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). Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. Contra accounts are not expenses because they do not represent costs that a business incurs in order to generate income. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.
A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported. The net amount is often referred to as the carrying amount or perhaps the net realizable amount. Contra asset accounts provide more detailed information to financial statement users by showing both the gross and net amounts of the related asset accounts. They also help organizations track specific adjustments and discrepancies, allowing for better financial analysis and decision-making. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts.
The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete.
- Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete.
- This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated.
- Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing.
- Contra revenue accounts typically offset revenue accounts in a firm’s income statement.
This is done in order to separate data in these accounts for the analysis and presentation purposes. To account for this potential loss, GreenThumb creates a contra asset account called “Allowance for Doubtful Accounts” with a credit balance of $1,200 (3% of $40,000). On the balance sheet, the net accounts receivable will be reported as $38,800 ($40,000 – $1,200). 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.
Importance of Allocating Costs to the Correct Cost Center
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. 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.
Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find.
Contra asset account example
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 hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow. And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general ledger and balance sheet. So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory. In its general ledger, the business will want to capture its gross sales figures and the actual value of the discount.
A contra revenue represents any deductions or offsets that need to be removed from gross revenue to provide a clearer understanding of actual income — such as in the example just provided. These accounts will typically help track sales discounts, product returns, contra asset accounts and allowances (e.g., a price reduction for a good with minor defects). 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.
Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. The equity section of the balance sheet is where the shareholder’s claims to assets are reported. The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders.
Do Contra Accounts Have Debit or Credit Balances?
The amount in the accumulated depreciation account is deducted from the assets of a company, such as buildings, vehicles and equipment. This can help anyone viewing the financial information to find the historical cost of the asset. The accumulated depreciation amount shows how much depreciation expense has been charged against an https://business-accounting.net/ asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. Accumulated depreciation is accounted on the credit side and has credit balance. Accumulated depreciation reduces costs of asset and contra account is used to have cost value and accumulated depreciation separately.
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. Contra accounts allow businesses to accurately reflect the value of their assets and liabilities on their financial statements. By offsetting the balance of a related account, contra accounts help to ensure that the financial statements are not overstated.
An example of recording a contra asset
Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Contra liability, equity, and revenue accounts have natural debit balances. 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. Contra liability accounts are less commonly used than contra asset accounts.
You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. 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. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of. 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.
Recent Comments