How does an inventory write-down for obsolescence work, and can a company reverse it under IFRS vs. GAAP?

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AcadiFi · Accepted Answer

Both IFRS and US GAAP require inventory to be carried at the lower of cost and net realizable value (NRV). When NRV drops below cost -- due to obsolescence, damage, or declining market prices -- the company writes the inventory down and recognizes a loss.

**Net Realizable Value (NRV)** = Estimated selling price - Estimated costs to complete - Estimated selling costs

**Write-Down Example**
Cascade Electronics carries 10,000 units of a GPS module at a cost of $75 per unit ($750,000 total). A newer model has rendered this module partially obsolete. The estimated selling price drops to $60, with $8 in selling costs per unit.

NRV = $60 - $8 = $52 per unit
Write-down per unit = $75 - $52 = $23
Total write-down = 10,000 x $23 = **$230,000**

This $230,000 is recognized as an expense (typically in COGS) and the inventory carrying value drops to $520,000.

**Reversal Rules: IFRS vs. GAAP**

| | IFRS (IAS 2) | US GAAP |
|---|---|---|
| Write-down required? | Yes, to NRV | Yes, to NRV (or market) |
| Reversal allowed? | **Yes**, up to original cost | **No**, write-down is permanent |
| Reversal treatment | Reduction in COGS | N/A |

Under IFRS, if Cascade's GPS modules regain value (say a new contract values them at $70 each, NRV = $62), the company reverses the write-down up to the original $75 cost:
- New carrying value: $62 per unit
- Reversal per unit: $62 - $52 = $10
- Total reversal: $10 x 10,000 = $100,000 (recognized as a reduction in COGS)

Under US GAAP, the $520,000 carrying value is permanent. Even if the modules' value recovers, the company cannot write the inventory back up.

**Analyst Implications**
1. IFRS companies can manage earnings through the timing of write-downs and reversals. An analyst should scrutinize large reversals.
2. US GAAP companies that take aggressive write-downs create a "cookie jar" effect -- future COGS is lower because inventory cost is permanently reduced, inflating future margins.
3. When comparing an IFRS company to a US GAAP company, adjust for differences in inventory carrying values.

**Exam Tip:** The key testable point is the reversal asymmetry. IFRS allows reversals (up to original cost only); US GAAP does not. If a question describes inventory recovering in value, the answer depends entirely on which framework applies.

Dive deeper into inventory analysis with our CFA Level I FRA materials.

How does an inventory write-down for obsolescence work, and can a company reverse it under IFRS vs. GAAP?

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