An obsolescence reserve is created when a company determines that specific items, or a category of items, in its inventory are worth less than their book value. When that occurs, a company creates an inventory obsolescence reserve on its balance sheet and enters the difference between the items' book value and their current market value. At the same time, an expense on the income statement would be recorded for the same amount. Let's consider the example of Jane's Pet Emporium. It has 10 fancy dog beds in inventory that cost $50 each. The competition is offering a comparable dog bed for $30. Jane decides to recognize that her dog beds won't sell for $50. She creates a $200 obsolescence reserve by first calculating the difference between the cost of her dog bed and the new expected market value of the dog bed ($50 - $30 = $20). She then applies the difference in value to each of the 10 beds in inventory (10 x $20 = $200). At the same time, she creates an obsolete inventory expense for $200.