What is the meaning of “set off” in accounting?

The term set off in English means to offset something against something else. It thereby refers to reducing the value of an item. In accounting terms, when a debtor can reduce the amount owed to a creditor by cancelling the amount owed by the creditor to the debtor, it is termed as set off.

It is commonly used by banks where they seize the amount in a customer’s account to set off the amount of loan unpaid by the customer.

Types

There are various types of set-offs as given below:

• Transaction set-off – This is where a debtor can simply reduce the amount he is owed from the amount he owes to the creditor.
• Contractual set-off – Sometimes, a debtor agrees to not set off any amount and hence he would have to pay the entire amount to the creditor even if the creditor owed some amount to the debtor.
• Insolvency set-off – These rules are mandatory and have to be followed under the Insolvency rules 2016.
• Bankers set-off – Here, the bank sets off the amount of a customer with another account of the customer.

Example

Let’s say Divya owes Rs 20,000 to Sherin for the purchase of goods. But, Sherin owed Rs 6,000 to Divya already for use of her Machinery. Therefore, the amount of 6,000 can be set off against the 20,000 owed to Sherin and hence Divya would effectively owe Sherin Rs 14,000.

This helps in reducing the number of transactions and unnecessary flow of cash.