Provisions for obsolete and slow-moving stock

An auto-parts wholesale warehouse holds 640 million so'm of stock. Most of it sells every week, but at the ends of the racking sit parts for a model bought two or three years ago that nobody asks for any more. In the books they still stand at purchase price. As a result both inventory on the balance sheet and profit look overstated. For such goods a provision is created in advance: it lets the fall in value be recognised without waiting for the day of sale.

How it differs from NRV

Net realisable value (NRV) looks at a specific item: the price has dropped and the selling price is below cost. A provision for obsolete and slow-moving stock goes by age: the longer goods sit without movement, the lower the chance of selling them, and if they do sell it will be at a discount. Both reduce inventory, but the reason and the method of calculation differ. Do not create a provision twice for the same goods.

The ageing report

The basis is the 1C report "age of goods" or "date of last movement". The balance is split into groups, for example:

• 0–90 days: normal turnover;
• 91–180 days: under watch;
• 181–365 days: slow-moving;
• over 365 days: treated as obsolete.

A provision rate is set for each group. The rates are not universal: they should rest on the company's own sales history. For instance, if over the last two years parts older than a year sold on average for 40 percent of cost, a 60 percent provision for them is justified.

A worked example

Total stock is 640 million so'm. Distribution and provision:

1. 0–90 days: 380 million so'm, 0 percent, no provision.
2. 91–180 days: 120 million so'm, 10 percent, 12 million so'm.
3. 181–365 days: 80 million so'm, 30 percent, 24 million so'm.
4. Over 365 days: 60 million so'm, 60 percent, 36 million so'm.

Total provision is 72 million so'm, about 11 percent of stock. If no provision is made, profit is overstated by exactly that amount.

Exceptions

The age rule is not applied mechanically. Some goods are slow by nature yet do not lose their value: a rarely used but critical spare part for equipment that cannot be allowed to stop. Conversely, in medicines, food and chemicals, goods past their expiry date are provided for at 100 percent whatever their age. Seasonal goods are valued after the season ends, not from its start.

What the auditor tests

• The accuracy of the ageing report. The most delicate spot: a transfer between branches or a return document resets the age, and old goods look "new".
• Sales after the reporting date: at what price did the "obsolete" goods go?
• The history of write-offs and cheap clearance sales in previous years: are the provision rates close to the losses actually suffered?
• Whether the provisioning policy is written down and applied the same way each year, or whether rates quietly shift in years of low profit.
• Whether the provision is being used to hide a shortage: sometimes goods marked "obsolete" are actually not in the warehouse at all.

The policy should be in writing

The provision rates, age bands, the list of exceptions and the review period are recorded in one short document (an annex to the accounting policy). It also states who approves the rates. A written policy secures two things: the calculation is made the same way every year, and the provision changes by rule, not by management's mood. When goods are later actually written off or sold cheaply, the loss is charged against the provision created earlier rather than afresh, so profit does not swing sharply.

Common mistakes

• Provision rates are set "by feel", with no history or reasoning behind them.
• In the ageing report, transfers and returns refresh the age.
• Obsolete goods are overlooked during the count, so they end up looking like a shortage.
• The tax treatment of the provision is not agreed with the accountant.

Conclusion

The longer stock sits, the lower its real value, and the books should reflect that in good time. OmborAudit rechecks the ageing report, compares provision rates with sales history and helps build a justified, documented provision for obsolete goods.