Definition of Obsolete Inventory
Obsolete inventory refers to products that a company had purchased or produced which cannot be sold. The obsolete items may be the result of one or more of the following:
- Innovations that make the products worthless, inconvenient, unattractive, etc.
- New technologies that disrupt the way things are done
- Decline in overall demand for the items
- Arrival of unique competitors
Consequences of Obsolete Inventory
When inventory items become obsolete, the reality is that their value is significantly lower than their cost. As a result, the U.S. accounting rules require that the cost of the obsolete inventory items be reduced to their net realizable value. Failure to reduce their cost will mean that the following amounts on the company’s financial statements will be overstated:
- Inventory
- Current assets
- Working capital
- Profits
- Owner’s or stockholders? equity
Benefits of Disposing of Obsolete Inventory
Since the value of the obsolete items may continue to decrease, it is wise to dispose of the items at any price as soon as possible. The benefits of disposing of the obsolete items will result in the company:
- Having realistic financial statements
- Being eligible for a U.S. income tax benefit
- Having less inventory holding costs
- Being confronted with the total cost of holding items in inventory
