Journal entry for disposal of obsolete inventory
Introduction
In business, we may dispose of obsolete inventory goods that no longer have value on the market. In this case, we need to make the journal entry for disposal of obsolete inventory in order to remove those obsolete inventory goods from the balance sheet.
Sometimes, even we can sell the obsolete inventory goods for a low price, selling them may make us lose more money. Hence, disposing of those obsolete inventory goods by discarding them completely may be a logical action sometimes.
Of course, if it is more logical to sell them at a lower price (e.g. lower than cost), we can choose to write down the value of the inventory and sell them at a lower price instead. In either case, there will be a loss that we need to record as an expense and charge it to the income statement in the period.
Journal entry for disposal of obsolete inventory
We can make the journal entry for disposal of the obsolete inventory by debiting the loss on inventory disposal account and crediting the inventory account.
| Account | Debit | Credit |
|---|---|---|
| Loss on inventory disposal | XXXX | |
| Inventory | XXXX |
The loss on inventory disposal account is an expense account that we charge to the income statement for the period. Likewise, this journal entry of disposal of obsolete inventory increases the total expenses on the income statement while decrease the total assets on the balance sheet.
Disposal of obsolete inventory example
For example, on December 31, we decide to dispose of $10,000 of the obsolete inventory goods that we have in our warehouse as we can not sell them at all due to their obsolete state. The process of the disposal of these obsolete inventory goods is to discard them completely as they no longer have value on the market.
In this case, we can make the journal entry for disposal of these $10,000 of the obsolete inventory goods by debiting this $10,000 amount to the loss on inventory disposal account and crediting the same amount to the inventory account.
| Account | Debit | Credit |
|---|---|---|
| Loss on inventory disposal | 10,000 | |
| Inventory | 10,000 |
This journal entry will increase the total expenses on the income statement by $10,000 while decrease the total assets by the same amount as a result of the disposal of the $10,000 obsolete inventory.
Disposal of obsolete inventory by selling at a lower price
In case we decide to dispose the obsolete inventory by selling it at a lower price (e.g. at a loss) instead of discarding it completely, we need to write down the value of inventory first. After that, we can record the sale of the obsolete inventory as a normal sale transaction.
Likewise, there will be one journal entry for writing down the value of inventory and two journal entries to record the sale revenue and cost of goods sold as below:
Record inventory write-down:
| Account | Debit | Credit |
|---|---|---|
| Loss on inventory write down | XXXX | |
| Inventory | XXXX |
In this journal entry, the loss on inventory write down account is an expense account that needs to be charged to the income statement for the period.
Record inventory sale:
| Account | Debit | Credit |
|---|---|---|
| Cash/accounts receivable | XXXX | |
| Sales revenue | XXXX |
Record cost of goods sold:
| Account | Debit | Credit |
|---|---|---|
| Cost of goods sold | XXXX | |
| Inventory | XXXX |
For example, on December 31, we have obsolete inventory goods that have an original cost of $500. However, due to its obsolete state, its fair value on the market is only $100 as of December 31.
Hence, on the same day of December 31, we make a cash sell of this obsolete inventory to one of customers for $100.
In this case, we can make the journal entry for the disposal of obsolete inventory by selling it off for $100 on December 31, as below:
Record inventory write-down:
| Account | Debit | Credit |
|---|---|---|
| Loss on inventory write down | 400 | |
| Inventory | 400 |
Record inventory sale:
| Account | Debit | Credit |
|---|---|---|
| Cash | 100 | |
| Sales revenue | 100 |
Record cost of goods sold:
| Account | Debit | Credit |
|---|---|---|
| Cost of goods sold | 100 | |
| Inventory | 100 |
An alternative method of recording
We may wonder why we don’t just record the cost of goods sold with the $500 instead of $100 since this way, we will need to record only two journal entries instead of three in the above example.
Actually, we can record the $500 into the cost of goods sold directly without the need to write down the value of inventory first if the value is considered a small amount or immaterial.
In that case, we can make the journal entries for the disposal of the $500 obsolete inventory by selling it for $100 as below instead:
Record inventory sale:
| Account | Debit | Credit |
|---|---|---|
| Cash | 100 | |
| Sales revenue | 100 |
Record cost of goods sold:
| Account | Debit | Credit |
|---|---|---|
| Cost of goods sold | 500 | |
| Inventory | 500 |
However, as we see in these journal entries, there is no record of the writing down inventory; hence no trace of obsolete inventory was recorded. Additionally, this method of recording goes against the accounting rule of “lower of cost or market” or “lower of cost or net realizable of value.
After all, the above journal entries show that the market value or net realizable value of inventory is only $100 but we still record the cost of goods sold that comes from the inventory as $500. That is why this can be done only when the amount is insignificant or immaterial.
In the business sense, it is important to record the writing down the value of the inventory as it allows us to keep track of how much we have lost due to the obsolescence of the inventory. This is important for us to see data of obsolete inventory if we want to avoid or reduce the amount that we loss due to the obsolete inventory in the future.