Inventory Write-Down Journal Entry and Gross Profit

An inventory write-down journal entry reduces inventory when its applicable valuation measure falls below cost. FIFO, average-cost, and specific-identification inventory use net realizable value (NRV). LIFO and retail-method inventory use market. Debit Cost of Goods Sold or an Inventory Write-Down Loss account and credit Inventory for the difference. For the FIFO example below, cost of $4,800 and NRV of $3,720 produce a $1,080 entry. Either debit reduces pretax income by the same amount.

The debit account determines how the write-down is tracked in the ledger. Income-statement classification determines how it affects gross profit. An ordinary decline on merchandise held for sale generally forms part of cost of goods sold, including when the journal entry uses a separate loss account. Following the goods into the next fiscal year also explains why a later sale can appear unusually profitable.

Watch Professor Farhat explain the inventory valuation rule

Review the lower-of-cost-or-NRV principle with Professor Farhat, then use the ledger and income statement examples below to follow the write-down through the accounts.

Watch the full inventory valuation lecture on YouTube (15:47).

How Do You Calculate The Inventory Write-Down Amount?

Suppose North Cove Supply holds 120 discontinued work lights that cost $40 each. At December 31, its fiscal year-end, it expects to sell each unit for $34 and pay $3 per unit in selling and delivery costs. The company uses first-in, first-out (FIFO) under U.S. generally accepted accounting principles (GAAP). This example uses a perpetual system, which keeps Inventory up to date throughout the year.

Each light has an NRV of $31 ($34 − $3). Its carrying amount (the value shown on the books) must fall from $40 to $31. Multiply the $9 shortfall by 120 units to obtain a $1,080 write-down. Check it against the batch totals. Inventory started at $4,800 and should end at $3,720. The difference is the required adjustment. The $3,720 belongs on the balance sheet.

When the problem starts with an expected selling price, calculate the lower of cost or net realizable value before choosing the accounts. If several products are involved, establish whether the comparison is by item or by group first.

Does Every Company Compare Cost With NRV?

No. Under ASC 330, inventory measured with FIFO, average cost, or specific identification uses the lower of cost and net realizable value. Inventory measured with LIFO or the retail inventory method uses the lower of cost or market instead.

Market there means replacement cost, but it can’t be higher than NRV (the ceiling) or lower than NRV minus a normal profit margin (the floor). The journal entry looks the same either way. Only the measurement of the write-down changes.

Inventory Write-Down Journal Entry: Example and Accounts

Follow these three simple steps to prepare the inventory write-down journal entry:

1. Determine the applicable valuation amount: Use net realizable value (NRV) for FIFO, average-cost, and specific-identification inventory. Use market, subject to its ceiling and floor, for LIFO and retail-method inventory.
2. Calculate the write-down: When the applicable valuation amount is below recorded cost, subtract it from cost. For North Cove, $4,800 minus $3,720 equals a $1,080 write-down.
3. Record the adjustment: Debit Cost of Goods Sold or Inventory Write-Down Loss and credit Inventory or the related allowance for $1,080.

Each row shows a complete journal entry. North Cove records only one of the two alternatives.

The credit lowers Inventory, an asset account with a normal debit balance. The debit records an expense or loss in the current year. Nothing physical changes: North Cove still has all 120 lights, and no cash leaves the business. Only the value on the books goes down.

What If The Company Uses An Allowance Account?

Some companies, and many textbooks, keep Inventory at its original cost and record the write-down in a contra-asset account instead. A contra-asset account carries a credit balance and reduces the asset it is paired with.

The balance sheet then shows Inventory at cost of $4,800, less the $1,080 allowance, for a net carrying amount of $3,720. That’s the same figure as the direct write-down.

After this year-end write-down, the allowance isn’t reversed solely because prices recover while North Cove still holds the lights. When the lights sell, the related allowance comes off the books along with their cost, so cost of goods sold still reflects the $31 basis.

How Does An Inventory Write-Down Affect Gross Profit?

Assume annual sales of $75,000 and cost of goods sold of $46,000 before the adjustment. Other expenses are $18,000. North Cove’s ordinary write-down of discontinued merchandise is included in cost of goods sold under either recording method. A separate loss account can identify the adjustment in the ledger and feed into the cost-of-goods-sold total on the income statement.

Cost of goods sold is $47,080 ($46,000 + $1,080). Gross profit is $27,920 ($75,000 − $47,080), and pretax income is $9,920 ($27,920 − $18,000). Both columns include the same $1,080 loss exactly once. Deducting it again below gross profit would understate pretax income by $1,080.

A separately identified write-down can help readers distinguish the decline on unsold stock from the cost of merchandise sold. ASC 330-10-50-2 requires disclosure of substantial and unusual inventory losses in the financial statements. Separate identification within cost of goods sold preserves the effect on gross profit. FASB’s Topic 330 update includes the guidance on substantial and unusual inventory losses. KPMG’s inventory handbook explains the presentation guidance in Question 5.2.50.

What Happens When Written-Down Inventory Is Sold?

At the close of the fiscal year, the written-down amount becomes the new cost basis. Suppose next year’s demand unexpectedly improves and all 120 lights sell for $39 each. A price recovery alone does not restore their former $40 cost under U.S. GAAP. At sale, North Cove records $4,680 of sales revenue and transfers $3,720 from Inventory to Cost of Goods Sold. That produces $960 gross profit before selling expenses. See SEC Staff Accounting Bulletin Topic 5.BB on inventory valuation allowances and the new cost basis.

Across the two periods, the $960 gross profit and the previous $1,080 write-down produce a combined $120 shortfall before selling expenses. That agrees with $4,680 of proceeds less the original $4,800 cost. This check explains why a high gross margin in the sale period can coexist with a loss across the inventory’s entire holding period.

Want to see more inventory problems worked step by step? The Intermediate Accounting course covers inventory valuation in video lessons you can watch at your own pace. You can also try the free sample course first.

Interactive Inventory Write-Down Exercise

Inventory starts at historical cost. When its value falls below cost, the company lowers the carrying amount and records a loss. FIFO and average cost inventory use net realizable value (NRV). LIFO and retail method inventory use market instead, as explained earlier in this guide.

Use these five questions to review what inventory cost means, why inventory loses value, and when a write-down is needed.

Practice questions and answers

What does the credit equal if cost is $12,600 and NRV is $11,900?

Credit Inventory for $700. After the credit, the asset balance is $11,900. A common mistake is crediting $11,900. That would leave only $700 in Inventory and mix up the loss with the ending balance.

How do the two recording methods affect gross profit in the year-end example?

Both recording methods reduce gross profit by $1,080 because this ordinary inventory write-down is included in cost of goods sold. Gross profit is $27,920 and pretax income is $9,920 under either method. Using a separate loss account in the ledger helps track the adjustment.

What cost goes to expense if only 30 lights sell next year?

Transfer $930 to Cost of Goods Sold (30 × the new basis of $31). The remaining 90 units carry $2,790, assuming no further decline. Together those amounts reconcile to the prior year’s $3,720 ending inventory.

Common Exam Traps To Avoid

• Crediting NRV instead of the difference. The credit equals cost minus NRV, which is $1,080 here, not $3,720.
• Forgetting selling costs. NRV is the $34 selling price minus the $3 cost to sell, so $31, not $34.
• Writing inventory back up. After the year-end write-down, a later price recovery does not restore the old $40 cost under U.S. GAAP.
• Using NRV for LIFO inventory. LIFO and the retail inventory method use lower of cost or market.
• Mixing comparison levels. Item-by-item, category, and total inventory comparisons can give different write-downs, so check which one the question uses.

Frequently asked questions

Is a write-down the same as a write-off?

A write-down reduces the carrying amount to a lower recoverable figure. A full write-off reduces it to zero. North Cove still expects to recover $31 per light, so the goods retain a balance.

Should the company wait until the lights are sold?

Recognize the decline in the period in which it occurs. At the later sale, record revenue and transfer the reduced carrying amount to cost of goods sold. This keeps the original loss out of expense a second time.

Can An Inventory Write-Down Be Reversed?

Under U.S. GAAP, inventory written down at a fiscal year-end has a new cost basis that cannot be increased solely because prices later recover (ASC 330-10-35-14). For interim reporting, ASC 270-10-45-6(c) requires recognition of recoveries on the same inventory in later interim periods of the same fiscal year, limited to the losses previously recognized. Under IFRS, IAS 2 allows a reversal when NRV recovers, limited to the original write-down. Differences between IFRS and U.S. GAAP are no longer tested on the CPA FAR section, though you may still see them in university courses.

Where Does The Write-Down Appear On The Income Statement?

An ordinary write-down of inventory held for sale generally forms part of cost of goods sold and reduces gross profit. It can be tracked in a separate loss account and identified separately within cost of goods sold. ASC 330-10-50-2 requires disclosure of substantial and unusual inventory losses in the financial statements. Pretax income falls by the full amount of the write-down.

Do You Record A Write-Down In A Periodic Inventory System?

Yes. In a periodic system, Inventory isn’t updated during the year, so the write-down usually happens through the ending count. If North Cove reported ending inventory at $3,720 instead of $4,800, cost of goods sold would automatically rise by $1,080. A company that wants the loss shown separately can value ending inventory at cost and record a separate entry debiting a loss account and crediting Inventory or an allowance. See periodic vs perpetual inventory costing for how the two systems differ.

What Is The Journal Entry For An Inventory Write-Off?

When goods have no remaining value, such as stock that is destroyed or can’t be sold at all, the company removes the full remaining carrying amount. Under the direct method, if all 120 lights became worthless before any write-down, North Cove would debit Inventory Write-Off Loss (or Cost of Goods Sold) for $4,800 and credit Inventory for $4,800. If they became worthless after the $1,080 direct write-down in this lesson, the remaining carrying amount would be $3,720, so both the debit and the credit would be $3,720.

Key Takeaways

• An inventory write-down lowers inventory to NRV (or to market for LIFO and the retail method) when that value falls below cost.
• The entry debits Cost of Goods Sold or an Inventory Write-Down Loss account and credits Inventory or an allowance account.
• An ordinary inventory write-down reduces gross profit through cost of goods sold, including when a separate loss account records it. Pretax income falls by the same amount under either recording method.
• A write-down recorded at fiscal year-end establishes a new cost basis under U.S. GAAP. A later price recovery does not restore the original cost.
• A later sale can show a healthy gross profit even though the inventory lost money over its whole life.

About the author: Mansour Farhat, CPA, CIA, DBA, teaches the Farhat Lectures accounting and CPA review courses and records the video lessons on the Farhat Lectures YouTube channel.

Continue learning: Farhat Lectures free sample course.