A company usually records an asset at the price at which it originally bought it, though there are cases where assets can be initially or subsequently recorded at their fair values. Eventually, it may become apparent that the amount recorded for an asset is too high, so management decides to reduce or even eliminate the amount of the asset. This is known as taking a write off. The write off process involves the following steps:
- Determine the amount of the write off. It is entirely possible that only a portion of the amount recorded on the books for an asset (known as its carrying amount) needs to be written off. For example, the market value of a fixed asset may now be half of its carrying amount, so you may want to write off just half of the carrying amount of the asset. However, a customer may have gone out of business, so all of the unpaid accounts receivable for that customer must be completely written off.
- Create entry. Create a journal entry to write off the appropriate amount of the asset. This will be a credit to the asset account. There are two choices for the debit part of the entry. It can be to an expense account, if no reserve was ever set up against the asset in the past. For example, the direct write off of an account receivable would be debited against the bad debt expense account. Alternatively, the debit can be against a reserve that was already set up to offset the asset. For example, if there is an allowance for doubtful accounts that offsets accounts receivable, the debit would be against the allowance account.
- Adjust detail records. Whenever you write off an asset, this can impact the detail records for an account. For example, when you write off an account receivable, make sure that the underlying aged accounts receivable report no longer contains the specific receivable that you wrote off.
It is also possible to write off a liability, such as when a lender forgives part or all of a loan. In this case, the journal entry is a debit to the liability account in order to reduce or eliminate the liability balance, and a credit to a gain account, since the transaction essentially increases the profits of the business. A liability write off is relatively uncommon; in most cases, businesses must deal with declines in the value of their assets, so that is where write offs must be recorded.