Obsolete inventory is any item remaining in stock that cannot be sold or used in the production of salable goods. These items have typically been replaced in the marketplace by more advanced or inexpensive goods, so there is no longer any demand for them. Since these goods cannot be used, their cost is either written off or written down. A write off completely eliminates the inventory asset from the accounting records, while a write down reduces the amount of the recorded asset to the price at which it can still be sold.
Ideally, a business should maintain an obsolete inventory reserve that is paired with and offsets the inventory asset accounts. The amount in this reserve should be the estimated amount by which the inventory asset will be written down, once specific inventory items have been identified as obsolete.
It is possible that some obsolete inventory can be sold off at very low prices; the prices obtained will be higher if the materials management department maintains close watch over the inventory and dispositions items as soon as their usage levels begin to decline.
The presence of a large amount of obsolete inventory is a significant red flag that a business may be entering financial difficulties, since it either implies that the market for the company's goods is weak, or that management is not able to properly manage its inventory asset.