What it means
Inventory sits on the balance sheet as an asset, normally carried at what it cost to buy or make. Accounting rules require that it never be carried above the amount the business can realistically recover from selling it, so when fashion turns, food ages or a part becomes obsolete, the carrying value has to come down.
The recoverable figure is usually called net realisable value: the expected selling price less any costs still needed to complete and sell the goods. If a coat cost $60 to buy but will only clear at $35 with $5 of packing and delivery attached, its net realisable value is $30 and the other $30 is gone.
This matters commercially because inventory writes hit gross profit, not some tidy corner of the accounts below the operating line. A single large write can turn a profitable quarter into a loss, which is why buyers, finance teams and auditors all watch the ageing of stock closely.
The size and frequency of writes also say something about how well a business is run. Regular small adjustments suggest disciplined stock management, while a sudden enormous write usually means someone had been avoiding an uncomfortable conversation for several quarters.
There is an important asymmetry to understand. Under the rules most companies follow, once inventory has been written down it generally cannot be written back up above original cost if conditions improve, and under US GAAP a write-down of this kind cannot be reversed at all.
In practice
Real-world examples.
Example
A grocery chain runs a monthly stock count and finds $18,000 of chilled products past their sell-by date. The full amount is written off, because expired food has no recoverable value, and the charge is booked to cost of sales for that month.
Example
An electronics distributor still holds 400 units of a discontinued tablet model that cost $210 each. After a review it concludes the units will only move to a liquidator at $70 each, so it writes the carrying value down by 400 x $140 = $56,000.
Example
A construction supplier discovers that steel fixings stored outdoors have rusted beyond use. The site manager scraps them, and the finance team writes off the $9,400 carrying value while opening a claim against the storage contractor.
Formula
Calculation
Inventory write = carrying value - net realisable value
Net realisable value = expected selling price - costs to complete and sell
A clothing retailer holds 1,200 winter coats bought at $60 each, so the carrying value is 1,200 x $60 = $72,000. The season has ended and the buying team believes the coats will only sell in a clearance event at $35 each, with $5 per coat of picking, packing and delivery cost attached.
Net realisable value per coat is $35 - $5 = $30, so the total recoverable amount is 1,200 x $30 = $36,000. The inventory write is $72,000 - $36,000 = $36,000, recorded as an expense this period. Inventory on the balance sheet falls from $72,000 to $36,000, and if the coats later sell exactly as expected, the clearance produces no further gain or loss.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Harbour Lane Outdoor, an invented outdoor clothing brand, bought 4,000 technical jackets at $48 each ahead of a mild winter, putting $192,000 of stock on its balance sheet. By March only a few hundred had sold at full price, and the merchandising team was still forecasting a strong spring clear-out rather than admitting the range had missed.
The finance director insisted on a proper net realisable value test. Comparable jackets were clearing at $26 online, and getting them there cost about $4 a unit in fulfilment, giving a net realisable value of $22 and a recoverable total of 4,000 x $22 = $88,000. The write was $192,000 - $88,000 = $104,000, which turned the fictional company's first half from a modest profit into a loss.
The more useful outcome was the change in behaviour that followed. Harbour Lane introduced a quarterly ageing review with automatic markdown triggers at 90 and 180 days, and the next season's buy was placed in two tranches instead of one, so the business could see real sell-through before committing the second half of the budget.
Watch out
Common mistakes.
- Delaying a write in the hope that stock will move next season, which does not change the economics and simply makes the eventual charge larger and more visible.
- Confusing an inventory write with shrinkage, which is stock physically missing through theft or error rather than stock present but worth less than its recorded cost.
- Booking the write below the gross profit line to protect margin optics, when the charge properly belongs in cost of sales where it affects reported gross margin.
Questions
People also ask.
Does an inventory write cost the business cash?
No, the cash left when the stock was bought; the write is the accounting recognition that the money will not be recovered in full.
Can a write-down be reversed if demand recovers?
Under IFRS a previous write-down can be reversed up to original cost if net realisable value genuinely rises, while under US GAAP the reduced value becomes the new cost basis and cannot be reversed.
How often should a business test inventory for writes?
At least at each reporting date, and in practice monthly or quarterly for anything perishable, seasonal or technology-related, since those categories lose value quickly.
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