What is meant by Write-Off?
The write-Off is the process of removing a certain asset, or a transaction from the financial statement, as a result of the inability of the particular transaction to move forward as planned.
In this regard, it is important to consider the fact that the process of eliminating a given item from the books of accounts is defined as a process of Write-Off.
In other words, the write-off is a transaction that needs to reflect the fact that a particular transaction or an asset is no longer for use by the business.
Therefore, it makes sense to write off the given asset, so that the financial assets can reflect that the assets are no longer possessed by the company, or they are no longer of economic use for the company.
What is Meant by Disposal?
Disposal of an asset mainly refers to the act of selling off an asset, essentially when it is no longer of any economic value for the company.
It must be noted that disposal of assets normally comprises selling the asset to a third party, as a result of which the company makes a profit or a loss on the given transaction.
Write-off and Disposals essentially comprise the same thing: eliminating assets from the accounting records.
The concept of asset disposal mainly focuses on reversing both, the cost of the recorded asset, as well as the cost of the fixed asset, as well as corresponding accumulated depreciation.
The difference between the cost of the asset, as well as accumulated depreciation, is subsequently recorded as the gain, or loss on the particular sale.
Example of Write-Offs
Write-offs are a common feature for businesses in their normal state of operations. Several different instances might require businesses to write off their assets. The concept of write-offs is explained in the following examples:
- An asset breakdown with zero salvage value, and zero utility to the company: For assets, that have reached the end of their economic life, and have no resale value, there is a need to write-off the given asset from the balance sheet. For assets that cannot be sold at any scrap value, and have ended the economic life, have zero (or almost zero) carrying value on the balance sheet. Therefore, they need to be removed from the Balance Sheet.
For assets that break down, and cannot be fixed also needs to be written off from the financial statements too.
- Outstanding recoverable: Outstanding Receivables, or Bad Debts also need to be written off from the financial statements. This is because this amount is no longer-recoverable, and therefore the financial statements should no longer state it as an asset in the financial statements.
- Loan Write-offs: In the case where the company had extended a long-term loan, and the debtor defaults, such a loan instrument needs to be written off the financial statement. In the same manner, if the company pays off a certain loan that it has borrowed, that needs to be written off from the financial statements too.
Example of Asset Disposal
Asset Disposal mostly occurs in cases when the company needs to discard the asset they have on hand. This might involve companies either replacing the asset or selling it off simply because it is no longer of any use to them. Some common examples of Asset Disposals are as follows:
- Selling an asset to get a bigger, and better asset.
- Disposing an asset because it has reached the end of its economic life.
- Selling an asset to get some liquidity.
In either of the scenarios mentioned above, there are three possible options:
- No gain, or loss on sale: In this case, the company breaks even on the sale of the given asset. Therefore, no gain, or loss is recorded as a result of the transaction.
- Gain on Asset Disposal: Gain on Asset Disposal implies that the organization has sold the asset at a price higher than the Net Book Value.
- Loss on Asset Disposal: Loss on Asset Disposal occurs when the selling price of the asset is lower than the net book value of the given asset.
Accounting Treatment for Write-offs
The concept of write-offs, as well as the accounting treatment for write-offs, is illustrated in the following example:
Henry Co. is a manufacturing concern that supplies materials in bulk to various wholesalers. For the year ended 31st December 2019, it can be seen that several different accounts were outstanding at the year-end.
The total balance of Accounts Receivables amounts to $45,000. However, after a detailed inspection, it was discovered that $19,000 was considered to be a bad debt.
This amount was subsequently declared as irrecoverable outstanding, which had to be written off from the accounting records.
In the scenario mentioned above, it can be seen that to write off these amounts, the following journal entries are required:
|Bad Debts (or Provision for Bad Debts)||xxx|
The journal entry above shows that the treatment required to reduce accounts receivables, as well as record the written-off accounts as an expense in the financial statement.
Accounting Treatment for Asset Disposal
The concept of Asset Disposal is illustrated in the following example:
Abdul Co. is a manufacturing concern, with two stitching units. The first stitching unit was purchased on 1st January 2010, for a price of $100,000.
The machine had a useful life of 10 years, and it was depreciated using a Straight-Line Method. At the end of 2019, Abdul Co. decided to sell the stitching unit for a price of $10,000. The machine was sold on 31st December 2019.
The scenario above is a prime example of Asset Disposal.
It must be noted that since the machinery was depreciated using the Straight Line Method, the monthly depreciation amounted to $10,000 per year.
Therefore, at the end of the useful life of the asset, i.e. 31st December 2020, the Net Book Value of the company was $10,000. The asset was completely written off at the end of the term.
However, the purchase consideration of the depreciated asset amounted to $20,000. This implies that the organization made a gain of $10,000 as a result of the sale of the asset. This is calculated using the following formula:
Gain (or Loss) on Sale = Selling Price of Asset – Net Book Value
Gain (or Loss) on Sale = $20,000 – $10,000 = $10,000
This is recorded in the financial statements using the following entries:
|Asset Disposal Account||$100,000|
|Asset Account (Stitching Unit)||$100,000|
|Bank (Asset Disposal)||$20,000|
Similarly, the Asset Disposal Account would have looked like this:
|Asset (Stitching Unit)||$100,000|
|Gain on Sale||$10,000|
Therefore, it can be seen that Asset write-off and disposal are two different things. A write-off is mostly an act of eliminating an asset because it is unlikely to render economic benefit to the organization. On the other hand, disposal is at the discretion of the company.
Organizations dispose of their assets when they want to. Moreover, write-offs mostly only have a singular outcome, in the form of loss.
However, asset disposal might result again for the company (if the carrying value of the asset is lower than the selling price of the asset).