What is a contra asset account?

The accumulated depreciation amount shows how much depreciation expense has been charged against an asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit.

• For stakeholders, looking at both accounts is also crucial in their decision-making process.
• The amount is not reported, and the net sales amount is reported on the income statement.
• To report the real value of the financial statement, you will need to record the amount you can reasonably estimate that will probably effect the financial statement classification.
• The purpose of a contra account is to accurately report value of operating performance and assets for a firm.
• Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance.

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. The contra equity account treasury stock is reported right on the balance sheet.

#4. Allowance for doubtful accounts

The contra account is used to report the correct assets while preserving the transactions and balance of the relating account. The most common contra assets are accumulated depreciation and the allowance for doubtful accounts. For example, the debit will be to the expense account in an estimated uncollectible amount from a credit sale.

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. The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount. This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms. Most accounts receivable would just be the time between purchase and credit card settlement.

What is the importance of Contra Accounts?

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. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account.

The above accounts are the standard items that a company’s financial statements will include. However, there are other items as well that may not show in those financial statements. For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the notes payable definition income statement. Both the asset and the corresponding CA 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. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future.

What Is a Contra Account & Why Is It Important?

Depreciation is calculated as a percentage of the asset’s current book value using the decreasing balance technique. Because the same percentage is applied each year, the amount of depreciation falls each year as the current book value decreases. While accumulated depreciation will continue to rise, the quantity of accumulated depreciation will fall each year.

Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. 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. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees.

A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. Accounts receivable is rarely reported on the balance sheet at its net amount.

Allowance for doubtful debts accounts

As mentioned above, these accounts also pair with a paired account and reduce its carrying balance. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation.

A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly below their paired accounts. Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance.

• Both of these accounts offset each other to represent a net balance on a company’s balance sheet.
• Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
• Therefore, a contra asset can be regarded as a negative asset account.
• Examples of contra expense accounts include Purchase Returns, Purchase Discounts, and Advertising Reimbursements.

In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why and how you would use contra accounts and more. 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). A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.

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. A contra-asset account is a form of asset account in which the account balance can be either negative or zero. This sort of asset account is called “contra” because standard asset accounts can have a debit, or positive, balance, whereas contra asset accounts can have a credit, or negative, value. Because these asset accounts are opposed, the contra account works as a ‘contrary’ aspect to the debit balances of ordinary asset accounts. Furthermore, because equalizing an asset account and a contra asset account results in the asset’s net, or total, balance, a contra asset account may also be considered a negative asset account.

Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. For example, if an organization purchases equipment for $100,000 and expects to use it for 10 years on a uniform basis, then it would not expense the entire $100,000 in the year of purchase. An organization would rather record $100,000 as an asset and would amortize $10,000 depreciation each year for the next 10 years.

Example Of Contra Asset Account

Managers and investors must understand contra accounts to accurately analyze a company’s balance sheet and determine the organization’s financial position. Although contra asset accounts have credit balances, they do not appear in liabilities or equity. Usually, credit balances include items from one of those two natures.