Different Methods of Creating Provision for Stock / Inventory Obsolescence (Part 5)

June 28th, 2006 Comments off
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Like the provision for doubtful debts, the accounting for provision for stock obsolescence is almost similar. [please refer to my earlier article on stock written off]

This article is to discuss the various methods of creating provision for stock obsolescence

METHOD 1: GENERAL PROVISION BASED ON AS % OF CLOSING STOCK BALANCE

This methodology is normally called “ general provision for stock obsolescence”

The term “ general” is because there is NO SPECIFIC identification of the stock which has really turn back.

This estimate is based on past trend or management in-depth understanding of the industry

Illustration:

Say, at Year End Closing Stock Balance is $5,000,000

Based on experience, Management decided to create a provision of 1% on the year end Closing Stock balance::

1% x $5,000,000=$50,000 by:

Debit: Provision for Stock Obsolescence (Income Statement) $50,000

Credit: Provision for Stock Obsolescence (Balance Sheet) $50,000

Being 1% general provision created based on year end closing stock balance

METHOD 2: GENERAL PROVISION BASED ON AS A PERCENTAGE OF WHOLE YEAR PURCHASES

Similar explanation as above.

The difference is that we are only taking an estimate based on the whole year purchases. This estimate is based on past trend or management in-depth understanding of the industry. This method is rarely used.

Illustration:

Say, whole year purchase is $10,000,000

Based on experience, we create a provision of 0.5% of the whole year purchase:

0.5% x $10,000,000=$50,000 by:

Debit: Provision for Stock Obsolescence ( Income Statement) $50,000

Credit: Provision for Stock Obsolescence ( Balance Sheet) $50,000

Being 0.5% general provision created based on whole year’s purchases

METHOD 3: AS SPECIFIC PROVISION BY IDENTIFY SPECIFIC STOCK WHO TURNS BAD

The word “SPECIFIC” means that this provision is created based on reviewing the INDIVIDUAL stock items. Assuming that the company has a total number of  100 stock items, management managed to identify 20 stock items needed for Stock Obsolescence provision.

Unlike the general provision, this is a SPECIFIC provision which is created based on solid reasons like change in fashion, monthly sales trend showing zero movement, stock almost near to their expiry date. This necessitates the requirement to create this specific provision

As for as the accounting treatment is concerned, it is the same as the general provision. ( see illustrations above)

METHOD 4: BASED ON DETAILED STOCK AGEING SCHEDULE

In this case, this provision for Stock Obsolescence is creating from the AGEING Stock Schedule. Every month, management are presented with such AGEING schedule which reflects the AGE of these stocks. Based on company’s internal policy /procedures, the provision for Stock Obsolescence is created.

Illustration:

Assuming that Company A has the following accounting policy & procedure for provision for Stock Obsolescence:-

Stock >120 days – 10% of stock amount

Stock >180 days old – 50% of stock amount

Stock >365 days – 100 % of stock amount

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Financial Accounting

 
 

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