Write-Offs: Understanding Different Types To Save on Taxes

What Is a Write-Off?

A write-off is an accounting action that reduces the value of an asset while simultaneously debiting an expense 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.

Understanding Write-Offs

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 will usually vary depending on each individual scenario.

Bank loans

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.

Receivables

A business may need to take a write-off after determining a customer is not going to pay their 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

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 unusable inventory and a credit to inventory. 

Tax Write-Offs

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 returns. 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 the 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.

Write-Offs vs. Write-Downs

A write-off is an extreme version of a write-down, where the book value of an asset is reduced below its fair market value. For example, damaged equipment may be written down to a lower value if it is still partially usable, and debt may be written down if the borrower is only able to repay a portion of the loan value.

The difference between a write-off and a write-down is a matter of degree. Where a write-down is a partial reduction of an asset's book value, a write-off indicates that an asset is no longer expected to produce any income. This is usually the case if an asset is so impaired that it is no longer productive or useful to the owners.

The Bottom Line

Understanding write-offs—and the difference between a tax write-off and a write-down can help you reduce taxable income and increase the accuracy of how you record a business' financial situation. Learn about the write-offs that apply to your situation and don't miss the chance to take advantage of them when they apply.