Millions of retailers and manufacturers across the nation have dealt with pandemic shutdowns and capacity restrictions that have not only negatively impacted their bottom line, but also led to an increase in the levels of inventory on hand. Depending on the type of inventory, the aged inventory will likely require special attention and analysis to determine if a reserve needs to be established or if the inventory needs to be written off all together.
While judgement is often required to establish if there is significant deviation from normal levels of operations in a given time period; inventory, usage and sales trends can also provide key indicators that the inventory on hand is becoming slow moving or obsolete. The following metrics are some of the most commonly used to evaluate inventory not only for recoverability, but also for slow moving items or obsolescence:
- A reduction in inventory turnover ratios
- The average age of your inventory is continually increasing
- The balance of inventory is increasing in relation to sales levels
More recently, we have seen the pandemic affect the recoverability of on-hand inventory due to challenges businesses face amid a pandemic. According to the Accounting Standards Codification (ASC) 330, the Financial Accounting Standards Board (FASB) requires that most inventory be recorded at the lower of its cost, market or net realizable value (NRV). Which means, once inventory is deemed slow moving or obsolete, impairment is necessary in order to adjust inventory levels to the lower of cost or NRV. The net realizable value represents the value at which the asset or inventory can ultimately be sold at. If slow moving inventory is likely to be sold at a future date, this may require establishing a reserve for the aged inventory which can be based on what is likely to be received from customers or purchasers, including any discounts that are likely to be offered to move the product. Also, net realizable value is the estimated selling price less reasonably predictable costs of completion, disposal and transportation. If these are significant, the value of inventory will be carried at an amount that is below its estimated selling price.
Industries with fast moving inventories such as food, will have different shelf life and timing thresholds to determine if their inventory is slow moving, excess or obsolete inventory. That is why the key to effectively managing inventory lies in the monitoring and analysis of inventory trends. Evaluating usage and sales trends frequently can give management insights and can often present key indicators that inventory is likely becoming obsolete, which will assist in financial reporting and financial statement presentations.
If your company has material amounts of inventories, you should have internal controls in place to monitor inventory for possible slow-moving inventory or obsolescence. If the number of inventory items that you carry are narrow, this should not be a difficult task. However, if your company carries a wide range of inventory items, your review and analysis will be more complex.
Jesse Porras, CPA