Contra Account Explained

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. Contra asset is a tool that business uses to manage their balance sheet more accurately. Businesses need to have contra assets because it gives investors and creditors a better idea of the company’s financial condition. When used correctly, contra assets can help businesses keep their balance sheets accurate and up-to-date. https://online-accounting.net/ For both contra asset accounts, the entry is a debit to an expense and the credit is to the contra asset account. 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.

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. Similarly, the company may choose to combine the amounts in both its contra and fixed asset accounts if the contra asset account has a relatively low balance. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

Overview: What is a contra asset account?

Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups. Companies that hold inventories for a long time may face accumulating obsolete inventory. The accounting entries for accumulated depreciation are as follows.

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Contra Asset

So, if the company reported receivables amounting to $100,000, the estimated 5% default rate would reduce the number of accounts receivable by $5,000. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. A less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. A contra asset is a negative asset account that offsets the asset account with which it is paired.

Learn about the meaning of contra accounts, how and why they are used, and how to account for balances with them. Let’s say you have a truck worth $20,000 that will last five years. 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. Accumulated depreciation is a contra account because it subtracts from the asset. Allowance for doubtful accounts is a contra account because it subtracts from the asset accounts receivable.

Contra Asset Account Example

They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset. Balance sheet, users of financial statements can learn more about the assets of a company.

Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets. 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. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account.

Accounting Dictionary

$100,000 – $5,000 (the 5% allowance for doubtful accounts) to equal a net receivable amount of $95,000. Nora O’Malley covers small business finance and entrepreneurship topics for The Balance. Along with her writing work, Nora is an entrepreneur and consultant who opened an all-tap wine bar in New York’s East Village dubbed Lois and owns a sophisticated snack food business Aida. For her businesses, Nora is responsible for finances, marketing, operations, and fundraising. Along with The Balance, her writing has appeared in Thrillist, Insidehook and Vinepair. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

• Treasury Stock AccountTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired.
• At the end of 2013, Morley Co. has accounts receivable of $700,000 and an allowance for doubtful accounts of $25,000.
• Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to.
• This account offsets the balance in the respective asset account that they pair with on the balance sheet.
• Contra revenue accounts reduce revenue accounts and have a debit balance.

This account only relates to a company’s intangible assets rather than tangible. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers. The amount is not reported, and the net sales amount is reported on the income statement.

A transaction is made under the sales return account when a customer returns a product to the company for a refund. Sales allowance represents discounts given to customers to entice them to keep products instead of returning them, such as with slightly defective items. The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. The two common contra liability accounts, discount on bonds payable and discount on notes payable, carry normal debit balances. The discount on bonds payable represents the difference between the amount of cash a company receives when issuing a bond and the value of the bond at maturity.

The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited separately. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.

Treasury Stock AccountTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. Despite being classified as a liability, it functions more like an asset because benefits are provided what is a contra asset to the company. While technically classified as an asset, it functions closer to a liability as it reduces the value of the asset it is paired with. 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).

• The amount of gross revenue minus the amount recorded in the contra revenue accounts equal a company’s net revenue.
• In this case, the depreciation and the original price are contra accounts with respect to each other.
• 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.
• When a company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account.
• An example would be a contra liability account which would be debited to offset a regular liability account.

In the Balance Sheet, the Fixed Asset will show the total of the cost of all the fixed assets acquired and the Accumulated Depreciation will show the total accumulated amount of depreciation expense recognized each year. An example of a contra account is Accumulated Depreciation which is a contra asset account. When the normal balance of an asset is a debit, a contra account’s normal balance would be a credit, and when a liability’s normal balance is a credit, the contra account is a debit. For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parentaccount gross balance to present the net balance. An example would be a contra liability account which would be debited to offset a regular liability account. Contra asset accounts help companies to record any reductions to their non-current and current assets. By doing so, they can bring their asset accounts to a more accurate position.