A write-off is a business accounting expense that accounts for unreceived payments or losses. A write-off reduces taxable income on a company’s income statement.
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.
Accounting Entries
Businesses regularly use accounting write-offs to account for losses. Generally Accepted Accounting Principles (GAAP) detail the accounting entries required for a write-off. Two common business accounting methods for write-offs include the direct write-off method and the allowance method.
Under the direct write-off method, bad debts are expensed. The company credits the accounts receivable account on the balance sheet and debits the bad debt expense account on the income statement. Under the allowance method, an uncollectible customer’s debt is written off by removing the amount from accounts receivable. The entries account for scenarios such as:
- Bank Loans: Financial institutions use write-off accounts when they have exhausted all methods of collection action on loans. Write-offs are tracked alongside an institution’s loan loss reserves, a non-cash account that manages expectations for losses on unpaid debts. Loan loss reserves project unpaid debts, while write-offs are the final action.
- Receivables: A business may take a write-off after a customer defaults on a 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.
- Inventory: Write-offs are used to account for inventory that is lost, stolen, spoiled, or obsolete. On the balance sheet, writing off inventory generally involves an expense debit for the value of unusable inventory and a credit action to inventory.
What Is a Write-Off, and How Does it Work?
The process generally involves:
Identification: Pinpoint the asset or debt requiring a write-off through a detailed analysis of its value and recoverability.
Authorization: Secure approval from appropriate personnel, such as management or the board of directors.
Accounting Entry: Record the write-off by debiting an expense account and crediting the asset or debt account.
Disclosure: For significant write-offs, disclose them in financial statements to provide transparency.
There are several different types of write-offs, including:
- Bad debt write-off: This occurs when a company determines that a customer’s debt is uncollectible. The debt is removed from the accounts receivable balance and recorded as an expense.
- Inventory write-off occurs when inventory becomes obsolete, damaged, or otherwise unsaleable. The inventory is removed from the balance sheet and recorded as an expense.
- Asset write-off: This occurs when a fixed asset loses its value or becomes unusable. The asset is removed from the balance sheet and recorded as an expense.
FAQs
What Business Expenses are Considered a Tax Write-Off?
The IRS allows businesses to write off various expenses that reduce taxable profits. Expenses may include office supplies, rent, insurance premiums, and internet or phone bills
How Is Profit and Income Affected By a Write-Off?
Businesses use accounting write-offs to account for losses. Write-offs usually involve a debit to an expense account and a credit to the associated asset account. Expenses are also reported on the income statement, and deducted from revenues. This leads to a lower profit and lower taxable income.
