Obsolescence definition
/What is Obsolescence in Accounting?
Obsolescence is a notable reduction in the utility of an inventory item or fixed asset. The determination of obsolescence typically results in a write-down of the inventory item or asset to reflect its reduced value. Obsolescence can arise when there are less expensive alternatives in the marketplace, or when customer preferences change.
Example of Obsolescence
A company purchases computer equipment for its employees for $50,000. Five years later, the technology is outdated due to advancements, and new software requirements are incompatible with the old hardware. Although the computers still function, their resale value is minimal, and they can no longer support the company's operations effectively. The company must account for the asset's diminished value by writing down some or all of its remaining book value. This scenario is a common example of functional obsolescence.
Obsolescence vs. Depreciation
Obsolescence differs from the ongoing decline in the value of assets that is caused by normal usage, resulting in wear and tear. Normal usage is accounted for with ongoing charges to depreciation, which reduce the carrying amount of an asset by a consistent amount over time. Conversely, obsolescence can result in the immediate and total write-off of the carrying amount of an asset.