A contra asset account is an asset account with a natural credit balance. This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
What is a contra asset account?
Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities include discount on notes or bonds payable. Contra liabilities hold a debit balance.
There is no reason for there to ever be a debit balance in a https://bookkeeping-reviews.com/; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.
You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory.
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A key example of contra liabilities include discount on notes or bonds payable. There are three contra asset accounts that commonly appear in an organization’s chart of accounts. It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts.
The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. By stating this information separately in a contra asset account, a user of financial information can see the extent to which a paired asset should be reduced. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method.
Example Contra Account – Allowance for Doubtful Accounts
The difference between an asset’s balance and the contra account asset balance is the book value. Contra liability, equity, and revenue accounts have natural debit balances. These three types of https://bookkeeping-reviews.com/contra-asset-account/ contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount.
Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. Contra asset accounts provide business owners with the true value of certain asset accounts. For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.
The contra asset account, accumulated depreciation, is always a credit balance. This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet.
- Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods.
- Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
- The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected.
- Contra liability, equity, and revenue accounts have natural debit balances.
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity).
Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete.
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.
Presentation of Contra Asset Accounts
Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account.
- By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive.
- A contra liability is an account in which activity is recorded as a debit balance is used to decrease the balance of a liability.
- Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month.
- If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete.
- The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold.
The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. The difference between an asset’s account balance and the contra account balance is known as the book value. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid).