Inventory Write-Down: NRV Test, Journal Entries and How It Differs from a Write-Off

Three questions decide what happens to inventory value at month-end. Is the quantity in the system right? Are the goods still usable? Will they sell for at least what they cost? A wrong quantity is corrected by an inventory adjustment. Goods that are damaged, expired or otherwise unusable are removed by an inventory write-off. Only the third question leads to a write-down — and it is the one most often answered late, because nothing physical has happened to the goods.

What is an inventory write-down?

An inventory write-down is a reduction of the carrying amount of inventory from its cost to its net realizable value (NRV) when NRV has fallen below cost. The goods remain in stock and remain sellable. What changes is the value at which they are carried, and the difference is recognized as an expense in the period the write-down occurs.

A write-down is therefore a valuation event, not a stock movement. No units leave the warehouse, no count changes and no scrapping note is raised. The trigger is new information about selling prices: a competing model, a price cut, a customer that no longer buys, a product line that is being run down. That information is compared with the cost the item carries — under FIFO the cost of its layers, under moving average cost the current average — and if the expected net selling price is lower, the difference is written down.

Write-down vs write-off vs inventory adjustment

The three transactions are confused constantly because all three reduce the inventory balance. They answer different questions and should never share a reason code. The short rule: a write-off changes quantity, a write-down changes only value. Damaged, expired or unusable goods leave stock and their value goes to zero — that is a write-off. Goods that are intact but will sell for less than they cost stay in stock at a lower value — that is a write-down.

The inventory write-off guide covers the write-off column with a damaged-goods case. The inventory journal entries guide shows all three entries side by side in one running example. This guide is about the write-down column.

The rule: lower of cost and net realizable value

Cost is what the item carries after every capitalized purchase cost: the purchase price plus freight, duties and other landed cost, consumed in the order the inventory valuation method dictates. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Two details in that definition do most of the work in practice:

• Ordinary course of business. NRV is the price the business expects to get by selling the way it normally sells, not a liquidation price — unless liquidation is the actual plan for that item.
• Costs to sell. Commissions, packaging, outbound freight and the cost of finishing an unfinished product all come off the selling price. Using the list price as NRV overstates the recoverable amount.

Two more rules shape how the test is applied. Inventory is written down item by item. Grouping similar items that are sold in the same market can be acceptable, but writing down a whole class — “all finished goods” — is not. And the estimate uses the most reliable evidence available at the reporting date, including events after the period end that confirm conditions that existed at that date. A price cut announced two weeks after the balance sheet date, for an item that was already slow-moving, supports the write-down at that date.

Net realizable value formula

Per unit:

NRV per unit        = estimated selling price − costs of completion − costs to sell
Write-down per unit = cost per unit − NRV per unit   (0 if the result is negative)
Write-down amount   = write-down per unit × quantity on hand

If NRV is at or above cost there is no entry: inventory is never written up above cost, however good the market. The test is one-directional.

Our example: 500 units that will sell below cost

Item FG-118 is a finished product. At month-end the position is:

A newer model has replaced FG-118 in the catalog. The sales team expects to sell the remaining units at €17.00 each over the next quarter, and each sale carries €2.00 of packaging, outbound freight and commission.

Nothing has moved. The warehouse still shows 500 units of FG-118. The general ledger now shows them at €7,500 instead of €10,000, and the €2,500 difference is this period's expense.

Inventory write-down journal entry

There are two ways to post the same €2,500, and the choice matters later.

Direct method — reduce the inventory account itself:

Allowance method — leave the item at cost and hold the write-down in a contra-asset account:

The balance sheet shows the same €7,500 net either way. The difference is what the records keep. The direct method makes €15.00 the item's cost from now on. The allowance method keeps the original €20.00 visible per item, which a later reversal and the period-end notes need: the amount written down in the period, the amount of any reversal and the reason behind it. Many companies use the allowance method in the ERP and present the net figure.

Where the expense sits on the income statement is a presentation choice. The write-down is an expense of the period it occurs in, and most companies present it inside cost of sales. A large or unusual write-down should be shown separately from the normal cost of goods sold, so a big obsolescence charge does not disappear into the gross margin line without explanation.

What happens when the written-down units are sold

The write-down moved the loss forward. When the goods sell, the margin is measured against the new carrying amount, not the original cost. In the following month 200 units of FG-118 are sold at €17.00.

Under the direct method the sale posts one entry: debit COGS €3,000, credit Inventory €3,000.

Under the allowance method the sale posts at original cost and releases the allowance for the units that left:

Net COGS is €3,000 in both cases. The second entry is the one that gets forgotten: without the release, COGS carries €4,000 for units that were already written down by €1,000, and the loss is counted twice. After the sale 300 units remain, carried at €4,500 — €6,000 of cost less €1,500 of allowance under the allowance method, or 300 × €15.00 under the direct method.

Can an inventory write-down be reversed?

Yes, if the price recovers — but never above the original cost. When the circumstances that caused the write-down no longer exist, or NRV clearly rises because the market has changed, the write-down is reversed. The reversal is limited to the amount originally written down, so the new carrying amount is again the lower of cost and the revised NRV. It reduces the inventory expense in the period it happens.

Continuing the example with the 300 remaining units, still at €20.00 cost and €15.00 carrying amount:

The second row shows the cap: even though NRV of €22.00 is above the original cost, the units go back to €20.00 and not a cent higher.

Not every set of accounting rules allows this. Under some, the reduced amount becomes the item's new cost and is never marked up again, so for FG-118 the €15.00 would be permanent. Check which rules your company reports under before planning on a reversal.

Where reversals are allowed, the allowance method makes them simple. The reversal is an entry against the allowance that references the original write-down, and the €20.00 original cost never left the item record.

Item by item, groups, and the raw-materials rule

Because the test is item by item, FG-118's write-down does not depend on how the rest of the range is doing. An unrelated item with a healthy margin cannot offset it, and a category with an overall healthy margin does not exempt it.

Raw materials follow a special rule. Materials and supplies held for production are not written down below cost if the finished products they will go into are expected to sell at or above cost. Only when a decline in the material price shows that the finished product's cost will exceed its NRV is the material written down — and then the material's replacement cost may be the best available measure of its NRV. In the write-off guide the 80 usable units of RM-204 stay in stock at €20.00 per unit. If the product they feed still sells above cost, a fall in RM-204's market price is not a write-down, however tempting the comparison looks.

Firm sales contracts are the other special case. Units covered by a firm contract are tested against the contract price, and only the quantity beyond the contract is tested against general selling prices.

Write-downs in an ERP: FIFO layers and moving average

A write-down is a value-only transaction. If it is entered as a stock adjustment the system will post a quantity change and a shrinkage expense, both wrong. The transaction has to touch the item's valuation without touching its quantity, and it has to leave a record of what the value was before. Two designs are common.

Reduce the cost record itself (new cost basis). Under moving average cost, €10,000 ÷ 500 = €20.00 becomes €7,500 ÷ 500 = €15.00, and every later issue leaves at €15.00. Under FIFO the 500 units may sit in two layers — say 300 units at €19.00 and 200 units at €21.50, which is the same €10,000 — and each layer is tested and reduced to NRV separately:

Same €2,500, but now each layer carries €15.00 and later issues consume it at that cost. One side effect deserves attention under moving average: a receipt after the write-down blends with the written-down value. If 100 more units arrive at €20.00, the average becomes (€7,500 + €2,000) ÷ 600 = €15.83, which is neither the new purchase cost nor the NRV. That is a reason to repeat the NRV test every period rather than treat a write-down as settled.

Keep the cost record and hold the allowance separately. The layers or the average stay at cost, the allowance is tracked per item, and the sale releases the allowance for the units that left, as in the journal above. This design keeps the original cost for a later reversal and for the period-end notes, at the price of one more step on every sale of a written-down item — a step the system should do, not the accountant.

Whichever design is used, the write-down document should record the item, the quantity on hand at that moment, the cost basis (layer or average), the NRV and the price data behind it, the write-down per unit, the approver and the period. If a later reversal cannot be tied back to that document, its cap cannot be proven.

The month-end NRV test as a report

The test is easier to run than to justify, and the justification is what the auditor asks for. A month-end NRV report shows, for each item:

• Quantity on hand
• Cost per unit from the costing method
• Current selling price from the price list or the last invoices
• Estimated costs to sell
• The resulting NRV
• The indicated write-down
• Date of the last sale and age of the stock
• Flags for slow-moving items, items below cost and items covered by firm contracts

Which items are reviewed is a policy question — every item below cost, every item without a sale in six months, every item with more than a year of stock on hand. The report should be the evidence attached to the write-down. A write-down that starts from a number typed into a journal, with the analysis somewhere in a spreadsheet, is the one that cannot be explained six months later.

Controls that keep a write-down honest

• Evidence before the entry. Price lists, the last three months of invoices, sales forecasts, firm contracts and stock aging — dated at the reporting date.
• Two roles. Sales or product management estimates the selling price. Finance approves the write-down. The person who created the slow-moving stock should not set its value alone.
• A reason code of its own. “NRV write-down” and “obsolescence reserve” are not the same reason as “damaged” (a write-off) or “count difference” (an adjustment). Mixed reason codes make the write-down disclosure impossible to build.
• No manual posting to the inventory account. The entry should come from a write-down document tied to the item records, so the general ledger inventory account stays reconcilable to them.
• Reversals reference the original. A reversal is capped at the original write-down per item, and the system should refuse a reversal that has no write-down to refer to.
• Allowance release on sale or disposal. It should be automatic, per unit and per item — the double-counted loss described above is a control failure, not a rounding error.
• A period trail. Totals of write-downs and reversals by period, by reason, ready for the period-end notes and for the audit trail.

Common inventory write-down mistakes

1. Writing down a category or a warehouse. The test is item by item. A blanket percentage on “all spare parts” is a policy, not a measurement.
2. Using the list price as NRV. Costs to sell and costs to complete come off first.
3. Booking a write-down for missing or damaged units. Missing units are an adjustment. Damaged units are a write-off. Both change quantity, and a write-down never does.
4. Forgetting the allowance release. The €1,000 in the example is counted twice if the sale posts at original cost and the allowance stays.
5. Reversing above the original cost. A reversal brings the item back to cost at most. In the example, NRV of €22.00 still returns FG-118 to €20.00, not higher.
6. Writing down materials whose finished products still sell above cost. Such materials stay at cost.
7. Treating the book write-down as a tax deduction. Tax rules differ by jurisdiction and often recognize the loss only on sale or disposal, or only with specific documentation.
8. Running the test once a year. Slow-moving stock accumulates quietly. A quarterly or monthly NRV report keeps the year-end charge from being a surprise.

How Gruvero approaches inventory write-downs

Gruvero keeps a change in value apart from a change in quantity. Its inventory reason codes have a separate revaluation type — cost revaluation and inventory value correction among them — defined to change value without moving stock, so a write-down is classified separately from scrap and count differences. Items are costed by FIFO cost layers, moving average, standard cost or specific identification, which means the cost an NRV test compares against is the cost the item actually carries in the inventory ERP.

On the roadmap: a revaluation document that posts the write-down to the inventory and write-down expense accounts, a month-end NRV report, and allowance and reversal tracking. Until then, the write-down is a journal entry in the accounting ERP, prepared from the NRV test described above.

FAQ

What is an inventory write-down?

An inventory write-down reduces the carrying amount of inventory from cost to net realizable value when the goods are expected to sell for less than they cost. The units stay in stock. Only their value falls, and the difference is an expense of the period.

What is the journal entry for an inventory write-down?

Debit an inventory write-down expense account, usually presented within cost of sales, and credit either Inventory directly or an allowance for inventory write-down, a contra-asset account. In the example: debit write-down expense €2,500, credit Inventory (or the allowance) €2,500.

What is the difference between an inventory write-down and a write-off?

A write-down lowers the value of goods that remain in stock and remain sellable. A write-off removes the value of goods that are damaged, expired or otherwise unusable, and the units leave stock. A write-down can be reversed if the price recovers, and a write-off cannot. In short: a write-off changes quantity, a write-down changes only value — see the inventory write-off guide.

Is an inventory write-down an expense or part of COGS?

It is an expense of the period in which it is recognized. Most companies present it within cost of sales. A large or unusual write-down is shown separately so that the gross margin can still be read.

Can an inventory write-down be reversed?

In most cases yes — when the reasons for the write-down no longer apply, up to the amount originally written down, so never above the original cost. Some accounting rules do not allow a reversal, and there the written-down value becomes the item's new cost.

Is an inventory write-down tax deductible?

That depends on the tax law of the jurisdiction, and the answer is often “not yet”: many tax systems recognize the loss only when the goods are sold or disposed of, or only with specific documentation. The book entry and the tax deduction should be tracked separately.

How do you write down obsolete inventory?

Identify the item, estimate its net realizable value from the price it will actually sell at less the costs to sell, compare that with the cost it carries, and post the difference as a write-down with the evidence attached. If the item will not sell at all, it is a write-off, not a write-down.

Does an inventory write-down change the quantity on hand?

No. A write-down changes value only. If the quantity is wrong, that is an inventory adjustment. If units are unusable, that is a write-off. An ERP should not let a write-down move stock.

Conclusion

A write-down answers one question — will these goods sell for at least what they cost — and it answers it item by item, with evidence dated at the reporting date. The entry is small: an expense against inventory or an allowance. What makes it defensible is everything around the entry: the NRV report that produced the number, the reason code that separates it from a write-off and a count difference, the allowance release when the goods finally sell, and the cap on any reversal. When a write-down is recorded as a valuation document with the NRV test behind it, the €2,500 in this example is a traceable decision rather than a plug, and next period's reversal, sale or disclosure starts from a record instead of a spreadsheet.