Write-Off | B2B Finance Glossary
What is a Write-off?
A write-off is a business accounting expense that accounts for both losses on assets and payments that were never received. Write-offs are also used to reduce taxable income on an income statement because they function as accounting actions that reduce the value of a particular asset while also debiting a liabilities account.
What is the Difference Between a Write-off and a Write-down?
A write-down is a term used in accounting for the reduction in the book value of an asset when the market value of an asset falls below its current carrying amount. The amount that’s written down is the difference between the asset's market value and the amount of cash that the business can obtain from relieving itself from the asset in the most optimum way possible. For example, if essential material is damaged by a flood, but some of it can still be partially used to make products, the value of that material is written down to the value of what remains of the usable material. It’s important that a write-down is noted as soon as the managing team becomes aware that the value of a particular asset has fallen.
A write-off is a much more extreme version of a write-down. The main difference between the two is, in a write-down, the book value of an asset is reduced in a company’s accounting records to a lower amount while, in a write-off, the full remaining balance of the asset is reduced to zero.
How are Write-offs Used?
Accounting teams regularly use write-offs as a way to keep track of losses on different business assets. On the balance sheet, a write-off will most likely involve a debit to an expense account and a credit to the associated account.
Two common business accounting write-off methods to handle bad debts are the direct write-off method and the allowance write-off method. A bad debt expense is recognized when a receivable is no longer collectible because customers cannot fulfill their obligation to pay what’s owed due to bankruptcy or some other financial issue. Businesses that offer credit to their customers report bad debts as an allowance for doubtful accounts on the balance sheet.
The direct write-off method allows businesses to write off bad debt whenever it becomes clear that a customer will not pay an invoice. Under this method, the amount of the bad debt expense is known since a specific invoice is written off. However, this method violates the matching principle used in accrual accounting and generally accepted accounting principles (GAAP). As a result, the bad debt expense is usually used in line with the allowance write-off method.
The allowance write-off method requires small businesses to estimate how much bad debt they have accrued throughout the year. Under this method, it’s required for a company to review all of its unpaid invoices and estimates the amount that it won’t be able to collect at the end of each year, and then this estimate is charged to a reserve account as soon as a sale is made.
What are the Most Common Types of Business Write-offs?
Three types of write-offs occur the most frequently for businesses. These include receivables, bank loans, and inventory.
- Receivables. There are times when a business might find itself in a position where it needs to write off the fact that a customer did not pay its bill and that there is no chance the customer will pay that bill in the future.
- Bank loans. If a financial institution cannot collect a loan and it’s done everything possible to collect the funds owed, that institution can write off the amount due that was never paid.
- Inventory. If an inventory is lost, stolen, damaged, goes bad, or obsolete, a company can write off that inventory. This process usually involves an expense debit for the value of the inventory that can no longer be used and a credit to inventory.
What is a Tax Write-off?
Finally, a write-off can refer to anything that reduces taxable income, such as expenses, credits, deductions, etc. A write-off is a tax deduction that reduces taxable income on a business’s income statement.
A business write-off accounts for losses on assets related to different circumstances, but it’s important to note that every write-off scenario will differ. On the balance sheet, write-offs typically involve debiting an expense account while crediting the associated asset account. Businesses of all sizes have many different expenses that can be used to reduce any business profits required to be taxed.