Contra asset definition

what is a contra asset

Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. 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. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.

  1. 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.
  2. 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.
  3. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.
  4. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question.
  5. 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.

In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. 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. 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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners.

Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company’s income statement. Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets.

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. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete. Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. A less common example of a contra asset account is Discount on Notes Receivable.

Types of Contra Assets

This helps the firms to evaluate the book value of their assets and liabilities. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Editorial content from The Ascent is separate from The Motley Fool explanation of certain schedule c expenses editorial content and is created by a different analyst team. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.

what is a contra asset

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. 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. 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.

Allowance for doubtful accounts

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what is a contra asset

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 to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold.

Contra revenue account

The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. 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. 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. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method.

Hence, the company will have gross revenue or net sales equal to $9,900. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has https://www.bookkeeping-reviews.com/how-to-manage-timesheets-in-xero/ made, along with any factor that has reduced that amount. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.

Definition and Examples of Contra Assets

Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. The main advantage of using a contra asset account is to separate this reduction from the asset account with which it is paired. By doing so, you can more clearly see the total amount of the related asset account, which would otherwise have been obscured by the offsetting amount of the reserve. The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors.