by Karen Rogers Updated April 18, 2018
No matter how carefully your employees handle your inventory, sooner or later you will incur a loss from items being damaged. Under generally accepted accounting principles, you must write off the value of the damaged inventory shortly after the loss occurs. The way you disclose the amount depends on how frequently your business experiences a loss from damaged inventory. Since you can write off the loss on your financial statements and take a deduction on your business income tax return, you must keep accurate records on the value of the items written off.
Isolate Damaged Inventory
Inspect inventory when it arrives at your business to identify goods that might have been damaged in transit. At this point you can contact the supplier and return the damaged inventory for a full credit or refund. Once the inventory is in your warehouse, it can be damaged while in storage, incur damage on the production line or experience damage from your store customers. Employees should identify and remove damaged inventory whenever it is discovered and place it in a designated bin or area. A loss/damage report should be prepared for each damaged inventory item.
Value the Inventory
At the end of your accounting cycle, you should calculate the value of the damaged inventory so you can write off the loss. However, you do not value the inventory at its purchase price. Rather, the damaged inventory is valued at the lower of the fair market value or the purchase price. The fair market value is the current purchase price for the same inventory items. This amount may be lower than the inventory’s original purchase price. In this case, you must value the damaged inventory at the lower market cost instead of the higher purchase price.
Journalize the Loss
If large amounts of inventory flow through your business, you can set up an inventory contra account to record the value of the damaged inventory. You reduce the amount of inventory carried on the books each time you make an entry into the inventory contra account. At the end of the month, you write off the damaged inventory by debiting the cost of goods sold account and crediting the inventory contra account. However, if you infrequently have damaged inventory, you can debit the cost of goods sold account and credit the inventory account to write off the loss.
Income Statement Disclosure
If you occasionally write off small amounts of damaged inventory, you do not have to make a separate disclosure on the income statement. The loss is included in with the cost-of-goods-sold amount. However, large dollar amounts of inventory that are written off should be disclosed on your income statement. A separate account such as loss from write-off of Inventory is included with the other inventory accounts. The loss from write-off of Inventory account should appear on the income statement each time inventory is written off.
References
Writer Bio
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.
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Michael Blann/Photodisc/Getty Images
FAQs
When inventory is damaged, the company must recognize the cost of that inventory in cost of goods sold (assuming that some level of damage is normal). The journal entry would be to debit cost of good sold (a specific damage account) and the credit would be to inventory (reduce the inventory).
How do you explain inventory loss? ›
An inventory loss occurs when an item is intended for sale is not sold. Losses can happen for a number of reasons. Sometimes stock becomes obsolete or outdated before it is sold. For example, unused food in a restaurant may spoil.
What do you call damaged inventory? ›
An inventory write-off is the formal recognition of a portion of a company's inventory that no longer has value. Write-offs typically happen when inventory becomes obsolete, spoils, becomes damaged, or is stolen or lost.
What happens to damaged inventory? ›
Damaged inventory (disposed): Record a credit for the asset to indicate the removal of the item and debit the expense indicating the cost of losing the item. Damaged inventory (not disposed): Record a credit in a contra asset account and record a debit item in the expenses category.
Do you include damaged goods in ending inventory? ›
Write-offs
The actual cost of damaged inventory reduces the value of ending inventory. Rather than taking a direct deduction for written-off inventory, you use Schedule C to factor the loss into your COGS. You report your beginning inventory, purchases and direct costs on Part III of Schedule C.
How do you write-off damaged inventory? ›
How to Write-Off Damaged Inventory? Examine the stock when it arrives to identify goods that might have been damaged and place it in a designated area. Prepare a damage report for each damaged inventory item. Calculate the value of the damaged inventory at the end of the accounting cycle to write-off the loss.
Is damaged inventory included in inventory? ›
When inventory is damaged, the company must recognize the cost of that inventory in cost of goods sold (assuming that some level of damage is normal). The journal entry would be to debit cost of good sold (a specific damage account) and the credit would be to inventory (reduce the inventory).
What is the reason for damaged inventory? ›
Damage: Inventory can be damaged due to natural disasters, accidents, or mishandling during transportation or storage. Damaged inventory may not be usable or saleable, and therefore must be written off. Theft or Loss: Inventory may be lost or stolen due to theft, misplacement, or other reasons.
What do you call something that is damaged? ›
bedraggled, broken-down, derelict, dilapidated, ramshackle, tatterdemalion, tumble-down. in deplorable condition. bent, crumpled, dented. crumpled or dented (of metal, for example) broken, busted.
What is the word for broken items? ›
Synonyms of damaged (adj. broken, not working)
- flawed.
- impaired.
- injured.
- run-down.
- bent.
- blemished.
- busted.
- dinged.
The basic approach to calculating damages is to compare the claimant's actual position with the position it would have been in but for the intervening event causing the loss; this requires an analysis of revenue, gross profit margin, variable and fixed costs and projections of the future.
What information must be included in the damage inventory? ›
Damage Inventory Form
- Category.
- Name of damage/facility.
- Address.
- Global Positioning System coordinates.
- Damage description.
- Primary cause of damage.
- Approximate cost.
- Percentage of work complete.
Formula and Calculation of Salvage Value
First, it may use the percentage of the original cost method. This method assumes that the salvage value is a percentage of the asset's original cost. To calculate the salvage value using this method, multiply the asset's original cost by the salvage value percentage.
How do you write a report on damaged goods? ›
What's a damage report and when do I need one?
- Provide details of the item (make, model, serial number, age, colour)
- Confirm how it was damaged (water damage, damage from impact, etc)
- Detail how bad the damage is.
- Advise whether repairs are possible.
- Estimate the cost of repair.
In accounting, normal spoilage is included in the standard cost of goods, while abnormal spoilage is charged to expense as incurred. This means that the cost of normal spoilage may initially be recorded as an asset and then charged to expense in a later period.
What are damaged goods? ›
1. : products that are broken, cracked, scratched, etc. 2. informal : a person who is considered to be no longer desirable or valuable because of something that has happened : a person whose reputation is damaged.
Is inventory loss an expense? ›
Inventory initially is considered an asset to a company because it has economic value and the potential for future benefit. When inventory is written off, that process is acknowledging that the item no longer has economic value and will not provide future value to the company, thus rendering it an expense.
Where does loss on inventory write down go on income statement? ›
If the amount of the Loss on Write-Down of Inventory is relatively small, it can be reported on the income statement as part of the cost of goods sold. If the amount of the Loss on Write-Down of Inventory is significant, it should be reported as a separate line on the income statement.
