Too Much Inventory

BlackBerry Ltd. faced a rough week in late September 2013. Within a seven-day period, the company not only announced a potential buyer for the company but also reported a quarterly loss of close to a billion dollars. The loss was generated primarily by write-down of BlackBerry 10 handsets (BB 10), the companys new flagship product. Prior to this result, the company had been struggling to keep up with other smartphone competitors, and sales of the new phone had not met expectations. As a result of the news reported during this week, the companys share price fell over 20 percent on the market.

When the company reported its annual financial results for the year ended March 1, 2014, the gross profit on hardware sales was actually negative. In fact, it was $2.5 billion. How can a company report a negative gross profit? In BlackBerrys case, a further write-down of the BB 10 handset occurred in the third quarter, resulting in total write-downs for the year of approximately $2.4 billion. As described in the companys Management Discussion and Analysis of Financial Condition report, evaluations of inventory require an assessment of future demand assumptions (BlackBerry Ltd., 2014). Sales of the new BlackBerry product were significantly lower than expected, resulting in a large number of unsold handsets. As the goal of financial reporting is to portray the economic truth of a company, BlackBerry Ltd. had no choice but to accept the reality that their inventory of BB 10 phones could not be sold for the amount reported on the balance sheet. The company described the causes of the write-down as these: the maturing smartphone market, very intense competition, and uncertainty created by the companys strategic review process.

Regardless of the causes, it was clear that this massive write-down had a profound effect on BlackBerry Ltd.s financial results and share price. Although the write-down was a symptom of other deeper problems in the company, it is clear that management of inventory levels can be a significant issue for many businesses. For the accountant, understanding the importance of the reported inventory amount is paramount, and critically analyzing the valuation assumptions is essential to fair reporting of inventory balances.

Question

1. Explain why BB Ltd had to undertake massive write-downs in 2014.

2. Based solely on the data given in the opening case, prepare the typical journal entry BB Ltd would probably have made to record its write-downs in 2014.