What is a Write-Off?
In accounting, a write-off reduces the value of an asset on the balance sheet while debiting a liabilities or expense account. Businesses use write-offs to account for losses such as unpaid loans, unrecoverable receivables, or unusable inventory. Recording losses also helps lower a business's annual tax liability.
How Write-Offs Work
In accounting, a write-off involves the following entries:
- Credit to the asset account (reduces the value of the asset).
- Debit to an expense account (reflects the loss incurred).
This adjustment appears on the income statement, reducing the net income by the value of the write-off.
Types of Write-Offs
- Unpaid Bank Loans:
- It occurs when a borrower fails to repay the loan despite all collection efforts.
- Banks utilise loan loss reserves to estimate potential loan defaults, with write-offs representing the final accounting action for irrecoverable loans.
- Stored Inventory Losses:
- Includes stolen, lost, damaged, spoiled, or obsolete inventory.
- Accounting involves debiting an expense for the unusable inventory and crediting the inventory account.
- Unpaid Receivables:
- It happens when customers fail to pay their invoices.
- The business records a debit to an expense or liability account and a credit to accounts receivable.
Advantages of Write-Offs
- Tax Savings: Companies can account for write-offs as expenses to reduce taxable income.
- Accurate Financial Statements: These allow an actual picture of the company's assets and its financial status.
- Streamlined Accounting: This procedure removes non-performing assets or uncollectible amounts from financial accounts.
- Risk Management: The companies can identify and plan for losses that will arise in future accounting.
Limitations of Write-Offs
- It is merely an accounting adjustment and not a recovery mechanism of lost assets or unpaid debts.
- Overwrite-offs can be regarded as poor management of assets or credits.
- Revenue Loss is a real loss for the company.
Key Takeaways
- Write-Off Management using Technology: Companies use artificial intelligence and automation to manage their accounts receivable and identify possible write-offs.
- Increased Transparency in Financial Reporting: Regulators highlight greater transparency in reporting write-offs, particularly in banking and finance.
- Post-Pandemic Recovery: Enterprises are revisiting bad receivables and lost inventory caused by disruptions stemming from global pandemics.
