Obsolete inventory is when a product batch has been lying idle in stock for a certain period, or is no more in demand. Managing inventory optimally is paramount for most companies. To meet the market demand, very often, companies end up adding more stock failing to understand that this practice can prove to be loss-making. While having stock to meet emergency demand is good, purchasing too much stock may diminish its value in the long run. And eventually, it may turn out to be obsolete.
In this article, we have explained obsolete inventory, how obsolete inventory works, inventory analysis, causes of obsolete inventory, how to avoid and reduce obsolete inventory, and more.
What Is Obsolete Inventory?
Obsolete inventory or dead stock is the inventory that is at the end of its product life cycle. It is the type of inventory that hasn't been sold for quite some time, and there is no scope for it to be sold in the future. This type of inventory must be either written down or written off, thus resulting in a loss.
The inventory becomes obsolete when it is no longer required, or its market value has fallen completely. Technology, and changing consumer preferences are the common contributing factors to obsolete inventory. In order to combat these causes, businesses can consider switching to effective obsolete inventory management measures and ensure effective inventory performance.
Accounting for Obsolete Inventory
It involves the identification and valuation of the inventory, which is not usable or saleable. Some of the steps involved in accounting for obsolete inventory are:
Identify Obsolete Inventory
The first step is to identify obsolete inventory which can include damaged inventory, no more in demand in the market, or inventory that is no more saleable.
Determine the Net Realizable Value (NRV)
It is the estimated selling price of the inventory after reducing any cost associated with selling or disposing it of. You should calculate the NRV to determine the recoverable value.
Write Down the Inventory
If the NRB of the inventory is lesser than its original cost, you need to write down the value of the inventory to its net realizable value. It can be done by mentioning the cost of goods sold account in the debit section and crediting the inventory account.
Disclosure in Financial Statements
Based on the regulations and standards followed in the company, you need to mention the obsolete inventory in your financial statement. For this, it is advisable to contact a financial advisor.
Disposal of Obsolete Inventory
Once you have determined the obsolete inventory, the next step is to dispose it of or put it on sale as decided by the management. The cost associated with the disposal should also be recorded separately.
Example of Accounting Obsolete Inventory
Let's assume that the company ABC Private Limited has an inventory that is no longer in demand and is considered dead inventory now. Now the original cost of this dead inventory or obsolete inventory is Rs. 10,000. After a thorough assessment, the company identifies its net attainable value at Rs. 2,000. Here's how the accounting entries would look:
Write-down of inventory
Debit: Cost of Goods Sold (COGS) Rs. 8,000 Credit: Inventory Rs. 8,000 This highlights that the value of inventory has been reduced from its original cost to net recyclable value. Now, Rs. 8,000 is recognized as an expense in the income statement.
Disposal of inventory
Debit: Inventory Rs. 2,000 Credit: Gain on Disposal of Inventory Rs. 2,000
If the company is able to find a seller or a supplier ready to buy it at a lesser rate, say Rs. 2000; now, this is recorded as a gain on disposal. If the inventory is scrapped or donated, the appropriate account would be used instead of the Gain on Disposal of Inventory.
Disclosure
The company may need to disclose the amount of the write-down and any gain or loss on disposal in the notes to its financial statements as required by accounting standards and regulations.
How Does Obsolete Inventory Work?
Before delving deeper to understand how a company can avoid obsolete inventory, it's important to understand how obsolete inventory works:
- Every company either purchases products or manufactures the same. These products are then sold to the customers.
- However, over a period, due to technological changes, or the changing dynamics of the market, the customer may no longer require the product.
- Because of this downfall in demand, the products slowly move to become unsellable. In this case, the inventory becomes obsolete.
- The company has the option to discard the same or hold the inventory with the hope of selling it. In some cases, the company sells the product at a discount. Thus, incurring a considerable loss.
How Bad Is Obsolete Inventory?
Obsolete inventory can be an added cost to the company. It can also lead to loss and sometimes use up the extra storage space. Overall having obsolete inventory in the warehouse is not a profitable asset for the organization. If the company has identified an inventory to be obsolete, then by the end of the accounting period, it must be reported as an inventory write-off in compliance with the Generally Accepted Accounting Principles (GAAP).
Inventory Analysis
Inventory analysis is the process of examining and evaluating various aspects of a company's inventory to gain insights and make informed decisions. It involves studying inventory levels, turnover rates, item classification, valuation methods, and other relevant factors. The purpose of inventory analysis is to optimize inventory management, reduce costs, improve efficiency, and enhance overall supply chain performance.
Causes of Obsolete Inventory
The dynamics around obsolete inventory may vary from one organization to another. Here are some common causes of obsolete inventory:
Inaccurate Inventory Forecasting
Poor forecasting can lead to dead stock or excess inventory that may later become obsolete. A company that fails to have precise and accurate information on inventory forecasting can lead to overstocking. Although, inventory forecasting cannot 100% guarantee nullifying the probability of obsolete inventory, having a good command over historical order data and real-time stock control is helpful. A software can facilitate this and enable the company to gain market insights and make the right decision.
The Dynamism of Consumer Choices
The consumer is the king of any business. As consumer preferences and trends change, businesses may find it difficult to sell their outdated products. This may result in the stocking of inventory, which may eventually become obsolete.
Lack of Effective Inventory Management
Another contributing factor to obsolete inventory is the lack of effective inventory management measures. Today, tools and software have replaced the manual calculation of inventory status, marking a departure from conventional practices. These tools are specially designed to automate the inventory management process and provide a comprehensive overview of the inventory status. A company that fails to implement these technologies and tools for obsolete inventory management may face higher losses. Without visibility into slow-moving items occupying valuable space, it becomes challenging for a company to accurately assess the extent of its obsolete inventory. However, by leveraging technology solutions that facilitate inventory tracking, a company can gain insight into inventory movement and obtain a holistic overview of its inventory activity.
Lack of Transparent Business Operations
Maintaining complete transparency in inventory movements is essential. Lack of visibility can cause obsolete inventory because most items go unnoticed. At the same time, it can also result in stock out for higher demand products. This becomes even more significant if the company has a wider product line. In such cases relying on manual interpretation can lead to erroneous results. Hence it is advised to switch to inventory tools that can help automate the entire process and maintain transparency.
Lack of Supply Chain Data
Inventory is the core of the supply chain system. Hence, having access to all the data that provides insights can help identify how well the supply chain system will work. Supply chain forecasting uses data and research to predict how smoothly a business will run. It considers the production lead time, order fulfillment, warehousing, shipping, and labor needs.
How to Identify Obsolete Inventory
As discussed above, obsolete inventory can be a major problem for the company. Hence, identifying obsolete inventory becomes significant. Some of the ways that companies can adopt to identify this include:
Regular Inventory Audit
One of the ways to identify obsolete inventory is to do regular inventory audits. Manual inventory audits are feasible for companies having limited product lines. But enterprises with a wider product range need to switch to automated processes that can simplify the audit process and share real-time updates.
Right Technology
Modern and automated software and tools help in identifying the status of inventory. You can get a closer overview of inventory days on hand, sales, and buying trends. These insights help in making better decisions.
Review Sales Data
Historical sales data is pivotal in identifying obsolete stock. It helps in identifying which stock is slow-moving or stagnant. Identify products that have shown a decline in sales over time or have not experienced an increase in demand. Such products are likely to fall into the category of obsolete inventory.
Set Inventory Aging Thresholds
Yet another effective way to identify obsolete inventory is by setting up the aging threshold for a particular product. Categorizing the inventory item based on their age like 6 months or 12 months old, can help you identify if the inventory has reached a threshold level. Knowing the obsolete inventory status in your warehouse can help you in preparing the right plan of action to assist in overcoming this problem.
What to Do With Obsolete Inventory?
There are several ways that a company adopts to avoid the problem of accumulated obsolete inventory. The following section throws light on certain measures that you can adopt to deal with unsellable inventory:
Writing off obsolete inventory
Obsolete inventory is usually a liability in the books of account. In such a case, it is always advisable to write off as a loss on your financial statement. This also helps reduce tax liability since this inventory has no value and cannot be sold.
Selling it at discount
You can also decide to sell the products at a discounted rate or flash sale. Running these promotional discounts can help you in selling your inventory. Although it may not give you profit, putting items on sale can help recover some parts of the cost involved in manufacturing.
Remarket the products
Remarketing is yet another effective way to manage the risk of an item becoming obsolete. If the item still has the potential to be sold in a specific market, you can rethink the marketing strategy. This can include changing the target audience or targeting another geographical location. While this method can help prevent inventory obsolescence, it may also incur additional costs in terms of investment. As a result, the return on investment may not be highly favorable.
How to Avoid and Reduce Obsolete Inventory?
Avoiding and reducing obsolete inventory is crucial for maintaining a healthy and efficient inventory management system. Here are some strategies to help you avoid and reduce obsolete inventory:
Demand Forecasting
A company can conduct accurate demand forecasting to prevent obsolete inventory. For this, the company can use historical sales data, analyze market trends, get customer feedback, and project future demand. This helps align the inventory levels with the anticipated sales, reducing the probability of obsolete or dead stock.
Lean Inventory Management
Inventory management practices like lean and just-in-time inventory can help in minimizing excess stock. Although companies emphasize maintaining safety stock levels, sometimes a lack of management, assessment, or audits can make this inventory obsolete. Maintaining optimal inventory levels by closely monitoring the sales pattern and replenishing it as and when required can help reduce the probability of obsolete inventory creation.
Regular Inventory Audits
Another effective measure to keep a check on the inventory level is to conduct regular physical audits. It helps in identifying slow-moving or obsolete items. However, this method has some downsides. If a company deals with a wider product line, manual editing may not be effective and efficient.
Continuous Monitoring and Analysis
Regularly monitoring the inventory performance, sales data, and market trend is also helpful in optimizing the inventory. The end objective of this practice is to help bring forth the inventory status and understand the declining demand patterns, thereby helping in adopting the right measure to prevent obsolete inventory buildup.
Obsolete Inventory Example
A company makes 20,000 cookies that it cannot sell by October 30 of that year. After this, the cookies will cross the expiration date and become inedible, and cannot be sold. By October 30th, if the company is able to sell only 17,500 cookies, the remaining 2500 cookies will become obsolete inventory for the company.
How Can TranZact Solve Inventory Obsolescence?
TranZact is a tech-enabled platform that offers sales, purchases, and inventory management solutions. Companies can easily manage their inventory and production with this high-end software and tool. Moreover, it also provides a comprehensive overview of the inventory status with smart dashboards.
Its user-friendly platform makes it easier for manufacturers to monitor inventory movements in real time along with vendor and logistic companies' data. The integration of this tool with business operations helps to reduce the probability of obsolete inventory pileup.
TranZact enhances the inventory audit process and helps business owners to save time, otherwise spent in manually collating data from various teams.
Obsolete inventory can be an added burden for the company. Hence adopting the right measures to overcome the same is essential. Companies like TranZact are changing how supply chain and logistic companies manage inventory levels!
FAQs on Obsolete Inventory
1. Is obsolete inventory bad?
Yes, obsolete inventory is bad as it can adversely impact the financial status of an organization. Obsolete inventory takes up storage space and maintenance costs and is an added liability for the company. The buildup of obsolete inventory is not a favorable sight from the company's perspective.
2. Are damaged goods considered obsolete inventory?
Damaged goods are a type of dead stock, however, if they are not fixable and cannot be sold in the market, they fall in the category of obsolete inventory.
