What Is a Charge-Off?
In corporate finance, a charge-off can be one of several different things. A charge-off can refer to an item on a company's income statement that is either an uncollectible accounts receivable (non-payment of a bill owed to the company) or otherwise related to a debt owed to the company that is deemed uncollectible. In this case, a charge-off item is written off of the balance sheet.
More commonly, a charge-off is a one-time extraordinary expense incurred by a company that negatively affects earnings and results in a write-down of some of the firm's assets. The write-down arises due to impairments of assets.
- A charge-off can refer to an item on a company's income statement that is either an uncollectible accounts receivable or otherwise related to a debt owed to the company that is deemed uncollectible.
- More commonly, a charge-off is a one-time extraordinary expense incurred by a company that negatively affects earnings and results in a write-down of some of the firm's assets.
- Companies will usually provide an earnings per share (EPS) figure with and without this charge to help demonstrate to stakeholders the irregular nature of the expense.
How a Charge-Off Works
If a company is willing to take a one-time charge against a particular accounting period, referred to as a charge-off, this likely means that an extraordinary event has occurred and, although it affects present earnings, it is unlikely to occur again in the foreseeable future. As a result, a company will usually provide an earnings per share (EPS) figure with and without this charge to help demonstrate to stakeholders the irregular nature of the expense. A charge such as this may also be referred to as a one-off, meaning that it is likely to only occur in this instance.
A charge-off of this nature can include the purchase of a large asset, such as a new facility or large piece of equipment, that is unlikely to be replaced for some time. Charge-offs can also include charges related to an uncommon event, such as repairs required after a fire that the company has been deemed responsible for paying or the payment of insurance deductibles for covered damages caused by a natural disaster.
Certain irregular maintenance expenses could also qualify, such as a roof replacement. Even though the need for such maintenance may be somewhat predictable, the precise timing and nature of the charge is often unknown. Further, this form of maintenance may only be required once every 20 or more years.
A company that is in the process of downsizing in order to restructure its business will probably have to lay off a lot of employees. The severance payments and early retirement costs that would result from downsizing are charge-offs that are unlikely to reoccur in the near future. The cost to settle a lawsuit can also be marked down as an extraordinary expense which could greatly affect earnings.
Charge-offs also occur when a business changes accounting methods or discovers errors from previous financial reports. The change or error correction could be costly to the company as figures could actually be adjusted downwards, affecting earnings negatively.
Accounting Standards For Charge-Offs
The formal recognition of extraordinary items was eliminated by Generally Accepted Accounting Principles (GAAP) standards in 2015. When it was used, GAAP required businesses to report charge-offs separately in the income statement. A company without a charge-off will normally have the regular bottom line or net income. A company with a charge-off will have an additional section before the bottom line called ‘Extraordinary and Unusual Items’ if the expense is of an unusual nature or infrequent occurrence. This line will list any extraordinary expenses incurred by the firm before calculating the final net income figure. The company was also supposed to disclose the tax effect of the item and the effect of the charge-off on earnings per share (EPS).
As of 2017, while companies are no longer required to separately show extraordinary items on the income statement, they are still required to disclose unusual or infrequent expenses without tagging these expenses as ‘extraordinary.’ These expenses can either be reported on the income statement or disclosed in the financial statement footnotes.