What Is a Write-Off?
A write-off is an accounting action that reduces the value of an asset while simultaneously debiting a liabilities account. It is primarily used in its most literal sense by businesses seeking to account for unpaid loan obligations, unpaid receivables, or losses on stored inventory. Generally it can also be referred to broadly as something that helps to lower an annual tax bill.
- A write-off primarily refers to a business accounting expense reported to account for unreceived payments or losses on assets.
- Three common scenarios requiring a business write-off include unpaid bank loans, unpaid receivables, and losses on stored inventory.
- Write-offs are a business expense that reduces taxable income on the income statement.
Businesses regularly use accounting write-offs to account for losses on assets related to various circumstances. As such, on the balance sheet, write-offs usually involve a debit to an expense account and a credit to the associated asset account. Each write-off scenario will differ but usually expenses will also be reported on the income statement, deducting from any revenues already reported.
Generally Accepted Accounting Principles (GAAP) detail the accounting entries required for a write-off. The two most common business accounting methods for write-offs include the direct write-off method and the allowance method. The entries used will usually vary depending on each individual scenario. Three of the most common scenarios for business write-offs include unpaid bank loans, unpaid receivables, and losses on stored inventory.
Financial institutions use write-off accounts when they have exhausted all methods of collection action. Write-offs may be tracked closely with an institution’s loan loss reserves, which is another type of non-cash account that manages expectations for losses on unpaid debts. Loan loss reserves work as a projection for unpaid debts while write-offs are a final action.
A business may need to take a write-off after determining a customer is not going to pay its bill. Generally, on the balance sheet, this will involve a debit to an unpaid receivables account as a liability and a credit to accounts receivable.
There can be several reasons why a company may need to write off some of its inventory. Inventory can be lost, stolen, spoiled, or obsolete. On the balance sheet, writing off inventory generally involves an expense debit for the value of inventory unusable and a credit to inventory.
The term write-off may also be used loosely to explain something that reduces taxable income. As such, deductions, credits, and expenses overall may be referred to as write-offs.
Businesses and individuals have the opportunity to claim certain deductions that reduce their taxable income. The Internal Revenue Service allows individuals to claim a standard deduction on their income tax return. Individuals can also itemize deductions if they exceed the standard deduction level. Deductions reduce the adjusted gross income applied to a corresponding tax rate.
Tax credits may also be referred to as a type of write-off. Tax credits are applied to taxes owed, lowering the overall tax bill directly.
Corporations and small businesses have a broad range of expenses that comprehensively reduce profits required to be taxed. An expense write-off will usually increase expenses on an income statement which leads to a lower profit and lower taxable income.