What is an 'Inventory Reserve'

An inventory reserve is a contra asset account on a company's balance sheet made in anticipation of inventory that will not be able to be sold. Every year a company has inventory that will not be able to be sold for various reasons. It may spoil, fall out of fashion or become technologically obsolete. In anticipation of this, the company will create an entry on the balance sheet called inventory reserve. Inventory reserve accounts for the predicted amount of inventory that will not be able to be sold that year. Inventory is counted as an asset, and inventory reserve is counted as a contra asset in that it reduces the net amount of inventory assets at the company. Inventory reserve is an estimation of future inventory spoilage based on the company's past experiences. Once inventory that is unable to be sold is actually identified it is written-down in official recognition of the loss.

BREAKING DOWN 'Inventory Reserve'

An inventory reserve is an important part of inventory accounting in GAAP. Tracking a company's inventory reserve allows that company to make a more accurate representation of their assets on the balance sheet. An asset is any good that has future value to the firm. Since a portion of a company's inventory goes unsold each year, it makes sense that the company would not include the entire amount of their inventory as an asset on their balance sheet. The inventory reserve contra asset account subtracts value from the inventory asset entry on the balance sheet to create a more accurate representation of the portion of inventory that will actually be sold to create a future value for the company. Without the inventory reserve entry, the value of the company's assets would be overstated.

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