Damaged Inventory Accounting: How to Manage and Record Losses Accurately

U.S. businesses lose over $45 billion every year due to damaged, spoiled, or unsellable inventory. This is not just a warehouse issue; it’s a silent profit killer.

Damaged goods don’t just damage your shelves. They also damage your margins, taxes, and compliance. 

From cracked packaging and expiration dates to supplier mishandling or storage failures, even minor slip-ups can trigger major financial headaches.

The real kicker? Most business owners don’t realize how badly damaged inventory skews their financial statements until it’s too late. And the IRS won’t accept “oops” as a valid audit response. This is where damaged inventory accounting comes into play.

And if tracking it all manually sounds like a nightmare, doola’s bookkeeping and accounting tools can help founders like you stay on top of every SKU, deduction, and decision.

Let’s break down how to identify, manage, and adequately account for damaged inventory without losing sleep (or money).

Causes of Inventory Damage

Have you ever opened a shipment of your products only to find crushed boxes, leaky containers, or packaging that looks like it went through a blender? 

Damaged inventory isn’t just a warehouse nuisance. It quietly eats into your margins, disrupts operations, and can even land you in tax or compliance trouble if not properly accounted for.

To protect your bottom line, it’s essential to understand where inventory damage comes from and how to stop it before it spreads.

Internal Factors: When the Problem Starts Inside Your Business

Some of the most common and preventable causes of inventory damage come from within your own four walls.

Poor Storage Conditions

Inventory that’s stored in areas with fluctuating temperatures, humidity, or improper shelving is more likely to spoil, warp, or degrade. 

For example, cosmetics can separate or melt if not kept in climate-controlled storage, and food items can spoil faster without FIFO (first-in, first-out) rotation.

Careless Handling by Staff

Even minor mishandling, like dropping boxes or using the wrong tape, can result in unusable products. 

This is especially risky during peak sales periods like BFCM or holiday seasons when teams are stretched thin.

Mislabeled or Mismatched SKUs

If your team picks the wrong item or puts the wrong barcode on a product, it can lead to lost sales, customer complaints and forced returns that damage otherwise sellable inventory.

Inadequate Packing Stations

A chaotic or under-resourced packing area invites mistakes. Without proper dividers, bubble wrap, or quality control protocols, you’re just one dropped item away from a write-off.

📌 doola’s Real-world Example: A fast-growing DTC apparel startup reduced its return-related inventory losses by 20% after investing in better packaging supplies and adding a final quality-check step to its outbound process.

External Factors: Risks Outside Your Four Walls

Even if your in-house operations are rock solid, things can (and do) go wrong once inventory leaves your facility or is delivered from a supplier.

Supplier Mistakes

Receiving pre-damaged goods from your supplier is more common than most businesses expect, especially when dealing with overseas manufacturers. 

Loose seals, weak packaging, or moisture exposure during transit can compromise entire shipments before they even hit your shelves.

Transportation Damage

Once your goods are on a truck, plane, or ship, they face temperature fluctuations, vibrations, impacts, and delays. 

Even a sudden brake during delivery can cause boxes to topple and products to crack or spill.

Natural Disasters

Floods, earthquakes, fires, or even minor roof leaks can destroy thousands of dollars of inventory in hours. 

If your warehouse lacks proper drainage, insurance, or contingency plans, you’re exposing your business to massive risk.

Border Delays & Customs Issues

For international sellers, customs delays can leave goods sitting in poorly controlled environments. 

This can ruin perishables or temperature-sensitive items and increase the likelihood of damage due to excessive handling.

📌 doola’s Real-world Example: One Amazon FBA seller began photographing each inbound supplier shipment and inspecting 100% of units upon arrival after realizing that nearly 15% of stock had minor defects, costing them thousands in refunds and customer churn.

Accounting Treatment for Damaged Inventory

Damaged inventory is not just a warehouse problem, it’s an accounting one too. It can lead to bad business decisions, inaccurate tax filings, or even trouble during an audit.

If you don’t handle it properly, you risk overstating your assets, underreporting expenses, and misrepresenting your profitability. 

Here’s how to account for damaged inventory the right way while staying compliant with accounting standards like GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards).

Write-Down vs. Write-Off: What’s the Difference?

Not all damaged inventory is created equal. Some products may still have partial value (like refurbished electronics or lightly torn apparel). Others are a total loss.

Here’s a quick breakdown:

For example, if $1,000 worth of gourmet snacks expire but can be donated or sold in a clearance bundle for $200, you write down the inventory to $200 and expense the $800 loss.

Recording Damaged Inventory

Accounting for inventory damage usually involves a journal entry to reflect the loss. The specifics depend on whether you’re writing down or writing off the value.

Here’s a simplified example of the journal entries:

Write-Down Entry:

Debit: Loss on Inventory Write-Down        $800  

Credit: Inventory                          $800

Write-Off Entry:

Debit: Inventory Loss Expense              $1,000  

Credit: Inventory                          $1,000

You’ll also want to document the reason for the loss, photos (if available), and any insurance claim or salvage receipts to support the entry, especially for tax purposes.

What About Salvage Value or Insurance Recovery?

If you can recover some value from the damaged goods, whether by selling them at a discount or filing an insurance claim, you’ll need to account for that too.

Let’s say you wrote off $2,000 in damaged electronics, but your insurer reimbursed you $1,200. You would:

Debit: Cash / Insurance Receivable         $1,200  

Credit: Gain from Recovery or Other Income $1,200

This ensures you don’t overstate your loss or understate your revenue.

📌 doola’s Pro Tip: Always check your insurance policy for coverage limits, deductibles, and proof requirements before filing a claim.

Decision Tree: Write Down or Write Off?

Here’s a quick way to decide:

• Can the item be sold at any price?
  → Yes → Write Down
  → No → Go to Step 2

• Was the item completely destroyed, expired, or unsafe to sell?
  → Yes → Write Off
  → No → Consult your accountant (it may require a partial adjustment)

Manual Tracking = Margin for Error

Trying to track damaged inventory in spreadsheets or paper logs? That’s a recipe for misstatements, especially during tax season.

That’s where doola Bookkeeping can help. Our all-in-one platform makes it easy to track inventory losses accurately, reconcile them with your financials, and maintain audit-ready records (no spreadsheets required).

Tax Implications of Damaged Inventory

Damaged inventory isn’t just a hassle, it can also be a tax-saving opportunity if you record it correctly. 

For e-commerce founders managing inventory at scale or across warehouses, the IRS rules around deductions can save you thousands and keep you in good standing come audit time.

But there’s a catch: claiming deductions requires proper documentation, accurate accounting, and awareness of how and when to adjust your inventory records.

When Can You Deduct Damaged Inventory?

Under U.S. tax law, businesses using the accrual method of accounting can typically deduct the cost basis (not retail value) of inventory that becomes unsellable due to damage, spoilage, or obsolescence. 

The deduction can only be taken in the year the loss occurred. Common deductible situations include:

• Flood-damaged clothing stored in a warehouse

• Expired cosmetics or supplements

• Cracked electronics returned by customers

• Moldy or temperature-spoiled food products

However, this deduction is only valid once you’ve removed the damaged items from your inventory value on the books (i.e., written them down or off).

IRS Requirements & Forms to Use

If you’re filing a U.S. business tax return, you’ll typically report adjusted inventory values on IRS Form 1125-A (Cost of Goods Sold). 

The inventory reduction will lower your taxable income for the year. To claim damaged inventory as a deduction, you must:

• Adjust the value of the affected inventory in your accounting records

• Maintain proof of the loss (photos, supplier emails, shipping damage reports)

• Show how you calculated the loss (original cost minus salvage or recovery value)

Let’s say you have $5,000 worth of smartwatches that were water-damaged due to a storage malfunction. You expect no insurance payout or salvage value.

Here’s how you’d log this in Excel-based bookkeeping:

Now, let’s say you later recover $1,500 by selling the damaged items at a discount or filing an insurance claim:

You can track this easily in a sheet like:

Common Mistakes That Trigger IRS Issues

• Claiming losses without evidence: Keep receipts, shipping logs, and photos of the damage.

• Using retail value instead of cost: Only the original purchase cost is deductible.

• Ignoring insurance or salvage recovery: Any reimbursement must be subtracted from the loss.

• Not updating inventory records: If you don’t reduce the inventory on your books, the IRS considers the deduction invalid.

Getting this right can mean the difference between maximizing your tax savings and facing a compliance headache. 

But manual tracking, spreadsheets, and inconsistent documentation often lead to missed deductions or worse, IRS red flags.

That’s where we come in. Our expert team helps you document, categorize, and deduct inventory losses the right way so you stay compliant and confident at tax time.

Book a demo with our experts today

How to Minimize Inventory Damage

Damaged inventory doesn’t just hurt your margins, it creates ripple effects across fulfillment, customer satisfaction, and cash flow.

But the good news? With the right systems in place, it’s preventable.

So, if you want to reduce damage by 30% this quarter, start with these 3 quick wins and turn costly mishaps into measurable improvements. 

1. Optimize Storage Conditions

Boxes get crushed, perishables spoil, and electronics get fried, not because of faulty products, but because of bad environments.

• Ensure shelving and racking systems are stable and labeled.

• Keep high-traffic areas clear to avoid collisions and tipping.

• Use pallets, climate control, and humidity monitors where needed.

• Perform monthly walkthroughs to identify storage hazards.

📌 doola’s Pro tip: Cold storage facilities should maintain temperature logs every 2–4 hours. A few degrees of fluctuation can mean thousands in spoiled goods.

2. Train Staff on Inventory Handling

Even the best inventory system can’t prevent damage caused by rushed or careless handling. Luckily, human error is avoidable with training.

• Train all warehouse and receiving staff on proper lifting, stacking, and box placement.

• Post clear signage for fragile items and heavy-lifting zones.

• Hold monthly refresher sessions or safety briefings.

📌 doola’s Real-world Example: A DTC apparel brand reduced return-related damage by 20% just by redesigning its packing station and re-training new hires on folding and packaging methods.

3. Apply FIFO or LIFO Correctly

Using the wrong inventory flow can lead to spoiled or outdated goods especially in food, cosmetics, and supplements.

• Use FIFO (First In, First Out) for perishable or time-sensitive goods.

• For durable items, LIFO (Last In, First Out) may reduce holding costs during inflation.

• Regularly cycle and audit shelf stock to ensure older inventory is sold first.

📌 doola’s Real-world Tip: If you’re selling skincare or supplements, use expiration tracking software that triggers alerts 30 days before shelf life ends.

4. Add Quality Control Checkpoints

Catching damage early can prevent bigger losses later  in high-volume e-commerce.

• Inspect goods at three stages: receiving, storing, and shipping.

• Snap photos of high-value items on arrival for documentation.

• Use barcode or RFID scans to track movement and condition updates.

📌 doola’s Real-world tip: Build a short “damage review” form for your shipping team, ask them to flag issues before packaging leaves your facility.

By implementing these practices with your accounting and inventory records, you can catch issues before they become expensive write-offs and protect both your margins and customer trust. 

Using Technology to Track and Manage Inventory Losses

Today’s e-commerce and inventory-heavy businesses need more than guesswork. They need real-time visibility, accurate data, and automated workflows.

Let’s break it down:

When inventory damage goes undetected or unrecorded, your books, taxes, and forecasts can all take a hit. 

But with the right tools in place, you can catch issues early, reduce waste, and make smarter decisions faster.

Our bookkeeping and analytical tools integrate with your systems to track, report, and reconcile damaged inventory automatically so you’re always audit-ready, and margin-aware.

Book a demo with our experts today!

How doola Bookkeeping Can Help

When it comes to damaged inventory, the cost isn’t just the lost product. It’s the misstatements in your books, the tax deductions you miss, and decisions you make based on incomplete data.

doola Bookkeeping is built to give e-commerce founders and small business owners total visibility into their inventory losses without the manual headaches.

With doola, you get real features for real impact:

• Automatic reconciliation of inventory adjustments and write-downs

• Smart categorization of damaged goods for accurate tax reporting

• Real-time financial dashboards that reflect true margins (even with inventory loss)

• End-of-year tax prep that captures every legitimate deduction

A DTC skincare brand uncovered $5K in hidden losses after switching to doola Bookkeeping.

With doola’s smart tracking and monthly reconciliations, you can keep track of the numbers, write off the losses, update your processes, and most importantly, protect your profit margins.

If you are looking for visibility and control, book a free demo today to see how much you could save.