Write-Off

What is a Write-Off?

Write-offis an accounting term referring to an action whereby the book value of an asset is declared to be 0. A write-down also lowers asset book value, but it does not take the value to 0. In either case, the loss enters the accounting system as an expense.

Write-off and write-down are nouns naming actions, and the non-hyphenated phrases write off and write down are verbs for taking that action.

Assets can lose book value or become worthless for a variety of reasons.

One frequent use for the write-off occurs when a seller's accounts receivableassets become non-collectible. In that case, the seller writes off the debt by registering a Bad debt expense

A write-off (or write-down) is also called for when inventory assets lose some or all of their value. Note that inventory can lose value through obsolescence, changes in market demand, damage, spoilage, or theft.

Purpose of the Write Off

In any case, accounting write-offs serve two purposes:

Firstly, write-offs support accounting accuracy objectives
Secondly, the "write-off" creates tax savings for asset owners. These actions reduce tax liability by creating (non-cash) expenses that result in lower reported income.

Broader Meaning of Write Off

Note by the way that the term is also used informally and more broadly to mean "worthless." In this sense, "write-off" might refer to a project, initiative, or program that is abandoned, or stopped, because it is not expected to deliver hoped-for results. Or write-off can merely refer to an investment of any kind that is now worthless.

Explaining Write Off in Context

Sections below further define, explain, and illustrate write off in context with related terms and concepts from financial accounting and finance, focusing on three themes:

First, the accounting definitions of Write-Off and Write-Down.
Second, example transactions that show how Accountants write off bad debt and other losses.
Third, how and why accountants write down inventory losses.

How Do Firms Write Off Bad Debt?

Sales transactions in business usually include payment timing provisions, such as "Net 30 from receipt of invoice." An invoice with this annotation means that payment is due no later than 30 days from invoice receipt. When a customer is late in paying, however, most companies continue to carry the obligation under "Accounts receivable" for some time. During this time, they use various means to encourage the customer to pay (see Bad Debt).

The Decision to Write Off a Bad Debt

Most firms, however, also have a specified cutoff period which may be something like 30, 60, 90, or 120 days, beyond which the firms must choose between two possible actions:

Firstly, the company may decide to write off the obligation as a bad debt.
Secondly, the company may choose instead to refer the debt to a collection service or their lawyers for further legal action.

Note that when accountants write off a debt, the customer's obligation to pay remains. Writing off the debt serves only to improve the company's accuracy in accounting.

Firms may also decide to write off a bad debt when it becomes clear for other reasons that the customer will never pay. They may admit this reality when, for instance, the customer goes out of business, other creditors sue the customer, or the customer challenges the legitimacy of the obligation.

"Bad Debt" Write-Off: Impact on Financial Statements

Specific "bad debt" write-off actions are standard accounting practice for every firm that uses accrual accounting and a double-entry accounting system. Writing of obligations in this way means making two accounting system accounts:

Firstly, the firm debits the amount of the debt to an account. This account is a non-cash account. "Bad debt expense
Secondly, the firm credits the same amount to a contra asset account, "Allowance for doubtful accounts."

Writing off the debt in this way therefore directly impacts two accounting system accounts: Bad debt expense and Allowance for doubtful accounts. Changes in these accounts, in turn, involve other accounts and the firm's financial reports as follows:

Income Statement Impact

Companies report revenues earned during the period on the Income statement. Note that "earned revenues" include those that are still payable. And, all "earned revenues" are carried in a Balance sheet "Current assets" account, "Accounts receivable." This account is itself is not an Income statement line item, but its balance is part of the Income statement item Total net sales Revenues.

When the period includes a bad debt write off, however, the Income statement does include the Bad debt expense balance as a line item. Items of this kind appear typically under "Operating expenses," below the Gross profit line. As a result, Bad debt expense from a write off lowers Operating profit and bottom line Net income.

Balance Sheet Impact

A bad debt write-off adds to the Balance sheet account, Allowance for doubtful accounts. And this, in turn, is subtracted from the Balance sheet Current assetscategory Accounts receivable. The result appears as Net Accounts receivable. The write off, in other words, means that Net Accounts receivable is less than Accounts receivable.

Statement of Changes in Financial Position (Cash Flow Statement)

Bad debt expense also appears as a non-cash expense item on the Statement of changes in financial position (Cash flow statement). Bad debt expense from a write off is subtracted from Sales Revenues, lowering Total Sources of Cash.

Statement of Retained Earnings

Net income (Net profit) from the Income statement impacts the Statement of retained earnings in two ways.

Firstly, as dividends paid to shareholders
Secondly, as retained earnings

At period end, the firm's Board of Directors decides how to distribute Net Income between "Dividends" and "Retained earnings." A write off impacts Net income, which means that the action also lowers dividends and retained earnings on the Statement of retained earnings.

For more on these transactions, and examples, see the article Allowance for Doubtful Accounts.