How to identify obsolete inventory
/What is Obsolete Inventory?
Obsolete inventory is any item in stock that can no longer be used. These items have typically been replaced in the marketplace by more advanced or inexpensive goods, so there is no longer any demand for them. Since these goods cannot be used, their cost is either written off or written down. A write off completely eliminates the inventory asset from the accounting records, while a write down reduces the amount of the recorded asset to the price at which it can still be sold.
Ways to Identify Obsolete Inventory
Obsolete inventory must be identified, so that management understands how much of its inventory investment is worthless. This can result in action to dispose of the obsolete items, perhaps returning a small amount of cash to the business. We note below several methods for identifying obsolete inventory.
Monitor Physical Count Tags
The simplest way to identify obsolete inventory without a computer system is to leave the physical inventory count tags on all inventory items following completion of the annual physical count. The tags taped to any items used during the subsequent year will be thrown away at the time of use, leaving only the oldest unused items still tagged by the end of the year. You can then tour the warehouse to see if an obsolescence reserve should be created for them. However, tags can fall off or be ripped off inventory items, especially if there is a high level of traffic in nearby bins. Though extra taping will reduce this issue, it is likely that some tag loss will occur over time.
Track the Last Usage Date
Even a rudimentary computerized inventory tracking system is likely to record the last date on which a specific part number was removed from the warehouse for production or sale. If so, it is an easy matter to use a report writer to extract and sort this information, resulting in a report listing all inventory, starting with those products with the oldest “last used” date. By sorting the report with the oldest last usage date listed first, you can readily arrive at a sorted list of items requiring further investigation for potential obsolescence. However, this approach does not yield sufficient proof that an item will never be used again, since it may be an essential component of an item that has not been scheduled for production in some time, or a service part for which demand is low.
Related AccountingTools Courses
Compare Withdrawals to On Hand Balance
An advanced version of the “last used” report compares total inventory withdrawals to the amount on hand, which by itself may be sufficient information to conduct an obsolescence review. It also lists planned usage, which calls for information from a material requirements planning system, and which informs you of any upcoming usage requirements. An extended cost for each item is also listed, in order to give report users some idea of the write-off that might occur if an item is declared obsolete.
Review a Where Used Report
If a computer system includes a bill of materials, there is a strong likelihood that it also generates a “where used” report, listing all the bills of material for which an inventory item is used. If there is no “where used” listed on the report for an item, it is likely that a part is no longer needed. This report is most effective if bills of material are removed from the computer system or deactivated as soon as products are withdrawn from the market; this more clearly reveals those inventory items that are no longer needed.
Review Engineering Change Orders
An additional approach for determining whether a part is obsolete is reviewing engineering change orders. These documents show those parts being replaced by different ones, as well as when the changeover is scheduled to take place. You can then search the inventory database to see how many of the parts being replaced are still in stock, which can then be totaled, yielding another variation on the amount of obsolete inventory on hand.
Review the Prior Obsolete Inventory Report
A final source of information is the preceding period’s obsolete inventory report. The accounting staff should keep track of these items and notify management of those for which there is no disposition activity.
The Need for Inventory Reviews
In order to make any of these review systems work, it is necessary to create policies and procedures as well as ongoing scheduled review dates. By doing so, there is a strong likelihood that obsolescence reviews will become a regular part of a company’s activities. In particular, consider a Board-mandated policy to conduct at least quarterly obsolescence reviews, which gives management an opportunity to locate items before they become too old to be disposed of at a reasonable price. Another Board policy should state that management will actively seek out and dispose of work-in-process or finished goods with an unacceptable quality level. By doing so, goods are kept from being stored in the warehouse in the first place.