inventory how to pay your taxes write-downs due to obsolescence in the accounting period

when profits are higher than expected (i.e., debit cost of goods sold). Later

on, when profits are lower than expected, the company might sell the

written-down obsolete inventory at high profit margins in order to increase the

reported profits (i.e., credit cost of goods sold).

When new components come to market, older parts become less useful and are usually designed out of a product or the manufacturing process. By adopting these strategies, you can minimize losses due to obsolescence and improve overall profitability for your business. Managing obsolete inventory can be a daunting task, but it is essential to ensure that your business stays profitable.

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There are several types of obsolescence, including functional obsolescence, technological obsolescence, and style obsolescence. Retailers have the same problem as manufacturers only with their inventory. Clothing and apparel retailers have the most difficulty with obsolescence. They need to get rid of the inventory before it becomes obsolete and worthless to them.


Additionally, you must disclose the method and assumptions used to calculate and estimate your inventory obsolescence reserve, and explain any significant changes or adjustments made during the reporting period. You should also disclose any contingencies or uncertainties that may affect your inventory obsolescence reserve in the future. GAAP requires companies to establish an inventory reserve account for obsolete inventory on their balance sheets and expense their obsolete inventory as they dispose of it, which reduces profits or results in losses. Companies report inventory obsolescence by debiting an expense account and crediting a contra asset account. No matter how an item becomes obsolete, there is accounting protocol for stating the impact on financial statements. First, inventory and assets should be periodically reviewed for obsolescence.