Inventory write-downs occur when a company is unable to sell its current products held for sale. While many companies that sell inventory, will usually have some write-downs, extremely high amounts of inventory write downs can indicate poor inventory management practices. Companies will often need to follow specific principles when writing down inventory. The write-down will typically result in a loss taken against the current accounting periodic net income.
If cost is lower than net realizable value, there is no accounting problem, because the inventory is stated at cost and the increase in value is not recognized, meaning there is no inventory writedown. And if net realizable value is lower than cost, the inventory is measured at net realizable value. In this case, the problem is the proper treatment of the write down of the inventory to net realizable value
Inventory Writedown Sample Problem
The XYZ Company inventory record shows the following data on December 31, 2017.
Cost = 44,000 (purchase cost per unit P22) multiplied by (# of units 2,000)
NRV = 40,000 (estimated selling price P20) multiplied by (# of units 2,000)
Valuation of Product A: 40,000 the lower amount between cost and NRV
Cost = 175,000 (purchase cost per unit P35) multiplied by (# of units 5,000)
NRV = 185,000 (estimated selling price P37) multiplied by (# of units 5,000)
Valuation of Product B: 175,000 the lower amount between cost and NRV
No write-down is necessary for Product B because the Cost is lower than the NRV.