Meaning & Explanation
In layman’s terms, write-off or expense-off simply means disregarding something as insignificant or eliminating something.
The term write-off or expense-off refers to the “elimination of an asset from the financial books” when it is no longer valuable to the business. For example, if a debtor fails to pay his/her dues, then the related account should be written off from the financial statements, or, if a company vehicle is destroyed, then the asset should be eliminated from the books of accounts and such accounts be closed.
It helps reflect the actual amount of revenue and assets in the books of the business entity. Also, it is treated as a non-cash indirect expense that reduces the taxable income & hence, benefits the assessee by reducing the tax liability.
Examples of a write-off in accounting (also known as an expense-off);
- Debtors failed to pay the amount owed by them to the enterprise. (Bad debts)
- Impairment of the entity’s machinery, equipment, etc. (Asset write-offs)
- Spoilage, wastage, loss due to theft, etc., of inventory.
Related Topic – Accounts not closed at the end of an accounting period
Example
Suppose Volkswagen Ltd. owns four machines worth 32,000 each. During the year, one of the machines got impaired, and as a result, the company writes off the same.
Therefore, machine write-off expense = book value of the impaired machinery = 32,000
Now, it will be recorded as follows in the books of the company as follows;
a) Credit the machinery account by the amount of machine impaired.
| Machinery Written Off A/C | 32,000 |
| To Machinery A/C | 32,000 |
(Impaired machinery written off)
Ledger Posting
| Machinery A/C | |||
| Particulars | Amt | Particulars | Amt |
| Machinery Written Off A/C | 32,000 | ||
b)Record write-off expense on the debit side of the profit & loss account as it is an indirect expense for the company.
| Profit & Loss A/C | 32,000 |
| To Machinery Written Off A/C | 32,000 |
(Amount of machinery written off transferred to the profit & loss account)
Related Topic – Balance of a Petty Cash Book is an Asset or Income?
Journal Entry for Write-Off in Accounting
1) Entry to record the amount of an asset written off.
| Expense A/C (write-off) | Debit |
| To (related) Asset A/C | Credit |
(Asset written-off)
2) Entry to transfer the amount of asset expense-off to the profit & loss account.
| Profit & Loss A/C | Debit |
| To Expense A/C (write-off) | Credit |
(Amount of asset written off transferred to the profit & loss account)
Related Topic – Meaning of Set-off in Accounting
Reasons & Similarities
Reasons
- In order for business owners to reduce their tax liability, they take advantage of write-offs by ultimately reducing the reported income.
- Additionally, it is helpful in ensuring that the accounting books are kept accurately.
Similarities
In accounting, various terms that are often used interchangeably with the term write-off or expense-off but have different meanings;
1) Consumption – It means to write down the value of the materials like stores & spare parts, loose tools, etc., with respect to their consumption & recording the same as a direct expense in the entity’s trading and profit & loss account as per the matching concept of accounting.
2) Depreciation – It refers to the gradual fall in the value of the entity’s tangible fixed assets like machinery, furniture & fixtures, etc., because of obsolescence, wear-tear, etc., over its expected useful life.
3) Amortization – The phrase “amortization” is used to write down intangible assets like goodwill, trademarks, patents, etc., until disposed of.
4) Depletion – The word “depletion” is used to write down the gradual degradation in the value of natural resources like coal, etc. which are being extracted from the earth.
Note – All the above-listed terms are a part of non-cash expenses & are a part of the write-down, not a write-off. The term “Written down” refers to reducing the value of an asset in order to match its current market value. It is a partial reduction in an asset’s value. Whereas an asset is written off if it has become completely unproductive to generate any revenue.
Additionally, fictitious assets like advertisement expenditures, etc, are always written off because fictitious assets don’t have any fair value.
Related Topic – Difference Between Receipt, Payment, Income, and Expense
Tax Write-Off
A tax write-off refers to an authorized expense that can be claimed as a deduction. Hence, it is also termed a tax deduction as it results in lowering the taxable income & thereby, the amount of tax payable.
In addition to business incomes, such tax write-offs can also be claimed on personal taxes, expenses, or credits to reduce personal taxable income. Some of the commonly availed tax write-offs are deductions on mortgage interest, student loan interest, dental & medical expenses, standard deductions, etc, provided the assessee qualifies all the required criteria of the governing tax laws.
Therefore, individuals, self-employed, small corporations as well as large business firms can benefit from tax write-offs. But, it must be noted that everyone can not avail of all the deductions because it is also based on several other factors like filing status, tax provisions, income, dependents, etc.
Write Off Vs Disposal
| Basis | Write Off | Disposal |
|---|---|---|
| 1) Meaning | Write Off refers to eliminating the entire amount of an asset from the books of accounts because it is no longer of any value to the business. | Disposal refers to discarding an asset because of uncertainty, asset replacement, or maybe it is no longer needed or of any use to the firm. |
| 2) Effect on Income Statement | It is an indirect expense for the enterprise. | It is an indirect income for the business, but there may be a loss on disposal if an asset is sold for a value less than its book value. |
| 3) Tax Benefit | Tax write-offs or deductions result in a reduction in the taxable income & hence in reducing the tax liability. | Unlike write-offs, the disposal of an asset leads to an increase in the taxable income, thereby further adding to the tax liability under certain conditions. |
| 4) Part or Whole | The write-off of an asset is done as a whole. | An asset may be disposed of in parts or as a whole. |
| 5) Other Name | It is also called Expense Off. | It is also known as sale or scrapping. |
| 6) Effect on Cash Flow | Write off of an asset will not affect cash flow as it is a non-cash expense. | The disposal of an asset will lead to the inflow of cash. |
Related Topic – Can Assets have a credit balance?
Write Off Vs Allowance Method
Direct Write Off Method & Allowance Method are the two methods to write off or expense off an asset.
The major difference between the two methods is that in the direct write-off method, the assets are written off only when the asset actually becomes valueless or the balance from debtors actually becomes uncollectible, whereas, in the allowance method, an amount is set aside from the asset for the possibility of future write-offs, as a matter of prudence.
In the direct write-off method, the amount of asset written off is directly credited to the concerned asset’s ledger account. Whereas, in the allowance method, a separate allowance account is maintained to write off an asset & hence, the amount written off is credited to the respective allowance account & not the asset’s ledger account.
Example
Suppose a company has debtors worth 57,000. Consequently, these debtors get bankrupt & fail to pay the amount due.
Case-1: (Direct Write-Off Method) If the company does not maintain a separate allowance to write off book debts.
| Bad Debts A/C | 57,000 |
| To Debtors A/C | 57,000 |
(Bad debts written off)
Case-2: (Allowance Method) If the company already maintains an allowance worth 66,000 to write off the bad debts if any arise.
| Bad Debts A/C | 57,000 |
| To Allowance for Bad Debts A/C | 57,000 |
(Bad debts written off)
>Read Profit and Loss Suspense Account