Introduction
In 2023, Pfizer recorded $6.2 billion of inventory write-offs and related charges in its cost of sales, $5.0 billion for its COVID treatment Paxlovid and $1.2 billion for its vaccine Comirnaty, as its 2023 annual report on Form 10-K shows. Demand had collapsed, and the doses and treatment courses it had built up were worth far less than they cost to make. The charges did not use any cash, because the cash had been spent when the products were manufactured. They recognized that the money would not come back.
An inventory write-down applies the same principle to every company that holds stock: inventory cannot stay on the balance sheet at more than the business expects to recover from it. Its statement effects follow the pattern of any non-cash charge, traced in impairments and write-downs on the three statements; what is particular to inventory is the test that decides when value has fallen, and the lower cost it leaves behind.
The Test: Lower of Cost and Net Realizable Value
Since Accounting Standards Update (ASU) 2015-11, US generally accepted accounting principles (US GAAP) have measured inventory valued on first-in, first-out (FIFO) or average cost at the lower of cost and net realizable value, under the inventory topic, Accounting Standards Codification (ASC) 330. If a product's expected selling price, less the costs still needed to complete and sell it, falls below its cost, the company writes inventory down to that net realizable value and records the loss, usually in cost of goods sold.
- Net realizable value
The estimated selling price of inventory in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Inventory measured on FIFO or average cost is written down to net realizable value when that amount falls below cost.
Inventory valued on last-in, first-out (LIFO) or the retail inventory method still follows the older lower of cost or market test, which compares cost with replacement cost, bounded above by net realizable value and below by net realizable value less a normal profit margin. Because LIFO inventory is usually carried at older, lower costs, it fails the test less often; the choice of method is covered in inventory costing: FIFO, LIFO and weighted average.
The test is usually applied item by item or by groups of similar items, and the common triggers are obsolescence, damage, excess quantities, falling selling prices and expiry dates. Suppose a company holds a product that cost $500, which it now expects to sell for $420, with $40 of costs still needed to sell it:
| Line item | Amount |
|---|---|
| Inventory at cost | 500 |
| Expected selling price | 420 |
| Less costs to complete and sell | (40) |
| Net realizable value | 380 |
| Write-down charged to cost of goods sold | 120 |
| Inventory carried after the write-down | 380 |
The 380 becomes the new cost basis of the inventory; under US GAAP it is not written back up if prices recover.
Under US GAAP, the written-down amount becomes the inventory's new cost basis. If prices later recover, the write-down is not reversed; PwC's guide to lower of cost or market notes that the reduced amount is treated as cost for later accounting, with an exception only for recoveries in a later interim period of the same fiscal year.
What Bankers Check
A write-down moves the statements like other non-cash charges: cost of goods sold rises, net income falls by the after-tax amount, the charge is added back on the cash flow statement, and inventory falls. For US tax, a reserve for an estimated fall in value is not deductible (Treasury Regulation 1.471-2); the loss usually counts only when the goods are sold, scrapped or offered for sale at the lower price, so the tax saving first appears as a deferred tax asset (tax the company expects to save later), as it did at Pfizer in 2023. For analysis, three points matter more than the mechanics:
- Recurring or one-off: some write-downs, such as Pfizer's, follow an unusual collapse in demand; others, such as routine provisions for obsolete stock at a fashion or electronics retailer, recur every year and belong in normal margins.
- Later margins: goods written down and then sold carry the lower cost basis, so the sale shows a higher gross margin than the product really earns, a delayed boost from the earlier charge.
- Reserve trends: the inventory note often shows gross inventory and a reserve for obsolete and slow-moving stock; a reserve growing faster than inventory can signal aging stock or weakening demand.
The related allowances for receivables, returns and warranties, which follow similar estimation logic, are covered in reserves and allowances. For inventory, the test is simple to state and judgment-heavy to apply: stock is worth no more than the business can sell it for, and the timing of that conclusion decides which year absorbs the loss.
