Contra Account Definition, Types, and Example

At the same time, depreciation for the van at the end of the year ended up at $500. Taking into account the list of contra asset accounts, how would you calculate the net value of assets? If the example looks difficult, rest assured the solution is very simple.

• The balance sheet shows the amount in the asset section underneath the accounts receivable.
• Contra equity accounts carry a debit balance reduce equity accounts.
• 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.

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. 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.

Allowance for Doubtful Accounts

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.

For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra https://accounting-services.net/bookkeeping-vancouver/ account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult. Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account.

Types of Contra Accounts

If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.

Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account.

Contra Asset, Contra Liability and Contra Equity

The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. For example, a building is acquired for $20,000, that $20,000 is recorded on the general ledger while the depreciation of the building is recorded separately. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. A contra account is a general ledger account with a balance that is the opposite of another, related account that it is paired with.

Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. 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. 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.

Types of Contra Accounts – Explanation

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. This depreciation is saved in a contra asset account called accumulated depreciation. The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. As mentioned above, the primary situation in which contra asset accounts appear has to do with accumulated depreciation.

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. Accounts receivable is rarely reported on the balance sheet at its net amount.

Such accounts are allowance for doubtful accounts and the accumulated depreciation account. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance. 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. 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.

• At the same time, depreciation for the van at the end of the year ended up at $500.
• We follow ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources.
• Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
• A less common example of a contra asset account is Discount on Notes 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.

This type of account can also be called the bad debt reserve or allowance for doubtful accounts. A contra asset is a negative asset account that offsets the asset account with which it is paired. 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. In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000. 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.

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• Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
• Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.
• Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
• 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 situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below.
• Contra Liability a/c is not used as frequently as contra asset accounts.