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. 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. 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. A less common example of a contra asset account is Discount on Notes Receivable.
Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened. They serve an invaluable function in financial reporting that enhances transparency in accounting books. The amount on the equity contra account is deducted from the value of the total number of outstanding shares listed on a company’s balance sheet. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account. 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 is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors. 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. Treasury stock is a contra equity account that is entered as a negative value on the balance sheet of public companies. It shows the amount of funds used to repurchase previous issuances of stock, reducing the total number of shares outstanding.
Definition of Contra Asset Account
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. In a balance sheet, accumulated depreciation would be reflected as a reduction from the asset’s account so that the net balance is evident.
If the example looks difficult, rest assured the solution is very simple. Because contra assets simply detract from the total value of the asset account, all one has to do is add up all the assets together first. Finally, take the total of depreciation and subtract it from total assets. If a ledger were to be observed in this situation, then one would see a balance of three asset debits (van, building, equipment) matched up against three contra asset credits (van, building, equipment). This process continues each year until the equipment is fully depreciated.
Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue. If you depreciated it evenly you would take $20,000, divide it by 5 and expense $4,000 each year. On the balance sheet you would list the asset at $20,000 then show the $4,000 in accumulated depreciation being subtracted from it for a net value of $16,000.
A contra asset account is an account that subtracts from an asset account.
A debit entry in a contra asset account is unnatural and most likely indicates an incorrect journal entry. 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. The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account.
The amount spent on their purchase is capitalized and treated as assets. The cost is amortized every year until the asset is expected to be used. Contra asset accounts are prepared so that a specific reverse effect on the corresponding asset could be recorded. 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. 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.
- To account for this potential loss, GreenThumb creates a contra asset account called “Allowance for Doubtful Accounts” with a credit balance of $1,200 (3% of $40,000).
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- In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet.
Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. This type is paired with the asset account, which allows a business to record the original price or value of the asset at time of purchase. The contra asset account then allows recording of the value factoring in depreciation. To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
How to Use Contra Asset Accounts
By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question.
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 (credited) because you’re lowering the balance. 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. 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.
Overview of Contra Asset Account
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Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Therefore, a contra asset can be regarded as a negative asset account. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. Contra assets are negative asset accounts that show an opposite balance to a normal account in the same asset category. The purpose of a contra asset account is to offset the asset account and show a reserved amount that reduces the balance of the corresponding asset account.
The amount is reported on the balance sheet in the asset section immediately below accounts receivable. 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.
Taxes Payable vs. Payroll Taxes
A contra account is used in order to better portray the relationship between certain debits and credits within the overall financial structure of an entity. A contra account can be used to remedy an error, to track depreciation of an asset, or to register payments that are not collectible. These assets are expected to provide future economic benefits for many accounting periods.
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. 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. In this way, an accumulated amortisation account offsets a related asset account (which is recorded as a debit). Accumulated depreciation accounts accumulate the depreciation expense provided so far about the corresponding asset.
Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
- 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.
- Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc.
- In general, accounts receivable are converted into cash within the operating cycle.
- Products that become unusable are recorded in this contra account to show that they are still owned by the company, but they should be excluded from the market value of inventory.
- Contra revenue accounts typically offset revenue accounts in a firm’s income statement.
For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. 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.
It is not classified as a liability since it does not represent a future obligation. quickbooks reviews are prepared so that an asset’s gross value and deductions can be shown separately. The accounting rules applicable to contra asset accounts are exactly opposite to asset accounts.