A write-off removes an asset or liability from a company’s financial statements. Assets are written off when they become obsolete. Lost inventory, unpaid debt obligation, bad debts, and unpaid receivables are also written off.
It is achieved by moving a part of or all of the asset account balance into an expense account. Writing-off is used for reducing tax liabilities. These expenses curtail the company’s taxable income and decrease the book value of the assets.
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- A write-off reduces the value of assets in a company’s book of accounts. This technique improves cost accounting accuracy. It even helps the company represent a fair asset and liability position—financial statements.
- The recorded book value of an asset is reduced to zero. Usually, this occurs when assets owned by a business cannot be liquidated. They have no further use to the business or have no market value.
- In retail companies, common write-offs comprise damaged goods. In industrial companies, productive assets get damaged beyond repair—such assets are written-off.
How Does a Write-Off in Accounting Work?
Businesses often write-off expenses and non-performing assets—to unload irrelevant elements from balance sheets. Writing off improves the accuracy of cost accounting. It is a technique used for reducing tax liabilities. Businesses create non-cash expenses, as they ultimately end up lowering reported income.
Hence, it can be defined as the process of removing an asset or liabilityLiabilityLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company. from the accounting books and financial statements. For example, this might happen when an inventory becomes obsolete or when there is no particular use for a fixed asset. Usually, this is achieved by moving a part of the balance or all of the asset account balance into an expense account. The procedure varies for different asset types.
Companies decrease the book value of the assets for depreciation, loss, theft, fire, and obsoletion. Non-performing assets do not generate revenue. But they are still considered so that a real-time balance sheet can be maintained—containing fair book values of assets and liabilities. This way, the true position of an organization can be determined.
Following are examples of businesses writing off various assets and expenses:
- Bad Debt: When a client purchases on credit and fails to pay the invoice amount before the due date, it is considered bad debt. Most defaults are caused by bankruptcy. The amount of debt that could not be collected is taken as a loss, and the company writes it off from its books of accounts.
- Asset Write-Off: In this case, the asset’s book value is reduced to zero (for completely depreciated, lost, or destroyed assets). Therefore such an asset value is written off from the accounting records.
- Unpaid Bank Loan: When all debt collection methods fail, banks consider the dues as a loss and write it off from their books.
- Unpaid Account Receivables: The bills which are non-recoverable from the customers are offset against the allowance for doubtful accountsAllowance For Doubtful AccountsAllowance for doubtful accounts primarily means creating an allowance for the estimated part that may be uncollectible and may become bad debt and is shown as a contra asset account that reduces the gross receivables on the balance sheet to reflect the net amount expected to be paid. , also known as a contra accountContra AccountContra Account is an opposite entry passed to offset its related original account balances in the ledger. It helps a business retrieve the actual capital amount & amount of decrease in the value, hence representing the account’s net balances. . It is shown as a liability on the balance sheet—credited to accounts receivable.
- Inventory Loss: Stocks can get damaged, lost, burnt, stolen, or outdated. Therefore, such inventories need to be written off. It can be charged directly to the cost of goods soldThe Cost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. . Alternatively, the loss can be offset against the obsolete stock reserve (contra account).
- Benefit Not Received Against Advance Pay: When an employee takes an advance salary and doesn’t turn up the next day, the company considers it as a loss—the charges are attributed to compensation expenses.
- Tax Write-Off – Any deduction, expense, subsidy, or credit that curtail the taxpayer’s taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation. is written off.
The Generally Accepted Accounting Principles (GAAP) have stated the accounting procedure for writing off expenses and assets. Following are the two methods used for it:
Direct Write-Off Method: The company’s non-recoverable outstanding accounts receivables are transferred straight to the bad debt account. The following entry is formulated:
|Bad Debt A/c… Dr||xxx|
|To Accounts Receivables A/c||xxx|
|Allowance for Doubtful A/c… Dr||xxx|
|To Accounts Receivables A/c||xxx|
Write-Off Vs. Write Down
Writing-off brings down the value of an asset to zero. A write-down, on the other hand, reduces the book value of an asset when its carrying value exceeds fair value (carrying value = purchase price – accumulated depreciation). The impaired amount is shown as a separate item in the income statement.
Both concepts account for the loss of assets, but the difference is in the degree of reduction. Written-off, assets completely lose their value. But, with write-downs, only a partial value of the asset is lost.
Frequently Asked Questions (FAQs)
A trader can write-off short-term stock losses against short-term gains. However, long-term equity losses cannot be written-off.
The following expenses can be written-off: business, insurance, depreciation, advance pay, charity contribution, medical expense, advertisements, promotion, mortgage expenses, professional service fees, and interest on loans.
Every bank maintains a provision for bad debts—the loan loss reserve. Unrecovered loan amounts are adjusted using the reserves—dead assets are eliminated from the balance sheet. Bank loans are considered revenue-generating assets.
This article has been a guide to what is a Write-Off and its meaning. Here we discuss the writing-off of bad debts, car loans, student loans, business expenses, and taxes from journal entries and accounting. You may learn more about accounting from the following articles –