The time might come when your business assets lose value because they’re aging or outdated.
This is a common scenario, especially for businesses that sell products in the retail or wholesale markets. If you find yourself in this scenario, you can write down the value of your inventory.
But what is a write-down, exactly, and what does it mean for your business?
What Is a Write-Down?
In accounting lingo, a write-down is the reduction of the value of an asset. The amount of the write-down is the difference between the book value listed on the balance sheet and how much you could recover from it now that the asset’s value has been reduced. The write-down will lower your net income and your owner’s equity in your business.
Besides inventory and equipment, other business assets could lose their value and be written down, such as buildings, accounts receivable, and goodwill, an intangible asset whose value comes into play when one business acquires another.
What Does a Write-Down Look Like?
There are many situations in which an inventory write-down makes sense, the Corporate Finance Institute notes. For example, your inventory could lose value when its goods get close to the end of their life span, if some of your items get damaged in production or transit, if part of your inventory is stolen, or if some of it accumulates wear and tear when used as in-store displays.
Let’s say you run a small clothing boutique and your total inventory has a book value of $200,000. But because some out-of-season and returned items need to be marked down, the market value of your inventory drops to $150,000. A write-down will note that $50,000 value reduction in your books.
Similarly, aging but still useable delivery trucks or last-year’s-model office machines could have their depreciating market values recorded as write-downs.
How Do I Report a Write-Down?
The way you document a write-down in your accounting records depends on the size of the value loss, certified public accountant Harold Averkamp notes in his blog. If your loss is relatively small, you could include it as part of your cost of goods sold.
If your loss is substantial, though, you must record it on a separate line on your income statement. You’ll also need to record the inventory write-down and the corresponding reduction in owner or stockholder equity on your company’s balance sheet.
What’s the Difference Between a Write-Down and a Write-Off?
It’s understandable if, when you started reading this article, your immediate question after “What is a write-down?” was “How is it different from a write-off?” Both are business expenses, and both reduce net income.
Here’s the key distinction: A write-down adjusts an asset’s value, but a write-off indicates that it no longer has any value. A write-down can become a write-off if the value of the asset continues to deteriorate. Once an asset becomes worthless, it’s removed from the ledger.
If you still have questions about the inventory write-down and whether it’s something your business needs, consult with an accountant.