The write down of inventory involves charging a certain amount of the inventory asset to expense in the current period. Inventory is written down when goods are lost or stolen, or their value has declined. This should be done at once, so that the financial statements immediately reflect the reduced value of the inventory. Otherwise, the inventory asset will be too high, and so is misleading to the readers of a company's financial statements.
For example, if a widget costs $100 and you can sell it to a scrap hauler for $15, then you should write down the value of inventory by $85. There are two ways to write down inventory. First, if inventory write-downs are not significant, debit the general cost of goods sold account and credit inventory, as shown in the following entry:
|Cost of Goods Sold||85|
Alternatively, if inventory write-downs are significant in size, record the expense in a separate account, so you can track their aggregate size. This should be a debit to inventory write-downs and a credit to inventory, as shown in the following entry:
If inventory has been tagged for disposition but not yet disposed of, the accounting staff should immediately create a reserve (contra account) for the total amount that is expected to be lost from the disposition of all the identified items. This would be a debit to the cost of goods sold expense and a credit to the reserve for obsolete inventory account. The reserve would appear on the balance sheet as an offset to the inventory line item. Then, as items are actually disposed of, the reserve would be debited and the inventory account credited. This approach immediately recognizes the full amount of the loss, even if the related inventory has not yet been disposed of.
If you are aware of an inventory issue that requires a write-down, you should charge the entire amount to expense at once. You should not spread the write-down over future periods, because that would imply that some benefit is accruing to your company over the write-down period (see the matching principle), which is not the case.