A writedown usually represents a diminishment in value or a correction of the cost of an asset on a business’ balance sheet. Writedowns are linked to purchases the business has made, of both products and services. There are many reasons why a writedown may be necessary, including overpaying for an asset in order to secure it or diminishing value of something over time.
The easiest way to describe a writedown in full is to go through a virtual step-by-step process of what a writedown would look like and how one would happen.
Understanding the Writedown Process
Here is an overview of the writedown process.
Your business needed some new technology products, so you went out and purchased computers for the office, paying £5,000 for them in total. This £5,000 will be listed on your balance sheet as having gone out of your account in terms of cash at bank, but be on there as an asset.
In terms of your balance sheet, these computers are worth £5,000 as they were the market value at the time you paid. If they were reduced from £10,000, you shouldn’t add on the value to make it look like you’ve had a £5,000 gain.
Over time, the value of these computers is going to reduce, because newer products will be released with better technology, and these systems will slow down and become of less use. You know at some point that these assets are going to need replacing.
You, or your accountant, should decide the level to which the asset is going to depreciate over time. Ensure this is realistic; you don’t want to write off the whole £5,000 at once. Not only will it skew and corrupt your business accounts but it’ll look somewhat dodgy when you submit them and your tax liability to the relevant authorities.
Once you have decided how to do it, you would simply writedown £1,000 a year, for example, on your balance sheet. Many accountants will list this as depreciation, some might even simply list it as writedown, but it will always be on there.
What Have You Lost?
You don’t actually lose anything in “real terms” by completing writedowns. You’ve paid your £5,000, so the £1,000 a year represents a paper loss.
While a writedown can be good for reducing your tax bill, you should also think about your need to replace assets that you writedown correctly. In this example, the tax you would save annually would be best served being earmarked for future investment into replacement assets.