A contra asset account is a type of asset account where the account balance may either be a negative or zero balance. This type of asset account is referred to as “contra” because normal asset accounts might include a debit, or positive, balance, and contra asset accounts can include a credit, or negative, balance. Because of the oppositional nature of these asset accounts, the contra account acts as a ‘contrary’ element to the debit balances of regular asset accounts.
Overall, contra accounts are offsetting balances that are the opposite of specific accounts. There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These https://online-accounting.net/ are all examples of contra asset accounts, which are the prevalent type of contra accounts. Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets.
An example of recording a contra asset
Lastly, the reserve for obsolete inventory is the contra asset account used to reduce the value of inventory that is no longer usable. The reserve for obsolete inventory account is used to record the amount of inventory that has been written off as uncollectible. Allowance for Doubtful Accounts contra asset account decreases the value of accounts receivable by an estimate of uncollectible receivables to show their net realizable value on a balance sheet.
- Anytime you need to depreciate an asset, you’ll use an accumulated depreciation contra asset account, which records the amount of depreciation that has been expensed while offsetting the value of the asset being depreciated.
- If you offer credit terms to your customers, you probably know that not all of them will pay.
- $100,000 – $5,000 (the 5% allowance for doubtful accounts) to equal a net receivable amount of $95,000.
- The accounting entries for allowance for receivables are as follows.
- As mentioned, companies do not represent these accounts on the balance sheet.
- A company can choose to state this information as separate line items on its balance sheet so that any financial planners or analysts can determine the extent to which a paired asset might be reduced.
A general ledger is a record-keeping system for a company’s financial data, with debit and credit account records validated by a trial balance. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.
They are categorized as current assets on the balance sheet as the payments expected within a year. Contra AssetDepreciation is an example of a contra asset because it reduces the carrying balance of property, plant & equipment (PP&E) while providing tax benefits since depreciation reduces pre-tax income. 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. So, the company’s total value of receivables results in $95,000, and Power Manufacturers may then adjust this calculation in their financial records as they receive more credit sales. Power Manufacturers, Inc. purchases new machinery for a total of $300,000. The company projects that the equipment will be usable for six years, and it subtracts a 16% yearly depreciation rate from the initial value to calculate the amount of depreciation over the next six years. Therefore, the depreciation of the equipment increases by approximately $50,000 for each year of use.
- This account is not classified as an asset since it does not represent a long-term value.
- Let’s say you have a truck worth $20,000 that will last five years.
- The resulting credit balances in these types of accounts may typically be amortized as interest revenue over the course of the note’s viable lifetime.
- So, if the company reported receivables amounting to $100,000, the estimated 5% default rate would reduce the number of accounts receivable by $5,000.
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Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced because you’re lowering the balance. 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 what is a contra asset 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. An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid. A contra liability account is a liability account that is debited in order to offset a credit to another liability account. This type of account could be called the allowance for doubtful accounts or bad debt reserve.
Liability Contra Account
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 information featured in this article is based on our best estimates of pricing, package details, contract stipulations, and service available at the time of writing.
For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. After each accounting period, the company records a depreciation expense of the asset. For example, if an account has a debit balance, a contra account will have a credit balance. Thus, netting off both will result in the final amount for the account. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to.
What are the types of Contra Asset Accounts?
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. Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares. The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts. A contra revenue account carries a debit balance and reduces the total amount of a company’s revenue. The amount of gross revenue minus the amount recorded in the contra revenue accounts equal a company’s net revenue.
Contra LiabilityFinancing fees in M&A are an example of a contra liability, as the fees are amortized over the debt’s maturity – which in turn reduces the tax burden until the end of the term. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
Reasons to include contra asset accounts on a balance sheet
When a corporation buys back its shares that have been previously issued, it is recorded as a Treasury Stock. A Contra Accounts is a general ledger account that is shown on the Financial Statements that is used to reduce the balance of its paired account. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from large corporates and banks, as well as fast-growing start-ups. The insurance company paid Prince $750,000 as compensation for the loss on the warehouse. The accounting entries for accumulated amortization are as follows.
What are 3 types of assets?
- Convertibility: Classifying assets based on how easy it is to convert them into cash.
- Physical Existence: Classifying assets based on their physical existence (in other words, tangible vs.
- Usage: Classifying assets based on their business operation usage/purpose.
Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. FREE INVESTMENT BANKING COURSELearn the foundation of Investment banking, financial modeling, valuations and more. Sales Allowances-Sales allowances are also a part of the sales account. Sales allowance reduces the selling price when a customer agrees to accept a defective unit instead of returning it to the seller. Is debited when a company buys back its shares from the open market.
Allowance for Doubtful Accounts
For example, GAAP accounting requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for. Obsolete inventory refers to a company’s products or goods that have become obsolete, or unusable, during routine use and operations. This type of contra asset account may generally be debited expenses, followed by a credit to the company’s contra asset account for recording unusable inventory. Similarly, a business may also write off these types of expenses from its financial records if the inventory has been completely phased out.
The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset. 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. 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.
Contra LiabilityA contra liability is a liability account that carries a debit balance as opposed to a credit balance. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. Now let’s focus our attention on the two most common contra assets – accumulated depreciation and allowance for doubtful accounts. Contra asset is used to offset or reduce the balance of the corresponding asset account in the balance sheet. Reducing or offsetting the gross value of an asset with the corresponding contra asset will give us the net value of the asset. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account.