What is a write-down?

A write-down is an accounting term for the reduction in the book value of an asset when its fair market value (FMV) has fallen below the carrying book value and thus becomes an impaired asset. The amount that has to be recorded is the difference between the asset’s book value and the amount of cash the company can get by selling it in the best possible way.

The reverse of a write-up is a write-down, which will turn into a write-off if the asset’s whole value is lost and removed from the account.

Understanding Write-Downs

Write-downs may significantly impact a business’s balance sheet and net income. Financial institutions had to raise capital to fulfill their minimum capital requirements during the 2007–2008 financial crisis due to the decline in the market value of the assets listed on their balance sheets.

A company’s goodwill, accounts receivable, inventory, and long-term assets like property, plant, and equipment (PP&E) are the accounts that are most likely to be written down. If PP&E is degraded, it might be because it is no longer relevant, irreparably ruined, or property values have dropped below their historical value. If a company in the service industry decides that its shops need to be renovated because they are no longer functional, it may write them down in value.

Write-downs are frequent in companies that manufacture or sell products since these companies need to have an inventory that may become damaged or out of date. For instance, car and technology stocks may depreciate quickly if they are unsold or replaced by more modern ones. There may be situations where a complete inventory write-off is required.

In the United States, generally accepted accounting rules, or GAAP, include precise guidelines for determining the fair value of intangible assets. If goodwill loses value, it must be recorded right away. Hewlett-Packard, for instance, declared a significant $8.8 billion impairment charge in November 2012 to write down a disastrous purchase of Autonomy Corporation PLC, located in the United Kingdom. This represented a substantial loss of shareholder value since the firm was only worth a small portion of its previously projected value.

Write-downs’ Impact on Ratios and Financial Statements

A write-down affects the balance sheet and the income statement. The income statement indicates a loss. The write-down could be documented as a cost of goods sold (COGS) if it involves inventories. Lenders and investors may evaluate the effect of devalued assets if they are not shown as a distinct impairment loss line item on the income statement.

The asset’s carrying value is reduced to its fair value on the balance sheet. The impairment loss on the income statement results in decreased shareholders’ equity on the balance sheet. Because the write-down is not tax deductible until the impacted assets are sold or otherwise disposed of, an impairment may also result in the creation of a deferred tax asset or the reduction of a deferred tax liability.

Because net sales will now be split by a lower fixed asset base, a write-down of a fixed asset will enhance the present and future fixed-asset turnover regarding financial statement ratios. Debt-to-equity increases as shareholders’ equity decreases. Because of the smaller asset base, the debt-to-assets ratio will also be more significant. Because future depreciation expenditures are reduced due to the decreased asset value, future net income potential increases.

Particular Points to Remember

Property Pended Sale

It is considered impaired when an asset’s net carrying value exceeds the amount of future unadjusted cash flow it may generate or sell for. As soon as it becomes clear that this book value cannot be recovered, impaired assets are required by GAAP to be reported. If the asset is still in use after being impaired, it might be written down or designated as an asset “held for sale” that will be sold or abandoned.

Because impaired assets are no longer anticipated to contribute to continuing operations after they are classified as “held for sale” or abandoned, the disposal decision differs from a standard write-down. It would be necessary to write down the book value as the item’s fair market value minus any selling expenses. Read more to learn about impairment assessment and identification. How can companies assess whether an asset could be impaired?

Big Bath Bookkeeping

Businesses sometimes “take a bath” by writing down assets during quarters or years when profits are already below expectations. This allows them to release all the bad news at once. A large bath is a tactic companies use to manipulate their income statements so that future results seem better or worse than they were.

For instance, when the economy enters a recession and banks face increased loan default and delinquency, they often write down or write off debts. They may claim higher profits if the loan loss provisions prove too gloomy when the economy improves since they wrote off the loans ahead of any losses and established a loan loss reserve.

Conclusion

• A write-down is required if an asset’s fair market value (FMV) exceeds its recorded carrying value.
• The income statement will show an impairment loss, lowering net income.
• The difference between the asset’s book value and the maximum cash the company might get by selling it in the best possible way is deducted from the asset’s value on the balance sheet.
• An impairment can only be written off in taxes once the asset is sold or disposed of.
• Should an asset be “held for sale,” the anticipated expenses must also be included in the write-down.