Expense Recognition for Obsolete Inventory
General Accepted Accounting Principles (GAAP) mandates writing off the unrecoverable portion of the obsolete inventory immediately upon its identification. The important accounting consideration in this regard is ensuring the proper expense recognition procedure for the obsolete inventory.
The steps in this direction include:
- Identifying the book value of the obsolete items.
- Estimating the most likely disposition value for the items identified as obsolete.
- Subtracting the most likely disposition value from the book value for the specific item.
- Setting aside the resultant difference as reserve.
The actual value obtained on actual disposition of the obsolete item would invariably remain different from the estimated disposition value. The reserve account then requires adjustment to reflect this change.
For instance, a computer dealer having identified obsolete CRT monitors worth $100,000 estimates that selling such items to e-waste recyclers would fetch $25,000. The computer dealer estimates the reserves as $75,000 ($100,000 - $25,000) and makes the following journal entry:
- [Debit]. Cost of goods sold = $75,000
- [Credit]. Reserve for obsolete inventory = $75,000
If on actual sale, the dealer realizes only $23,000, the following adjustments to the journal entry reflect the $2,000 as additional expenditure:
- [Debit]. Reserve for obsolete inventory = $75,000
- [Debit]. Cost of goods sold = $2,000
- [Credit]. Inventory = $77,000