The beginning of a new year is often when businesses analyze their inventory and consider writing off old or obsolete products. Manufacturing company owners should be aware that IRS regulations make the process of writing off inventory more complicated than simply expensing the value of the outdated product.
Essentially, there are two types of obsolete products: 1) finished goods, and 2) unusable raw materials and work-in-process inventory.
For finished goods that may still potentially be sold, IRS rules state the inventory may be valued at a price of an actual offering of goods during a period ending not later than 30 days after the inventory date.
For example, on December 31, a manufacturer determines the market for one of its products, Widget A, has deteriorated. The prospects of the business selling its remaining units of Widget A for a profit are nonexistent. Widget A units cost $150 to produce, but the manufacturer determines the units can only be sold at a price of $100 each. To write off the $50 per unit loss in the current tax year, the manufacturer will have to offer Widget A for sale at a price of $100 per unit within 30 days.
Unusable Raw Materials and Work-in-Process Inventory
Unusable raw materials and work-in-process inventory may be written off without being offered for sale. However, the obsolete inventory should never be less than scrap value.
Expanding on the example above, the manufacturer had several unfinished units of Widget A recorded as work-in-process. The manufacturer may use a reasonable basis to determine the value of the unfinished units and record the loss without offering the units for sale. The value used to determine the loss may not be less than the value of the items if they were sold as scrap materials.
Raw materials that have been rendered unusable by obsolescence or poor quality may be written off using a reasonable basis. Once again, the new value may not be less than the scrap value of the materials.
Documentation is Key
While the process of writing off inventory seems cut-and-dried, it is important to remember that documentation of all the inventory and pricing is crucial. When writing off obsolete products, the burden of proof lies with the manufacturer to support the expense that recorded the change in the value of the outdated product.
Two types of simple documentation you will want to keep:
- 1.Copies of the offering price, such as a pricing sheet or website listing.
- 2.Documentation showing the dates offerings are made to ensure the sale date is within the 30-day period.
If you have questions regarding writing off obsolete inventory, please contact a member of Yeo & Yeo’s Manufacturing Services Group.