Also called a non-cash charge, a writedown is an expense that occasionally happens to even the best managed companies. Due to an accounting change (such as changing how inventory is tracked or a change in depreciation) or from mark to market accounting, the value of an asset must be reduced. This is found on the income statement below the operating profit line and is often called an unusual or extraordinary item.
The result is usually a major reduction in net income in the period in which the writedown occurs. At times, it can even turn a net profit into a loss. Examles include the reduction in inventory that management determines cannot be sold at full price (or at all), adjusting the value of derivative securities such as CDOs to market value. These kinds of charges hurt many financial companies during the credit meltdown of late 2008.
The effect on the income statement is obvious -- it reduces net income.
The effect on the balance sheet is a little less obvious. It reduces the "carrying" value or book value of the asset, which has the effect of lowering equity and affects such ratios such as debt-to-equity. This can also trigger debt covenants.
At times, a company will push a lot of these charges into a single year or quarter, "take a bath," with the intention of wiping the slate clean, so to speak. This also has the effect of making the following year's comparison artificially very good.
Recent Mentions on Fool.com
- Disney's Sequel Nightmare Is a Win for Twenty-First Century Fox and Comcast!
- Should You Bet on the Action at Lululemon Athletica?
- 1 Bad Sign for Microsoft Corporation's Tablet Dreams
- The Amazon Fire Phone Will Be a Flop
- Barrick Gold Corp. Spins the C-Suite Revolving Door Once More
- Should Investors Fear ConAgra's Debt Load?