What is a Contra Asset?

contra asset

Contra asset accounts are prepared so that a specific reverse effect on the corresponding asset could be recorded. Accumulated depreciation accounts accumulate the depreciation expense provided so far about the corresponding asset. It is shown as a reduction to the asset account and is reversed when the asset is disposed of.

contra asset

For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts. There are different types of Contra Accounts and the most common are contra asset, contra liability, contra equity and contra revenue accounts. A contra account is used for account classification and is also reported in a company’s financial statement alongside its corresponding or related account.

What is the Effect of Contra Accounts to the Balance of Related (Paired) Account?

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. 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. A contra liability account is the lesser known type of a contra account.

contra asset

In general, accounts receivable are converted into cash within the operating cycle. This is treated as loss during the period, also called bad debt expense. This loss is treated as an ordinary business expense and is deducted from the asset’s balance. A contra asset (CA) account is an account in the balance sheet that offsets the balance of a regular asset account. 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 may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.

A final word about contra asset accounts

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). When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. 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.

The difference between an asset’s account balance and the contra account balance is known as the book value. 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. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account.

What is a Contra Account?

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. When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable. The net value of both these figures is usually reported on a third line.

For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value. Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books. If a listed company purchases its own shares from the open market, it will have to debit the treasury stock account in order to record the transaction. A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends.

Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. In the books, the account of the asset would have a debit value of $100,000, and the CA account would have a credit value of $30,000. If the asset account had a credit balance or the CA account had a debit balance, this would indicate an error in the journal entries. For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost.

  • If the company repays the loan early, the lender may provide a discount.
  • 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.
  • The purpose of the Sales Returns account is to track the reduction in the value of the revenue while preserving the original amount of sales revenue.
  • 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.

Contra revenue accounts typically offset revenue accounts in a firm’s income statement. However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. An example of a contra asset account is «Accumulated Depreciation.» It is used to record the cumulative amount of depreciation expense charged against a depreciable asset over its useful life. As an asset account, the «Accumulated Depreciation» account has a credit balance, while the related asset account (e.g., «Equipment» or «Buildings») has a debit balance.

In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels. 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). Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.

  • When reporting a contra account in a company’s financial statement, it is reported immediately below the account it relates to or corresponds.
  • In general, accounts receivable are converted into cash within the operating cycle.
  • Although a bond discount is a contra liability account, it cannot be considered as a liability since no future obligation can be expected from it.
  • 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.

Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. This process continues each year until the vehicles are fully depreciated. When examining the term “contra asset account,” look no further than the root of contra to get a vague grasp of the definition. Because contra means “against,” one could quickly conclude that a contra asset account is going to be an account that goes against the regular asset account on the Balance Sheet.

Contra Account Definition, Types, and Example

Therefore, for these three, the debit balance actually represents a negative amount. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits.

Allowance for doubtful debt is a contra account against which bad debts are charged. Therefore, in the allowance method, relevant bad debt expense is recorded and accounts receivable are written off when these are considered not recoverable. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future. This means that the $85,000 balance is overstated compared to its real value.