Inventories are sensitive in nature – they’re bought in stock that you hope to sell or use some day. This “some” day is your estimate of the possible need of the market and as we know with estimates, they may be wrong.

In this sense inventories are sensitive because they’re your stock, you’ve paid for them and you hope to sell them. However, on your balance sheet they should be recognized in lowest of either the cost of the item or the value you hope to sell them one day (it’s called “net realisable value”). This is where sensitivity comes in. 

If they’re not moving very well, that is the market isn’t really interested in those goods, it’s obvious the price you’re trying to sell them with isn’t right. For an example if the cost is 10, your selling price is 20 and the market would buy them with 15, the net realisable value would be 15. However, as I mentioned, the price on the balance sheet should be lowest of the cost and net realisable value, so it’s still 10.

So, say the selling price the people would be interested in the good with would be 5, the net realisable value is now 5 instead of the cost of 10. As you can imagine, the new price of your inventory item should be 5 and not 10. In your accounting you would do a following entry:

Db Write-off expense

Cr Inventory

Always, when certain items are not selling very well, ask yourself if the cost price is correct and maybe you’re selling them lower your own cost. If the answer is “yes”, make sure you write those inventories down to their net realisable value.