Definition of Write-down in Inventory
Under FIFO and average cost methods, when the net realizable value of inventory is less than the cost of the inventory, there needs to be a reduction in the inventory amount. Often the balance in the current asset account Inventory is reduced through a credit to a contra inventory account, which is referred to as a valuation account. The debit in the entry to write down inventory is recorded in an account such as Loss on Write-Down of Inventory, which is an income statement account.
Example of Reporting a Write-down in Inventory
Under FIFO and average cost methods, if the net realizable value is less than the inventory’s cost, the balance sheet must report the lower amount. If the amount of the Loss on Write-Down of Inventory is relatively small, it can be reported on the income statement as part of the cost of goods sold. If the amount of the Loss on Write-Down of Inventory is significant, it should be reported as a separate line on the income statement.
Since the amount of the write-down of inventory reduces net income, it will also reduce the amount reported on the balance sheet for owner’s equity or stockholders’ equity. Thus, the balance sheet and the accounting equation will show a reduction in inventory and in owner’s or stockholders’ equity.
