For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. 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. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected a thorough understanding of off balance sheet financing to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.
A key example of contra liabilities includes discounts on notes or bonds payable. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. 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. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting.
This frequently happens to manufacturing companies that sell products with an expiration date annualized income installment method since any inventory remaining in stock past the expiration date quickly becomes obsolete. Master accounting topics that pose a particular challenge to finance professionals. Provision for a discount from creditors and discount on bills receivable are other widely used examples. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
Fixed assets like plants & equipment are depreciated every year, and this balance is transferred to the accumulated depreciation account. So, in this case, accumulated depreciation is a contra asset account related to plant & equipment. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset.
Understanding a Contra Account
He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete.
Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
How to Use Contra Asset Accounts
Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. 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.
Examples
Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. 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. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. By the end of the first-year machinery, the balance will be $100,000, and accumulated depreciation will show $20,000. By the end of 2nd-year, the machinery balance will still be $100,000, and accumulated depreciation will show $40,000.
- Therefore, for these three, the debit balance actually represents a negative amount.
- The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
- A key example of contra liabilities includes discounts on notes or bonds payable.
- The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
- Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.
The netbook value of the machinery by the end of the first year will be $80,000 ($100,000-$20,000) and $60,000 ($100,000-$40,000) by the end of the second year. This method helps a third person identify what the book value was at the time of purchase and the remaining value of an asset. If we show $60,000 as an asset in the third year, it will be challenging to understand whether $60,000 is all new purchases or the remaining value of an asset. This account helps all the stakeholders understand the financial numbers accurately. Whenever an organization buys an asset and depreciates it over the asset’s useful economic life, the reduction in value accumulates over the year, which is called accumulated depreciation.
You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount. 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). Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.
Is a Contra Balance Negative or Positive?
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. In the financial statements the asset a/c would be offset against the contra asset a/c to show the net balance. In bookkeeping terms, a contra asset account refers to an account which is offset against an asset account. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold.
Double Entry Bookkeeping
Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. 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.