What Is A Contra Account & Why Is It Important?

March 31, 2020

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. You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable. This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for. A company might use a combination of different types of asset accounts, and the following six types of contra asset accounts can be usedin conjunction with these fixed and current asset accounts.

For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account. A contra asset shows a zero or negative balance on your company’s balance sheet. A normal asset has a debit balance, while a contra asset sits against this to show the net balance of both assets on your financial statement. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance.

This type of account can also be called the bad debt reserve or allowance for doubtful accounts. So, essentially, all these situations are mistakes that people could make. The only real reason you would want to have asset accounts with a credit balance is if they were intentionally set up as a contra asset account.

Unlike regular asset accounts, which always have a debit balance, contra asset accounts will have a credit balance. Contra asset accounts are used to track everything from depreciation expenses to returned merchandise. Learn what a contra asset is and how you can use these accounts in your small business.

Is Accumulated Depreciation A Current Asset?

You could do that by miscalculating how much money is in your account or putting money into or taking money out of the wrong bank account by accident. Accumulated depreciation is a contra-asset account which is subtracted from asset accounts. It seems that another example of a contra account would be an expense account associated with a security deposit (eg. rental property).

The interest owed on a security deposit would show as a debit in the expense account until the tenant moved and the account settled. at that time, cash is debited and the expense account credited for the interest owed/paid. 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’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. 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.

With each debit to the depreciation expense account, a corresponding credit is created in the accumulated depreciation account. The fixed asset account tracks the cost.The fixed asset account minus accumulated depreciation is used to calculate the book value. Since asset accounts are debit accounts, a contra asset account is a credit account used to offset the balance of the main debit account. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Contra asset accounts are used in relation to a standard asset account and are designed to offset the balance of the account that they’re associated with.

At the end of the first year, net value of the equipment would be $300,000 – $50,000 in accumulated depreciation, so the net value of the equipment at the end of the first year would amount to $250,000. Bad debt expense is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. An adjunct account is an account in financial reporting that increases the book value of a liability account. A contra account is an account used in a general ledger to reduce the value of a related account.

  • 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.
  • 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.
  • 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.
  • Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.

A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect.

Contains either an allowance for returned goods, or the actual amount of revenue deduction attributable to returned goods. Obsolete inventory is a term that refers to inventory that is at the end of its product life cycle and is not expected to be sold in the future.

Accounting 101 Quiz 2

Whenever cash is received, the asset account Cash is debited and another account will need to be credited. Accounts Receivable is an asset account and is increased with a debit; Service Revenues is increased with a credit. 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.

contra asset account

If a debit is the natural balance recorded in the related account, the contra account records a credit. “Daybooks” or journals bookkeeping are used to list every single transaction that took place during the day, and the list is totalled at the end of the day.

Debits and credits are traditionally distinguished by writing the transfer amounts in separate columns of an account book. Alternately, they can be listed in one column, indicating debits with the suffix “Dr” or writing them plain, and indicating credits with the suffix “Cr” or a minus sign. Despite the use of a minus sign, debits and credits do not correspond directly to positive and negative numbers. When the total of debits in an account exceeds the total of credits, the account is said to have a net debit balance equal to the difference; when the opposite is true, it has a net credit balance. For a particular account, one of these will be the normal balance type and will be reported as a positive number, while a negative balance will indicate an abnormal situation, as when a bank account is overdrawn. Debit balances are normal for asset and expense accounts, and credit balances are normal for liability, equity and revenue accounts.

The information recorded in these daybooks is then transferred to the general ledgers. Not every single transaction needs to be entered into a T-account; usually only the sum of the book transactions for the day is entered in the general ledger. From the bank’s point of view, when a debit card is used to pay a merchant, the payment causes a decrease in the amount of money the bank owes to the cardholder. From the bank’s point of view, your debit card account is the bank’s liability.

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 https://www.savingadvice.com/articles/2020/10/30/1077781_surviving-the-coronavirus-resources-for-small-business.html they receive more credit sales. Trade accounts receivable refer to an amount that a company bills to its clients when delivering goods or services.

When you actually pay the interest, you can debit interest payable and credit cash . Contra accounts are also called valuation allowances because they are used to adjust the carrying value of the related asset or liability. Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock. $100,000 – $5,000 (the 5% allowance for doubtful accounts) to equal a net receivable amount of $95,000.

Contra Asset Account Definition

contra asset account

The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. Contra assets may be stated in separate line items on the balance sheet. An account with a balance that is the opposite of the normal balance.

While financial information on these accounts might include receivables collected, the company can also choose to include its contra asset accounts as a separate line item on the balance sheet. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Accumulated depreciation is an asset account with a credit balance known as a long-term contra asset account that is reported on the balance sheet under the heading Property, Plant and Equipment. The amount of a long-term asset’s cost that has been allocated, since the time that the asset was acquired.

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. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. Current retained earnings balance sheet liability, when money only may be owed for the current accounting period or periodical. Treasury stock and drawing accounts are examples of contra equity accounts. A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected on the balance sheet.

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. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account. 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. Asset accounts are economic resources which benefit the business/entity and will continue to do so.

Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants, traders and bankers. This system is still the fundamental system in use by modern bookkeepers. Indian merchants had developed a double-entry bookkeeping system, called bahi-khata, predating Pacioli’s work by at least many centuries, and which was likely a direct precursor of the European adaptation. Designed for freelancers and prepaid expenses small business owners, Debitoor invoicing software makes it quick and easy to issue professional invoices and manage your business finances. If you have questions regarding account category, including whether an account should be marked as a Contra account or Control account, contact your accountant. Firms can capitalize interest costs on debt outstanding ____________ of construction. ____ is the most common inventory valuation method in the US; _______ is prohibited under the IFRS.

Obsolete inventory refers to a company’s products or goods that have become obsolete, or unusable, during routine use and operations. This type of bookkeeping 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 contra asset account can also be combined with a current inventory account, allowing a financial analyst to determine the current market value of the company’s inventory. At the end of the quarter/term you would close out these contra asset accounts by canceling them out with their corresponding “asset” by Zero-ing out the Contra Asset account into the corresponding Asset account.

Allowance for doubtful accounts offsets a company’s accounts receivable account. Accumulated depreciation offsets a company’s real property assets, such online bookkeeping as buildings, equipment and machinery. Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset.

Each of the following accounts is either an Asset , Contra Account , Liability , Shareholders’ Equity , Revenue , Expense or Dividend account. All “mini-ledgers” in this section show standard increasing attributes for the five elements of accounting. for freelancers and SMEs in the UK & Ireland, Debitoor adheres to all UK & Irish invoicing and accounting requirements and is approved by UK & Irish accountants. A control account is a General Ledger account that allows you the option to summarize details from a subsidiary ledger when reporting. To compare firms that use different methods, compute financial statements of a _______ firm as if it used ______ for all its inventories.

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