|What do Charge-offs mean?
Charge off stands for the amount of uncollected credit card debt removed from the accounting books and charged against a specific financial institution’s loss reserves. The charge off rate is a formula used in the industry, it is the number of charge offs which is divided by the average outstanding credit card balances owed to the credit card issuer.
These charge offs are basically accounts receivable which will most likely stay uncollected and will probably be written off. They appear as part of the expense on the institution’s income statement, which leads to the reduction of the net income of the bank. Generally, banks, based on previous records, make a pretty accurate estimate of all the charge off expenses, that might incur over the next time span. This is a common practice in order to estimate earnings. Most financial institutions have a charge off allowance, which will serve them when creditors fail to pay them back in full. This allowance exists, since it is virtually impossible for all of the charges to be paid by costumers. Charge offs are often named bad debt by the industry.
A charge off would probably fall into one of the categories bellow:
a. A kind of debt which is believed uncollectible by a reporting company and is then written off. This kind of charge off will be branded as ‘bad debt expense’ on the company’s income statement, then it will not be evidenced in the overall balance sheet.
Bad debt expenses occur when a company is incapable of collecting some of its accounts receivable (or AR for short). When this is the case, the company has little choice, it can either write off this uncollectible amount as an expense on their income statement, or they can try to sell the bad debt to a collection agency, in which case a sale will be documented on the company’s books, and it wont be present as an expense.
b. It can also be a possibly one-time expense, that is out of the ordinary, that has incurred at a firm and has negatively affected earnings. The outcome of this is a write-down of a few of the company’s assets. This write-down occurs because of the impairment of assets.
Firms often declare that they will “take a one time charge against earnings” in the upcoming quarter, which means that a situation or event has arisen, that is out of the ordinary. This event will no doubt affect present earnings but fortunately it is not likely to arise again. A consequence to this is that the firm will typically provide an earnings per share (or EPS for short) figure. This figure will either contain this charge or it will not, depending on the situation.