Recently, Abercrombie & Fitch (NYSE: ANF) has been implementing a turnaround str
ID: 2573019 • Letter: R
Question
Recently, Abercrombie & Fitch (NYSE: ANF) has been implementing a turnaround strategy since its sales had been falling for the past few years (11% decrease in 2014, 8% in 2015, and just 3% in 2016.) One part of Abercrombie’s new strategy has been to abandon its logo-adorned merchandise, replacing it with a subtler look.
Abercrombie wrote down $20.6 million of inventory, including logo-adorned merchandise, during the year ending January 30, 2016. Some of this inventory dated back to late 2013. The write-down was net of the amount it would be able to recover selling the inventory at a discount. The write-down is significant; Abercrombie’s reported net income after this write-down was $35.6 million.
Interestingly, Abercrombie excluded the inventory write-down from its non-GAAP income measures presented to investors; GAAP earnings were also included in the same report.
Questions
What does “write-down” mean?
What journal entry would Abercrombie & Fitch have made to write down its merchandise inventory during the year ended January 30, 2016?
What impact would the write-down of inventory have had on Abercrombie’s assets? Liabilities? Equity?
What impact would the write-down of inventory have had on Abercrombie’s expenses? Gross margin? Net income?
What impact, if any, would the write-down of inventory have had on Abercrombie’s current ratio?
From an investor standpoint, do you think that the effect of the inventory write-down should be considered when evaluating Abercrombie & Fitch? Explain.
Explanation / Answer
Write down of inventory means reduction of inventory assets in the books of account. If inventory becomes obsolete /impaired, or there is shortage of physical inventory due to loss/ theft, the book value of inventory assets needs to be reduced to give a true and fair view of financial position of the entity.
The fair value is reflected by write down of inventory
JOURNAL ENTRY:
Account Title
Debit
Credit
Loss on write down of inventory
$20,600,000
Inventory
$20,600,000
It can also create a contra inventory account to identify write down.
In this case the journal entry is shown below:
Account Title
Debit
Credit
Loss on write down of inventory
$20,600,000
Allowance for obsolete inventory
$20,600,000
IMPACTS
ASSETS: It will be reduced by the amount of write down
LIABILITIES: No effect
EQUITY: Loss on inventory write down will reduce net income. Consequently, it will reduce Retained earnings. Hence Equity will reduce.
EXPENSES: Expenses will increase
GROSS MARGIN: Since cost of goods is not changed, there will be no impact on Gross Margin. In case there is small amount of write down, some companies charge the loss to cost of goods sold. In such cases there would be reduction of gross margin
NET INCOME: Net income will decrease, since the expenses will go up.
CURRENT RATIO:
Current ratio=Current assets/current liabilities.
There is no change in liabilities. Current asset is decreased. Hence the Current Ratio will decrease
From the investors’ point of view, the inventory writes down needs to be considered because shareholders equity is reduced. The book value per share is also reduced.
There is reduction in the value of the company.
All these will affect the ability of the company to generate wealth. Earning per share will decrease, price earning ratio will change. These will affect the market price of s
Account Title
Debit
Credit
Loss on write down of inventory
$20,600,000
Inventory
$20,600,000
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