Writing off inventory means that you are removing some or all of the cost of an inventory item from the accounting records. The need to write off inventory occurs when it becomes obsolete or its market price has fallen to a level below the cost at which it is currently recorded in the accounting records. The amount to be written down should be the difference between the book value (cost) of the inventory and the amount of cash that the business can obtain by disposing of the inventory in the most optimal manner.
An alternative approach when specific inventory items have not yet been identified is to set up a reserve for inventory write offs. This is a contra account that is paired with the inventory account. When items are actually disposed of, the loss is charged against the reserve account. The result of this approach is a more rapid recognition of inventory write offs, which is a more conservative method of accounting. The amount stated in the contra account is an estimate of probable write offs, usually based on whatever historical write off percentage the company has experienced.
The accounting for the write off of inventory is usually a reduction in the inventory account, which is offset by a charge to the cost of goods sold account. If management wants to separately track the amount of inventory write offs over time, it is also acceptable to charge the amount to a separate inventory write offs account, rather than the cost of goods sold. In the latter case, the account is still rolled up into the cost of goods sold section of the income statement, so there is no difference in either approach at an aggregate level.
It is not acceptable to write off inventory at a future date, once you become aware of such an item, nor can you spread the expense over several periods. Doing so would imply that there is some future benefit associated with the inventory item, which is presumably not the case. Instead, the entire amount of the write off should be recognized at once.
A key point is that writing off inventory does not mean that you necessarily have to throw out the inventory at the same time. Instead, it may make sense to hold onto the inventory, in hopes that its value will increase over time. It may also be necessary to hold inventory for a short time, while the purchasing staff is finding the highest price at which it can be disposed of. However, inventory that has been written off should not be retained too long, if the result is an extra investment in inventory storage, or an overly cluttered warehouse area that interferes with normal warehousing activities.