What Is Obsolete Inventory?
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Talk to our experts- Obsolete inventory
- Obsolete inventory is stock a business no longer expects to sell or use in the normal way, because the product was discontinued, replaced by a newer version or went out of style. It is usually marked down, scrapped or written down, and for US tax a write-down needs evidence, such as reduced-price sales or disposal records.
How it works
Obsolete inventory is stock that has lost its normal market, such as discontinued products, parts for retired models or styles that have changed.
Obsolete inventory is not the same as excess inventory. In Thor Power Tool Co. v. Commissioner, a Supreme Court tax case, the company's management classed as excess inventory the items held in excess of any reasonably foreseeable future demand. The Court described those excess goods as normal and unexceptional.
For US income tax, IRS Publication 538 lists the methods generally available for valuing inventory: cost, lower of cost or market, and retail. Two of its rules bear on obsolete stock:
- Lower of cost or market: compare the market value of each item on hand on the inventory date with its cost and use the lower of the two. Publication 538 says this method does not apply to goods on hand or being manufactured for delivery at a fixed price on a firm sales contract, or to goods accounted for under the LIFO method; those must be inventoried at cost.
- Offered below market: under the same method, when you offer merchandise for sale at a price lower than market in the normal course of business, you can value the inventory at the lower price, minus the direct cost of disposition. You determine these prices from actual sales for a reasonable period before and after the inventory date.
Goods that cannot be sold at normal prices because of damage, imperfections, shop wear, changes of style, odd or broken lots or similar causes follow their own valuation rule, covered on our dead stock page.
This is general information, not tax or accounting advice.
Obsolete vs. excess inventory in a write-down
The Thor Power Tool case (decided January 16, 1979) shows why the label matters for tax:
- Obsolete stock that was scrapped: after a physical inventory, Thor wrote off about $2.75 million of obsolete parts, damaged or defective tools, demonstration or sales samples and similar items. The Commissioner allowed that write-off because Thor scrapped most of the articles shortly after removing them from closing inventory.
- Excess stock still offered at full price: Thor also wrote down excess inventory, mostly spare parts, to its own estimate of net realizable value, while it kept the items in inventory and continued to sell them at original prices. The Commissioner disallowed it, and the Supreme Court held that he did not abuse his discretion, since the write-down was plainly inconsistent with the governing regulations. The Court said the regulations demand hard evidence of actual sales and records of actual dispositions.
Example
A distributor holds 500 units of a discontinued pump model at a cost of $40.00 each: 500 x $40.00 = $20,000.00 on the books.
In the normal course of business it offers the pumps at $15.00 each, below their market value, and the direct cost of selling them off is $2.00 a unit. Using the lower of cost or market method and Publication 538's rule for goods offered below market, the inventory value is 500 x ($15.00 - $2.00) = $6,500.00, a write-down of $20,000.00 - $6,500.00 = $13,500.00.
If the distributor booked the same write-down but kept listing the pumps at the old price, it would be repeating the pattern the Commissioner disallowed in Thor.
On Shopify
When obsolete units leave stock, Shopify's inventory adjustments can record why. Among the reasons in Shopify's developer documentation:
- damaged: used to remove units from inventory count due to damage
- promotion: used to remove units from inventory count due to a promotion or donation
- correction: used to correct an inventory error or as a general adjustment reason
Shopify's Help Center says every adjustment is recorded, so you can review who changed a quantity, when, and why. For the Shopify reports that help surface stock that has stopped moving, see dead stock.
How Uncap helps
Uncap's guide to managing beauty product variations describes a deprecation workflow for discontinued shades that removes them from the orderable catalog without deleting the order history that references them. A buyer who searches for a discontinued shade should see a clear message that the shade is no longer available and, where possible, a recommendation for the closest available alternative.
Sources
Frequently asked questions
What is meant by inventory obsolescence?
Inventory obsolescence means stock has lost its normal market, for example because the product was discontinued, replaced by a newer version or went out of style.
What is the difference between excess inventory and obsolete inventory?
In the Thor Power Tool case, excess inventory meant items held in excess of any reasonably foreseeable future demand, and the Supreme Court described those goods as normal and unexceptional. Obsolete inventory has little or no demand left at its normal price, because the product itself is outdated.
Can I deduct obsolete inventory on my tax return?
For US income tax, IRS Publication 538 lets you value goods you offer below market in the normal course of business, under the lower of cost or market method, at that lower price minus the direct cost of disposition, and the Thor Power Tool case shows a write-down needs evidence such as actual reduced-price offers or scrapping. Ask a tax adviser for your own case.
