DJ Stockbridge is currently pursuing a Masters degree in Accounting.
In this lesson, we'll discuss how accountants write off a plant, property, or equipment from the balance sheet. We'll use two examples: one from a personal balance sheet and another from an electric utility who just bought a power plant.
Calculate Your Net Worth
Let's imagine that your entire net worth is composed of three items:
Cash you have in the bank of $10,000
Your investment account of $50,000
An antique car you grandfather gave you that he said is worth $20,000
Assuming you have no liabilities, what is your net worth in this simple example? It's $80,000. Now, let's fast forward one year into the future. Your cash is still $10,000. Your investment account has grown to $55,000, and your car is still worth $20,000. Your net worth is now $85,000 and the difference in net worth, $5,000, is equivalent to your earnings in that year.
The $5,000 would be recorded on your personal Income Statement, which acts as the bridge between your personal Balance Sheets. Now, what if you took the car to an antique car expert and he said it wasn't worth $20,000, but instead was only worth $5,000? Yikes! What's your new net worth? It would decrease from $85,000 to $70,000. Your Income Statement, as the bridge between the two balance sheets, would record a $15,000 loss.
This same logic applies to companies when they write-off a plant, property or equipment (PPE). When the book value of PPE is less than its actual value, then book value is lowered and a change on the Income Statement is recorded.
In this lesson, we'll give a general definition of a write-off of PPE, then we'll work through an example so we can see the journal entries and impact on the Balance Sheet and Income Statements.
Write-Off of a Plant
A write-off is a reduction in book value. You can write off many of different things, like inventory, equipment, buildings, plants, and property. For this example, we'll assume that we are writing off a plant. Assume you are the accountant at a large electric utility. Your company just bought a new coal-fired power plant for $100M in cash. The journal entry you'd record would look like this:
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Now, assume the plant will be depreciated, or lose value, at the rate of $5M every year. In 20 years, the book value of the plant will be zero. $100M - ($5M x 20 years) = $0
Okay, let's fast forward 10 years into the future. The plant is now 10 years old. The plant will be recorded at book value, which takes into account the accumulated depreciation. The value of the plant will then be $100M - ($5M x 10 years) = $50M. Let's say in that same year, we conduct a thorough analysis and realize we should have depreciated the plant over just 10 years. The plant's book value should be $0, not $50M. As the accountant, we need to write off the plant from our books. To do this we record a loss. The journal entries would look like this:
That $50M loss captures the change in book value from $50M to $0, and it will flow through the Income Statement as either a 'loss on write down' or a 'restructuring cost' or a 'loss from discontinued operation.'
In this lesson, we learned when an accountant needs to do a write-off, which means they must reduce the book value of an asset when it becomes clear the actual value of the asset is less than its book value. We also learned that the book value is the asset's historical cost minus the accumulated depreciation. The accountant then adjusts for a loss by recording a journal entry that debits 'loss on write down' for the difference between the asset's book value and actual value. The loss is then carried through the income statement, lowering net income for that period.
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