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. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. The definition can be expanded to include contra accounts in general.
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. If you offer credit terms to your customers, you probably know that not all of them will pay.
Free Financial Statements Cheat Sheet
Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement.
- Management may disclose its method of estimating the allowance for doubtful accounts in its notes to the financial statements.
- Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.
- 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.
- Including contra asset accounts on your balance sheets can be hugely beneficial for your business.
Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible. Two primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected. Companies that hold inventories for a long time may face accumulating obsolete inventory.
How Contra Asset Accounts Work
On the other hand, accumulated depreciation is a contra-asset account. However, there are some prevalent contra-asset accounts that may exist for all companies. A contra account is an account that companies use to reduce the value of a related account.
Types of Contra Assets
The accounting entries for allowance for receivables are as follows. The accounting entries for accumulated depreciation are as follows. 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’re using the wrong credit or debit card, it could be costing you serious money.
A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly top-down and bottom-up planning as an important aspect in epm below their paired accounts. Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented.
What Is a Contra Account: Definition and Example
A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger. You record the allowance for doubtful accounts by debiting the Bad Debt Expense account and crediting the Allowance for Doubtful Accounts account. You’ll notice the allowance account has a natural credit balance and will increase when credited. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible.
Examples of Contra Accounts
The most prominent of these include allowing companies to present a more accurate picture of their assets. After each accounting period, the company records a depreciation expense of the asset. Instead, the existence of contra-asset accounts for companies will differ based on a company’s requirements.
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. 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. ACCUMULATED DEPRECIATION– This type of contra asset account is commonly used to keep track of properties, plants, and equipment’s value. One premise of accounting is that an asset’s value must be recorded, starting from when it was initially purchased up to the current time.
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. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
Obsolete inventory or obsolete inventory reserves is another popular type of contra asset accounts. This type of accounts involves the products or goods of a company that is now unusable or obsolete. Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. When a contra asset account is first recorded in a journal entry, the offset is to an expense.
However, the actual payment behavior of customers may differ substantially from the estimate. In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount. Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired. Instead of increasing assets or decreasing liabilities (as would be typical when spending cash), buying treasury stock reduces shareholders’ equity.