A Beginner’s Guide to Using Contra Asset Accounts

what is a contra asset

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets.

  1. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
  2. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.
  3. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability.
  4. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.

If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. 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. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services.

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. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. 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. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts.

Contra asset accounts journal entries

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, what is the margin of safety formula where readers can readily see it. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100.

For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the 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. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. 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. Contra accounts act like regular accounts on the balance sheet but have a unique purpose.

what is a contra asset

The difference between an asset’s account balance and the contra account balance is known as the book value. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes.

A debit will be made to the bad debt expense for $4,000 to balance the journal entry. 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 accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. 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. A contra asset is a negative asset account that offsets the asset account with which it is paired.

What Is a Contra Account?

Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000.

what is a contra asset

This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. 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.

Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever https://www.online-accounting.net/what-is-fixed-cost-the-difference-between-fixed/ be a debit balance in a contra asset account; 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. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.

What Is a Contra Asset?

The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. 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. 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. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

Definition of Contra Asset Account

Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.

The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level. The amount of this reserve is typically based on the company’s historical loss experience for each reserve. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.

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