Inventory Write-Down Rules: GAAP, IFRS, and Tax Treatment

An inventory write-down reduces the carrying value of inventory on your balance sheet when the goods are worth less than what you paid, and the loss has to be recognized in the period you identify it rather than when you eventually sell or scrap the items. How you measure the reduction depends on your cost method and whether you report under U.S. GAAP or IFRS. How you deduct it for tax is a separate question with a much narrower answer.

When You Have to Write Inventory Down

A write-down is required any time inventory can no longer be sold or used at its original cost. The common triggers:

Physical damage or spoilage.
Obsolescence, when a newer version arrives and your stock loses appeal. Electronics and fashion goods are the frequent examples.
Declining market prices, where the replacement cost of your inventory drops below what you paid.
Excess or slow-moving stock that will only move at a steep discount.
Expiration of perishable goods or shelf-life-limited products.

The loss belongs in the period you identify it. Waiting until you physically dispose of the goods overstates assets in the meantime and violates the conservatism principle that sits under inventory measurement in both GAAP and IFRS.

Measuring the Write-Down Under GAAP

U.S. GAAP splits the measurement rule based on which cost flow method you use. FASB drew that line in ASU 2015-11, and the two tracks still catch people out.¹

FIFO and Average Cost: Lower of Cost and NRV

If you use FIFO or average cost, compare carrying cost to net realizable value and report whichever is lower. NRV is the estimated selling price in the normal course of business, minus the costs you would still have to spend to complete and sell the product. Those completion costs include finishing labor, packaging, sales commissions, and shipping. If NRV drops below cost, the difference is your write-down.

LIFO and Retail Inventory Method: Lower of Cost or Market

If you use LIFO or the retail inventory method, the older “lower of cost or market” (LCM) rule still applies.¹ “Market” here is not the intuitive meaning. It requires three figures:

Replacement cost: what you would pay today to buy or reproduce the item.
Ceiling: NRV (estimated selling price minus costs to complete and sell). Market cannot exceed this.
Floor: NRV minus your normal profit margin. Market cannot fall below this.

Calculate all three and pick the middle value as the “designated market.” Compare that to historical cost and report the lower figure. If replacement cost lands between ceiling and floor, it is the designated market. If it exceeds the ceiling, the ceiling becomes market. If it falls below the floor, the floor takes over.

Measuring the Write-Down Under IFRS

IFRS is more uniform. IAS 2 requires all inventory to be carried at the lower of cost and net realizable value, regardless of cost flow method.² There is no LCM track. IFRS also does not permit LIFO at all. The NRV calculation works the same as under GAAP: estimated selling price minus estimated costs of completion and sale.

Recording the Entry

Two methods exist for booking the loss, and they produce identical hits to net income but different balance sheet presentations.

Direct Method

Debit Cost of Goods Sold and credit Inventory for the write-down amount. Inventory drops immediately and COGS increases, reducing gross profit and net income. The trade-off is that the historical cost disappears from the ledger once you reduce Inventory directly, so future readers cannot see what you originally paid.

Allowance Method

Debit a separate loss account, often called “Loss on Inventory Write-Down,” and credit a contra-asset account such as “Allowance to Reduce Inventory to NRV.” The Inventory account keeps its historical cost, and the balance sheet shows the original figure minus the allowance. Most accountants prefer this method because it preserves the audit trail and makes cumulative write-downs easier to track.

Can You Reverse a Write-Down Later?

This is where the two frameworks split hard.

Under U.S. GAAP, no. Once you write inventory down, the reduced amount becomes the new cost basis. ASC 330-10-35-14 makes the year-end write-down permanent, even if the market price recovers the next quarter.¹

Under IFRS, yes. IAS 2 requires that if NRV rises after a previous write-down, the recovery is recognized as a reduction of the cost-of-goods-sold expense in the period the increase happens. The reversal is capped at the amount of the original write-down, so inventory can never be carried above its original cost.²

GAAP reporters need to be more cautious with timing and magnitude, since there is no way to claw back an overly aggressive adjustment.

Tax Treatment Is Not the Same as Book Treatment

The IRS is considerably more restrictive than either accounting framework. IRC Section 471 requires inventories to be valued using a method that clearly reflects income.³ In practice, a taxpayer using a cost method like FIFO generally cannot deduct a write-down until the inventory is actually sold or disposed of. The book entry does not create a tax deduction on its own.

The Subnormal Goods Exception

The main carve-out applies to what the Treasury Regulations call “subnormal goods”: items unsalable at normal prices or unusable in the normal way because of damage, imperfections, style changes, broken lots, or similar causes. These can be valued at their bona fide selling price minus the direct cost of disposing of them.⁴

The catch is the 30-day rule. “Bona fide selling price” means you must have actually offered the goods for sale during a period ending no later than 30 days after your inventory date. A theoretical markdown in a spreadsheet does not qualify. You need documentation of the actual offering, and the burden of proof is on you. Keep records of the reduced-price listing, any sales made, and the ultimate disposition.⁴

For subnormal raw materials or partially finished products, value them on a reasonable basis considering their usability and condition, but never below scrap value.

LIFO Conformity

LIFO users have an extra restriction. IRC Section 472 requires that taxpayers electing LIFO use the same method for financial reporting, and no procedure other than LIFO can be used for reports to shareholders, partners, or creditors.⁵ This conformity requirement generally prevents LIFO users from writing inventory below LIFO cost for tax purposes. The subnormal goods rule remains a narrow carve-out.

Small Business Exemption

Not every business has to work through these rules. Under IRC Section 471(c), taxpayers meeting the gross receipts test of Section 448(c) are exempt from the general inventory accounting requirements.³ These businesses can treat inventory as non-incidental materials and supplies, or conform their tax method to their financial statements or books and records.

For tax years beginning in 2026, a business meets the gross receipts test if its average annual gross receipts over the prior three tax years do not exceed $32 million.⁶ The threshold is adjusted annually for inflation, up from the $25 million base set by the Tax Cuts and Jobs Act in 2017. If your business qualifies, you may be able to skip the formal write-down rules entirely for federal tax purposes.

Donation as an Alternative to Scrapping

Donating impaired inventory to a qualified charity can produce a tax benefit. The rules depend on the business structure.

C corporations donating inventory to a qualifying Section 501(c)(3) organization may claim an enhanced deduction under IRC Section 170(e)(3), but only if the donated property will be used solely for the care of the ill, the needy, or infants, and the donee will not resell it. The deduction can exceed the property’s tax basis, up to the lesser of (a) basis plus half the appreciation, or (b) twice the basis.⁷

For non-C-corporation businesses, the deduction is generally limited to the property’s adjusted basis, which for written-down goods may be very low. Either way, you need a written acknowledgment from the charity confirming how the property will be used and that it will not be sold.

Documentation That Holds Up Later

The journal entry is the easy part. What causes problems months or years later is the supporting evidence.

Photograph damaged or obsolete goods with timestamps. Physical evidence of condition costs nothing to create and is hard to challenge.
Document the NRV calculation. Show the estimated selling price, the completion costs included, and the source of those estimates. Market quotes, recent sales of similar goods, and liquidator bids all work.
For subnormal goods deductions, retain evidence of the actual price reduction dated within 30 days of the inventory date. Website screenshots, catalog markdowns, and email blasts all qualify.
Track disposition. Record what happened to each batch of written-down inventory: sold at discount, donated, scrapped, or returned to a supplier.

What Happens if You Skip It

Delaying a required write-down inflates current assets and the current ratio. Lenders watch that ratio in loan covenants, and a delayed correction can trigger a covenant breach and accelerate repayment at the worst time. The same logic applies to working capital targets in acquisition agreements and vendor credit lines.

For public companies, the SEC treats inventory overstatement as a potential violation of the internal controls and financial reporting provisions of federal securities laws. Enforcement actions have produced multi-year restatements, civil penalties, exchange delistings, and executive compensation clawbacks. The cost of the internal investigation alone often dwarfs the write-down that should have been taken.

Private companies are not immune. Auditors flag unreasonable inventory balances, and a restatement damages relationships with banks, investors, and business partners. Taking the loss in the correct period is always less disruptive than correcting it later.

1
FASB. Accounting Standards Update 2015-11, Inventory (Topic 330)
2
IFRS Foundation. IAS 2 Inventories
3
Office of the Law Revision Counsel. 26 U.S. Code 471 – General Rule for Inventories
4
eCFR. 26 CFR 1.471-2 – Valuation of Inventories
5
Office of the Law Revision Counsel. 26 U.S. Code 472 – Last-in, First-out Inventories
6
Internal Revenue Service. Rev. Proc. 2025-32
7
Office of the Law Revision Counsel. 26 U.S. Code 170 – Charitable, Etc., Contributions and Gifts