Inventory reserve is an asset contra account that retains a planned charge for inventory that the company won't be able to sell, but which was manufactured. Usually the inventory reserve is set based on experience from the past. If the company usually losses 5% of inventory, the reserve should be created for the 5% of inventory value.
So those 5% (e.g. €10000) debit cost of goods sold and credit inventory reserve. If then we learn that €3000 are obsolete, we can debit inventory with that sum and credit inventory account. We leave €7000 reserve.
Inventory reserve enables analysts to predict more accurately value ot the assets.
- Nelson, M., Elliott, J., & Tarpley, R. (2002). How are earnings managed? Examples from auditors.
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