IT Financials Glossary

Write off

Posted in Accounting by mgentle on August 26, 2010

Write off: to reduce the value of an asset to zero by charging it to expense or loss, resulting in the asset being removed from the books. So, if an IT system were decommissioned after only a few years, it would have to be written off.

A write-down is a partial write-off of an asset, to account for a reduction in its value while still remaining on the books.

Important: a write-off is not “free”! To take a simple analogy, if you suddenly decide you can no longer afford your monthly car payments over the next 5 years, you know you’re going to have to pay the outstanding instalments. Similarly, cancelling a project or decommissioning a system before the end of its useful life can have significant financial impact, because outstanding depreciation expenses have to be written off. In other words, the now worthless asset is removed from the balance sheet and recorded as an expense against the current period’s P&L.

A write-off can have unintended consequences on current year expenses. Staying with the car example, paying off 5 years of outstanding instalments all at once will represent a huge, unplanned expense for that year – and you’ll probably have to cut down on other discretionary expenses, such as vacation.

Similarly, cancelling a failed $1m IT project one year after launch would result in the IT budget taking a big hit. If the project was supposed to be straight-line depreciated over 5 years, then the annual cost against the IT budget is only supposed to be $200k. If instead it is now cancelled in year 2, then the IT budget would end up taking a hit to the tune of $800k (years 2-5)! The IT department might then have to cut down on other expenses – eg, postpone or even cancel some other project in order to pay for the cancelled project.

So, paradoxically, cancelling a project soon after depreciation has started might save money in the long run (by not providing ongoing funding to an application with a poor return on investment), but in the year of its cancellation, it would end up costing money!

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