How to Deal with Obsolete Inventory - dummies

How to Deal with Obsolete Inventory

By Stephen L. Nelson

Obsolete inventory refers to items that you’ve purchased for sale but turn out not to be saleable. Within QuickBooks 2012, you record inventory disposal by adjusting the physical item count of the inventory items.

Perhaps customers no longer want it. Perhaps you have too much of the inventory item and will never be able to sell everything that you hold.

In either case, you record the fact that your inventory value is actually less than what you purchased it for. And you want to record the fact that, really, the money you spent on the obsolete item is an expense. For example, suppose that you purchased some $100 item that you now realize is obsolete. How do you record this obsolescence? Here is the conventional approach.

Journal Entry 7: Recording an Allowance for Obsolete Inventory
Account Debit Credit
Inventory obsolescence 100
Allowance for obsolete inventory 100

As Journal Entry 7 shows, to record the obsolescence of a $100 inventory item, you first debit an expense account called something like “inventory obsolescence” for $100. Then you credit a contra-asset account named something like “allowance for obsolete inventory” for $100.

A contra-asset account gets reported on the balance sheet immediately beneath the asset account to which it relates. The contra-asset account, with its negative credit balance, reduces the net reported value of the asset account.

For example, if the inventory account balance was $3,100 and you had an allowance for an obsolete inventory contra-asset account of $100, the net inventory balance shows as $3,000. In other words, the contra-asset account gets subtracted from the related asset account.

QuickBooks requires you to record Journal Entry 7 yourself using the Make Journal Entries command.

When you ultimately do dispose of obsolete inventory, you record a journal entry like the following one. This journal entry debits the contra-asset account for $100 and credits inventory for $100. In other words, this journal entry removes the value of the obsolete inventory both from the allowance for obsolete inventory account and from the inventory account itself.

Journal Entry 8: Recording Disposal of Inventory
Account Debit Credit
Allowance for obsolete inventory 100
Inventory 100

You record this journal entry when you actually physically dispose of the inventory. This may be, for example, when you pay the junk man to haul away the inventory or when you toss the inventory out into the large Dumpster behind your office or factory.

In general, one of the things you should do every year for tax accounting reasons is deal with your obsolete inventory. The tax rules generally state that you can’t write off obsolete inventory unless you actually dispose of it for income purposes.

You can, however, typically write down inventory to its liquidation value. Such a write-down works the same way as a write-down for obsolete inventory. A write-down can be a little tricky if you’ve never done it before, however, so you may want to confer with your tax advisor.

One more really important point about recording disposal of obsolete inventory: Within QuickBooks, you record inventory disposal by adjusting the physical item count of the inventory items. You should know that you don’t actually enter a journal entry like the one shown in Journal Entry 8.

You adjust the inventory accounts for the obsolete inventory. This adjustment would automatically reduce the inventory account balance. When QuickBooks asks you which account to debit, you specify the allowance for obsolete inventory account.