What Is a Write-Down?
Let me explain what a write-down means in accounting. It's the reduction in the book value of an asset when its fair market value has fallen below the carrying book value, turning it into an impaired asset. You calculate the amount to write down as the difference between the book value and the cash you could get by disposing of it optimally.
This is the opposite of a write-up, and if the asset becomes completely worthless, it turns into a write-off where you eliminate it from the accounts entirely.
Key Takeaways
- A write-down happens if the fair market value of an asset is less than its current book value.
- It leads to an impairment loss on the income statement, which cuts net income.
- On the balance sheet, you reduce the asset's value by the difference, considering optimal disposal cash.
- You can't deduct the impairment for taxes until you sell or dispose of the asset.
- For assets held for sale, include expected sale costs in the write-down.
Understanding Write-Downs
You need to understand that write-downs can hit a company's net income and balance sheet hard. Think about the 2007–2008 financial crisis, where falling asset values forced financial institutions to raise capital to meet obligations.
Accounts like goodwill, accounts receivable, inventory, and long-term assets such as property, plant, and equipment are most prone to write-downs. These can happen if assets become obsolete, damaged, or if property prices drop below historical cost. In services, you might write down store values if they're no longer useful and need revamping.
For businesses with inventory, write-downs are routine because stock can damage or become obsolete. Technology or auto inventories, for instance, lose value fast if unsold or outdated. Sometimes, you have to write off the entire inventory.
Under U.S. GAAP, intangible assets like goodwill must be written down immediately if their value declines. Take Hewlett-Packard's 2012 case: they took an $8.8 billion impairment on the Autonomy acquisition, as it was worth far less than estimated.
Effect of Write-Downs on Financial Statements and Ratios
A write-down affects both your income statement and balance sheet. You report a loss on the income statement— if it's inventory-related, it might go under cost of goods sold; otherwise, it's a separate impairment loss line so investors can see the devalued assets' impact.
On the balance sheet, you reduce the asset's carrying value to fair value, which cuts shareholders' equity due to the income statement loss. This might create a deferred tax asset or reduce a liability, since the write-down isn't tax-deductible until sale or disposal.
Looking at ratios, a fixed asset write-down improves current and future fixed-asset turnover because net sales divide by a smaller asset base. It raises debt-to-equity and debt-to-assets ratios with the lower equity and assets. Future net income could rise as lower asset values mean reduced depreciation.
Special Considerations
Consider assets held for sale: they're impaired if net carrying value exceeds future undiscounted cash flows from use or sale. Under GAAP, recognize them once recovery is impossible. If still in use, write down; if held for sale or abandoned, they're not contributing to operations anymore, so write to fair market value minus sale costs.
Big Bath Accounting
Companies sometimes do write-downs in bad quarters or years to bundle all negative news—called 'taking a bath.' This manipulates the income statement to worsen poor results now, setting up better future ones. Banks, for example, write off loans in recessions, creating reserves that boost earnings later if overly pessimistic.
Frequently Asked Questions
How do write-downs impact a company? They significantly affect net income and the balance sheet, especially for goods-producing companies with potentially obsolete inventory.
Which accounts are most likely to have write-downs? Goodwill, accounts receivable, inventory, and long-term assets like property, plant, and equipment.
Where does a write-down impact a business? It hits the income statement with a loss (possibly as COGS or separate) and reduces asset value on the balance sheet, cutting shareholder equity and potentially affecting taxes.
The Bottom Line
To wrap this up, a write-down in accounting reduces an asset's book value when its fair market value drops below the carrying value, making it impaired. The write-down amount is the difference between book value and optimal disposal cash.
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