20 Ago A Beginner’s Guide to Using Contra Asset Accounts
Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. 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.
- This means that this person is not capable of paying the borrowed 1,000.
- The second method of estimating the allowance for doubtful accounts is the aging method.
- And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand.
- To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.
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Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. According to the balance sheet equation, all accounts that fall under the Assets category will normally increase with a debit entry. However, there are cases when a credit entry to reduce this account cannot be made. In simple words, this is an account with a credit balance that is assigned to a particular asset account with a goal to be used to offset the balance of the last one.
The Contra Revenue Account
It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. A business might elect to separately state contra asset accounts on its balance sheet, so that the users of its financial statements can obtain additional information about the contents of these accounts. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account.
In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart.
It represents all the depreciation related to an asset or the company’s overall assets. Usually, companies add to the accumulated depreciation account after every accounting period. Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets. The contra asset account, accumulated depreciation, is always a credit balance.
Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
- 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 not classified as a liability, since it does not represent a future obligation.
- The company must be aware of outliers or special circumstances that may have unfairly impacted that 2.4% calculation.
- A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
A contra asset account is added right after the asset account it is used to reduce, but before net assets on the Balance sheet. The list of asset accounts on your general ledger and balance sheet conveys the combined, potential value of all of the tangible and intangible items that your organization possesses. But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible. Instead, you need to record this value gap, and a contra asset account serves that purpose. Sometimes, the current value of a note receivable will fall compared to its face value.
What is the importance of Contra Asset Accounts?
By doing so, they can bring their asset accounts to a more accurate position. After each accounting period, the company records a depreciation expense of the asset. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. For example, if an account has a debit balance, a contra account will have a credit balance. Thus, netting off both will result in the final amount for the account. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.
Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts. A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly below their paired accounts.
Why are contra asset accounts important for businesses?
Typically, these notes reflect purchases made on credit by your customers. To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value. An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account). For example, the contra asset account Allowance for Doubtful Accounts is related to Accounts Receivable. The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources. Accumulated depreciation is the most prevalent type of contra-asset account.
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In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. Note that in accounting, the term “book value” is also used interchangeably with net value.
What is a Contra Asset Account? Simple Explanation and Example
For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. 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.
Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This writing the evaluation plan for your grant application would let users of the financial statements calculate the book value of the liability. 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.