Overall, contra accounts are offsetting balances that are the opposite of specific accounts. There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra-asset accounts, which are the prevalent type of contra accounts. A contra asset account is an asset account with a natural credit balance. This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet. Even small businesses benefit immensely from contra asset accounts.
- This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet.
- 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.
- Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
- Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.
- The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.
Businesses can also write off many expenses like these from the financial records even if the inventory has been phased out completely. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Suppose a clothing business has sold $50,000 of inventory on credit.
Definition of Contra Asset Account
The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. Contra accounts are a significant part of a company’s financial statements. These accounts can significantly reduce balances on the balance sheet.
There are two major methods of determining what should be booked into a contra account. 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. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even https://www.bookstime.com/ as the asset’s depreciation is recorded separately. At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset. For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the income statement.
How to Use Contra Asset Accounts
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. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.
Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations. For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account.
Presentation of Contra Asset Accounts
The allowance for these doubtful accounts can ultimately result in the total number of receivables. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The $10,000 contra asset account of depreciation will reduce the book value of the car. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values.
Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. 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.
Allowance for Receivables
In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” 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). A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
The accounting entries for a discount on notes receivables are as follows. Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts. Any company that owns intangible assets such as software, patents, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset.
What is Contra Account?
A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed 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 asset accounts also provide a clear picture of the companies’ accumulation of assets.
- These contra revenue accounts tend to have a debit balance and are used to calculate net sales.
- If the related account is an asset account, then a contra asset account is used to offset it with a credit balance.
- This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
- And it’s particularly important to track and manage these assets.
- The contra liability account is less common than the contra asset 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. 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. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. The definition can be expanded to include contra accounts in general.