How Does Obsolete Inventory Affect Financial Statements

When a business realizes that a portion of its inventory is obsolete, causing the asset to decline in value, it must create an allowance on its balance sheet. The effect of this allowance will increase the cost of goods sold, which modifies the income statement appropriately.

How are obsolete items reflected in financial statements?

To recognize the fall in value, obsolete inventory must be written-down or written-off in the financial statements in accordance with generally accepted accounting principles (GAAP). A write-down occurs if the market value of the inventory falls below the cost reported on the financial statements.

What is the biggest impact of obsolete stocks in inventory accounting?

It affects inventory turnover ratio. It usually leads to stock being sold at a discounted price e.g a lower net resaleable value, or being written off altogether. It therefore hits a business’ bottom line at the end of the year, when the cost is usually absorbed in the Cost of Goods Sold on the profit and loss sheet.