What is meant by Write-Off?
Write-Off can be defined as the process undertaken by accountants to remove a specific asset from the financial statement.
This is primarily resulting from the underlying need to record the given asset at fair value, so that a better, and more accurate depiction can be declared in the financial statements. Therefore, in other words, the process of write-off entails eliminating a given item from the books of accounts.
The process of write-off itself is a transaction that needs to be made in the financial statements as journal entries or adjusting entries to communicate that an asset is no longer for use by the business.
Since it would be no longer used by the company, it bears no economic value. Hence, writing off the given asset is the option that accountants mostly resort to.
What is meant by Impairment?
Impairment or impairment loss is defined as a recognized deduction in the carrying amount of a particular asset. The main reason for the decline in the value of the asset mainly occurs because of the fall in the fair value of the asset.
In the case where the fair value of the asset falls greater than the carrying amount of the asset, the difference is supposed to be written off as an impairment loss.
Mostly, impairment losses take place for assets that are relatively newer on the firms’ portfolios. For assets that have been possessed by the organization for a longer period, the carrying value already tends to be low (and aligned with the fair value) because of the ongoing depreciation that is charged on a yearly basis.
In the same manner, impairment losses are also not incurred on low-cost assets. This is because it is considered to be counterproductive to account for changes in the fair value of these smaller assets, particularly when the materiality threshold is not that significant pertaining to these assets.
Example of Write-Offs
The process of write-off is mostly undertaken by accountants during the regular course of business. The main reasoning behind this particular process of write-off ensures that the asset outlay of the company is properly accounted for.
In the same manner, write-offs are also executed by companies so that there is proper clarity in the financial statements pertaining to financial statements within the company.
Write-Offs are mostly executed at the discretion of the management of the company. Multiple different scenarios might occur when accountants might choose to consider this particular aspect:
- Asset utilization with no salvage cost: This category is for assets that have reached the end of its economic life, and they are no longer supposed to be used by the business. Hence, these assets need to be written off from the Balance Sheet, since they no longer fulfill the asset recognition criteria laid out by assets.
- Outstanding Recoverable: For companies that sell goods and services on credit, bad debts are a common occurrence. This implies that some of the credit customers might not pay their debts in time, because of which they need to be written off from the financial statements.
- Loan Write-offs: For long-term investments that have been unable to be fulfilled, businesses might be required to write off the amount in order to ensure that the long-term investment is duly removed from the financial statements of the business.
Accounting Treatment for Write-Offs
All assets are supposed to be declared at fair value by the organizations. This is to ensure that the financial statements are not overstated by the company. In this regard, it is important to make sure of the fact that the assets need to be written off in order to align the fair value of the asset with the historical cost.
This holds true for both, Current Assets as well as Non-Current Assets. The main accounting procedure that is undertaken by companies in order to write off the given asset is to reduce the asset by the specific amount and charge a similar amount to the Income Statement as a loss.
Example for Write-offs
The concept of write-offs, as well as the accounting treatment for write-offs, is illustrated in the following example:
Abjad Co. purchased machinery worth $50,000 on 1st January 2010. The machine has a useful life of 10 years. It was perceived to be used evenly across the course of the business.
However, after using machinery for a period of 8 years, the organization realized that they no longer need the machine, and hence, it was decided to completely write off the machine from the financial statements. The machine has no salvage value.
In the example given above, it can be seen that with the cost equivalent to $50,000, and a useful life of 10 years, the annual depreciation on the machinery amounted to $5,000.
At the end of the 8th year, Accumulated Depreciation of the machinery was $40,000, and hence, the Net Book Value (or the carrying value) of the machine was equivalent to $10,000. However, since the machine had no scrap value, it was supposed to be directly written off the financial statements.
The journal entry required to record the following transactions are as follows:
|Fixed Asset write-off||$10,000|
The journal entry above shows the write-off of an asset from the Balance Sheet.
Accounting Treatment for Impairment
Impairment majorly constitutes a reduction in the value of an underlying asset. In order to record the reduction in the value of the asset, the loss needs to be charged to the Income Statement as an expense.
On the other hand, the value of the asset needs to be revised in order to depict an accurate value of the financial statements of the company.
Example of Impairment
The concept of impairment is illustrated in the following example:
Genie Inc. is a retail store that has a Non-Current Asset worth $25,000. This amount represents the carrying value or the Net Book Value of the business. The asset had a historical cost of $30,000, and Accumulated Depreciation worth $5,000.
There was a flood, after which all the machines were severely impacted. After the flood, the machine was reassessed, and the fair value was calculated to be $15,000.
In the example mentioned above, it can be seen that the fair value of the asset saw a decline from $25,000 to $15,000. Hence, based on this information, there was an impairment loss equivalent to $10,000 that needs to be recorded on the financial statements.
The journal entries that are required to record these transactions are as follows:
|Loss on Impairment||$10,000|
In the journal entries above, it can be seen that the loss on impairment of the asset is realized as an additional cost in the Income Statement. It is recognized in the form of the revised value in the financial statements (Balance Sheet).
This implies that the asset will be recorded at the price of $15,000 (30,000 Historical Cost – 5000 Accumulated Depreciation – $10,000 impairment loss) .
After the new asset value on the Balance Sheet of the company, depreciation will also be charged in accordance with the new impaired value.
Therefore, it can be seen that write-off and impairment are two different concepts that ideally have the same implications: reduction in the value of the underlying asset.
In this regard, it can be seen that write-off mostly comprises of entirely removing an asset from the Balance Sheet of the company, whereas impairment comprises a certain write-down in the value.
Normally, writing off assets is at the discretion of the management of the company. On the other hand, impairment needs to be reviewed on a regular basis to ensure that assets are not overstated on the financial statements of the company.