Inventory management strategies attempt to save money by ensuring the inventory is properly tracked, ordered and sold. On the accounting side of inventory management, the goal is to save money by creating accounts to hold key inventory changes, which can be added together at the end of each period to create financial statements. This is especially effective for businesses with a large amount of inventory, but it requires making an inventory reserve account for some entries.
The reserve account is a special type of accounting object used to protect businesses against unforeseen but likely events that will lower asset value. Essentially, by setting money or value aside into reserve accounts, accountants can prepare for unfavorable future events. This ensures that it will not drastically affect company profits or require widespread alterations in other accounts, instead draining only the reserve account. In this case, the account itself is responsible for the offset, offsetting the change in asset value.
Uses for the Reserve Account in Inventory
For specific inventory reserve accounts, inventory value is set aside to account for losses beyond the control of the business, especially losses that occur before products are actually out on the shelves. For example, the business may use the reserve account to cover spoiled or defective products that go bad in storage. At other times, in a rapidly changing market, products in storage may become obsolete and must be sold as scrap or recycled. These changes lead to losses and are accounted for in the inventory reserve.
The key purpose of an inventory account is to offset asset value. When an accountant moves value into the inventory reserve account, it is considered an offset, or set against the actual value of inventory. In other words, the account exists to reflect diminished asset value, even though asset value on the books remains unchanged until the period is over and all losses are calculated.
Offsetting the Reserve Account Itself
At the end of the period, the business will closely examine inventory and record all losses that occurred. It is at this point that the reserve account will be matched by a reduction in balance sheet inventory value. However, if the loss is not as large as planned for, the accountant will need to offset the reserve account itself with an adjustment to ensure the two sides balance.
- Accounting Coach: What is a LIFO Reserve?
- Princeton University, American Association of University Professors: Reserves & Allowances
- The Perfect Business Plan Made Simpler; William Lasher; 2005
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