In business accounting, you’ll probably come across the term “write-off.” Some people assume this is the reduction of taxable income — and that’s not necessarily wrong. If you run a taxi business, for instance, you can write-off things like vehicle expenses, gas and insurance on your income tax statements. This essentially lowers your net profit while subsequently reducing the total amount of taxes you are required to pay. However, there’s another type of write-off used in business accounting.
Write-Offs: The Basics
In addition to taxes, a write-off may also refer to the reduction of an asset’s value. It’s used to refer to an investment like a purchase of goods when the return on such investment is unlikely. The purchased goods’ return is removed from the business’s balance sheet, as it’s “written off.”
A common example of a business write-off is shrink in the retail industry. Shrink is defined as loss of inventory between acquisition and sale. Retail store,s for instance, often suffer from financial loss caused by theft. When a thief steals a product, the respective store must count that product as shrink — and this shrink can be written off from the store’s balance sheet.
Financial institutes may also perform write-offs when debt goes uncollected. If a person or business borrows a loan but fails to pay it back, the financial institute may count it as “bad debt” and subsequently remove it from their balance sheet. Regardless of the circumstance, write-offs are essential in protecting a business’s financial statements by ensuring that the balance sheet correctly reflects the business’s financial health.
Write-Off vs Write-Down
There are also write-downs, which differ from write-offs in several ways. A write-down is used to recognize the reduced value of an asset. If the value of an asset changes, the business must “write it down.” The difference between the asset’s original purchase price and its reduced value is recorded as goodwill. With that said, the terms write-offs and write-downs are often used interchangeably in business accounting. The key thing to remember is that a write-down is used when an asset’s value is depreciated but still contains some value, whereas a write-off is used when an asset’s value is decreased to zero. Hopefully, this gives you a better understanding of write-offs and write-downs in business accounting.
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