Write-Down vs. Write-Off: An Overview
"Write-down" and "write-off" are both accounting terms. The difference between them is largely a matter of degree, but it's also important to understand which one to use under what circ*mstances.
A write-down is a technique that accountants use to reduce the value of an asset to offset a loss or an expense. A write-down can become a write-off if the entire balance of the asset is eliminated and removed from the books altogether. Write-downs and write-offs in this sense are predominantly used by businesses. The term "write-off" can also apply to the deductions that individual taxpayers take to reduce their taxable income, but that is a different meaning, as explained below.
Key Takeaways
- A write-down reduces the value of an asset for tax and accounting purposes, but the asset still retains some value.
- A write-off reduces the value of an asset to zero and negates any future value.
- A write-off is typically a one-time event, entered in a company's books immediately when an asset has lost all usefulness or value, but write-downs can be entered incrementally over time.
How Write-Downs Work
A write-down is recorded on a company's books as an adjustment to the existing inventory. A credit is applied to the equipment or whatever the inventory item is, and the total value is reduced accordingly.
A write-down can instead be reported as a cost of goods sold (COGS) if it's small. Otherwise, it must be listed as a line item on the income statement, affording lenders and investors an opportunity to consider the impact of devalued assets. Large write-downs can reduce owners' or stockholders' equity in the business.
Companies can also reduce a portion of an asset's value based on depreciation or amortization.
How Write-Offs Work
Writing an asset off in business is the same as claiming that it no longer serves a purpose and has no future value. The business is effectively declaring that the value of the asset is now zero. Once an asset has been written off in this manner, this valuation is permanent.
Old equipment can be written off even if it still has some potential functionality. For example, a company might upgrade its machines or purchase brand-new computers. The equipment that's being replaced can be written off in this case. Its economic value would be listed as $0.
A bad debt write-off can occur when a customer who has purchased a product or service on credit fails to pay the bill and is deemed to have defaulted on that debt. From the perspective of the business that debt is now uncollectible. When that happens, the accounts receivable on the company's balance sheet will written off by the amount of the bad debt, which reduces the accounts receivable balance by the amount of the write-off.
An adjustment to revenue must be made on the income statement to reflect the fact that the revenue once thought to be earned will not be collected if the company uses accrual accounting practices.
A negative write-off is essentially the opposite of a normal write-off in that it refers to a business decision to not pay back or settle the account of a person or organization that has overpaid.
It's up to the company to credit back the amount of a discount to the consumer when that customer pays full price for a product on credit terms, then is given a discount after a payment is made. It's considered to be a negative write-off if the company decides not to do this and keeps the overpayment instead. Negative write-offs can harm relationships with customers and also have negative legal implications.
Write-Down vs. Write-Off Example
Company X's warehouse, worth $500,000, is heavily damaged by fire, but it's still partially usable. Its value is written down by half to reflect the event. It's now worth $250,000.
Company X's warehouse burns to the ground. It can't be repaired or ever used again. Its former $500,000 value is written off. Its value is now $0.
Periodically assess the assets below to see if you have any write-offs or write-downs for your company. For instance, it might make sense to revalue certain assets quarterly or annually.
Common Types of Write-Downs or Write-Offs
Here's a non-exhaustive list of activities a business may undertake that may need to get written off or written down.
- Accounts Receivable Accounts receivable may be written off when it becomes clear that a customer will not pay the amount owed. This often occurs after repeated collection attempts have failed, meaning the receivable is uncollectible.
- Inventory: Inventory is written down when its market value falls below its cost due to obsolescence, damage, or declining market demand. If inventory becomes completely obsolete or unsellable, it may be written off entirely.
- Fixed Assets (Property, Plant, and Equipment): Fixed assets are written down when their market value declines significantly, often due to technological advancements, physical damage, or changes in market conditions. This ensures the balance sheet reflects a more accurate value of the assets. For example, think of how commercial real estate valuations were negatively impacted post-pandemic.
- Intangible Assets: Intangible assets, such as patents, trademarks, and goodwill, may be written down if they lose value due to legal challenges, changes in market conditions, or impairment. Goodwill, in particular, is written down when the acquisition value of a company exceeds its fair market value.
- Investments: Investments in securities or other companies can be written down when their market value decreases below the acquisition cost. This adjustment reflects the current fair value of the investments on the balance sheet, as the company usually has to report the unrealized gain on its financial statements.
- Research and Development Costs: Capitalized can be written down if a project is discontinued or fails to achieve the desired results. This ensures that only successful and valuable projects are reflected in the financial statements, and projects that didn't make the cut and won't provide future benefits to the company are expensed in the current period.
Write-offs and write-downs are a common part of business. It's not necessarily a poor reflection of the company.
Write-Down and Write-Off Journal Entries
The journal entries for a write-off and a write-down are similar but different. Here's the accounting entry for each.
Journal Entry for Write-Down
Before you post the journal entry, you need to determine the amount by which the asset's carrying value exceeds its fair market value. This is usually done through some sort of analysis or independent valuation.
The journal entry to record the write-down is to debit an expense account. Note that you'll want to debit some sort of expense account, though it not be a normal operational expense account. For example, you'll likely want to book a write-down to some sort of loss account (assuming a write-down).
Your offsetting credit can be directly booked to the asset account. Alternatively, you may choose to have a little bit more transparency in your financial records to bifurcate the historical cost of an asset from its valuation. For this reason, it may be more appropriate to credit a contra-asset account that can be netted against the actual asset account.
Journal Entry for Write-Off
To write off an asset, the journal entry is fairly similar. However, the end goal is to wipe off the entire asset, as it should no longer be carried on your books. For example, think about inventory that was stolen. In this case, you don't want to carry the inventory on your balance sheet anymore.
To record the write-off, you want to debit a similar 'loss' account. However, you'll want to credit the asset (in this example, inventory). This reduces the asset down to $0 so it's no longer on the books. Note that your debit may go to an expense account instead; for example, you may set up a "bad debt expense" account specific to receivables you write down or write off.
Implications of Write-Downs and Write-Offs
When a company decides to write off an asset, it essentially acknowledges that the asset no longer holds any economic value. The immediate impact of a write-off is a reduction in the asset’s book value to zero, which directly affects the company's total assets and its net worth.
On the income statement, a write-off results in an expense, which reduces net income for the period in which the write-off is recognized. This decrease in net income can affect financial ratios such as return on assets and return on equity. If you frequently write off amounts, this may raise concerns about your company's asset management practices, potentially leading to implications in case you need to do a third-party audit.
From a tax perspective, write-offs can provide immediate benefits. The expense recognized from the write-off may reduce taxable income, thereby lowering your company’s tax liability for the period. This can improve cash flow in the short term, as less cash is required for tax payments.
Unlike a write-off, which removes an asset entirely from the balance sheet, a write-down reduces the asset’s carrying amount. The primary implication of a write-down is its impact on the balance sheet, where the asset’s reduced value results in lower total assets and equity.
On the income statement, a write-down is recognized as a loss, which reduces net income for the period. This reduction in net income can affect financial ratios such as the gross margin ratio. For fixed assets, a write-down can affect depreciation expense in future periods, as the asset's lower carrying amount will result in lower depreciation charges.
What Is a Write-Off on Personal Income Taxes?
In the case of personal income taxes, the term "write-off" is often used as a synonym for tax deductions that the taxpayer can use to reduce the amount of income on which they will have to pay taxes. Common deductions include state and local income and sales taxes, property taxes, mortgage interest, and medical expenses over a certain threshold. Taxpayers have a choice of writing off these deductions individually, known as itemizing, or taking the standard deduction instead.
What Is Depreciation?
Depreciation is an accounting technique that allows a business to write down a portion of an asset's value over a period of time. Companies can use a variety of depreciation methods, including straight-line depreciation and accelerated depreciation. A simple example of straight-line depreciation would be a piece of machinery with an expected useful life of 10 years that the business depreciates at a rate of 10% a year until its value for accounting purposes is $0. Accelerated depreciation, as the name implies, allows a business to depreciate a greater percentage of an asset's value in the early years of its useful life. The Internal Revenue Service explains the various methods and when they can be used in its Publication 946: How to Depreciate Property.
What Is Amortization?
Amortization is an accounting technique much like depreciation. The difference is that while depreciation is used to reduce the value of physical assets like office equipment or a fleet of trucks, amortization applies to intangible assets like patents, trademarks, and goodwill.
What Is a Charge-Off?
A charge-off is an accounting term similar to a write-off but usually associated with loans and credit cards. For example, a bank might charge off debt from a credit cardholder that it believes to be uncollectible, reducing its value to zero. However, the debt doesn't necessarily end there, as the bank may sell it to a collection agency, which will continue attempts to collect it.
The Bottom Line
Write-downs and write-offs are two ways that businesses account in their financial statements for assets (including physical assets and outstanding credit balances) that have lost value. Write-offs are the more severe and final of the two, indicating that the company believes the asset to be worthless.
