Cost of Goods Sold - Write-downs and Allowances

Write-downs and Allowances

The value of goods held for sale by a business may decline due to a number of factors. The goods may prove to be defective or below normal quality standards (subnormal). The goods may become obsolete. The market value of the goods may simply decline due to economic factors.

Where the market value of goods has declined for whatever reasons, the business may choose to value its inventory at the lower of cost or market value, also known as net realizable value. This may be recorded by accruing an expense (i.e., creating an inventory reserve) for declines due to obsolescence, etc. Current period net income as well as net inventory value at the end of the period is reduced for the decline in value.

Any property held by a business may decline in value or be damaged by unusual events, such as a fire. The loss of value where the goods are destroyed is accounted for as a loss, and the inventory is fully written off. Generally, such loss is recognized for both financial reporting and tax purposes. However, book and tax amounts may differ under some systems.