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E&O Reserve Reversal

My question concerns when E&O inventory reserves can be released. I understand that E&O reserves can only be reversed if the reserved inventory has been disposed or consumed. However, if a company has both active and reserved inventory, is the company required to deplete (use/consume) all the active inventory before releasing the reserve on the reserved parts? If yes, what is the basis for this requirement? I appreciate your guidance on this issue.

Answers

Topic Expert
Keith Perry
Title: Consulting CFO and Business Operations A..
Company: Growth Accelerator
(Consulting CFO and Business Operations Advisor, Growth Accelerator) |

Anon,

Typically, it depends on what your reserve is based on. To answer accurately we'd need the rules you're applying. If the "reserved" inventory is known (as opposed to estimated), and you liquidate it, then yes you can act on it. Similarly, if the reserved inventory is clearly marketable at a price above book cost, you intend to market it and there is a market for it, then it is totally valid to reverse the expense along with the reserve, increasing your inventory figure.

If the reserved inventory is based on the active inventory (such as can happen with very volatile inventory like tech parts that may go obsolete and be unmarketable), then you have the E&O as a function of active based on your history, and there is a natural "write up / write down / realize" cycle. You would normally realize some portion of the loss as you liquidate the E&O, and the new E&O would be the net of liquidated and estimated based on current inventory, which at times of low inventory could result in a write-up of inventory (eg reversal of the E&O accrual).

Note that abuse of this can be done to manage earnings, so you need to have a pretty clear reason both as to why you wrote it down, and why you are writing it back up.

Cheers,

KP

Anonymous
(Sr. Manager Financial Planning) |

Thanks Keith!

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