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. Although contra-asset accounts have credit balances, they do not appear in liabilities or equity. Usually, credit balances include items from one of those two natures. A contra-asset account is an account that opposes the balances of other asset accounts. As mentioned, a company will usually have debit balances in its asset accounts.

  • They are called “contra” asset accounts because these accounts are contrary to normal accounts.
  • Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
  • Most accounts receivable would just be the time between purchase and credit card settlement.
  • This allows the financial analyst to evaluate the company inventory’s current market value.
  • That is to completely or partially offset the balance of their related asset accounts.

While assets have natural debit balances and increase with a debit, contra assets have natural credit balance and increase with a credit. Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance. Also, note that when writing off the specific account, no income statement accounts are used.

Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. 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. The company’s contra asset account will record unusable or obsolete assets.

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Presentation of Contra Assets

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 also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations.

By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

It is the general accumulated depreciation that an asset went through, putting into account the term. The first step in accounting for the allowance for doubtful accounts is to establish the allowance. This is done by using 11 things to watch out for when buying a leasehold property one of the estimation methods above to predict what proportion of accounts receivable will go uncollected. For this example, let’s say a company predicts it will incur $500,000 of uncollected accounts receivable.

Understanding contra accounts

By doing so, they can bring their asset accounts to a more accurate position. Contra accounts are a significant part of a company’s financial statements. These accounts can significantly reduce balances on the balance sheet.

Is a Contra Balance Negative or Positive?

However, the details for contra accounts usually exist on the notes to the financial statements. However, these can cause a reduction in other balances on the statement. 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. You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.

Contra accounts definition

There are three contra asset accounts that commonly appear in an organization’s chart of accounts. 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.

What is the importance of Contra Asset Accounts?

A contra asset account example is an accumulated depreciation account that will help the company track and offset fixed assets. 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.

Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. Another question that we get is what is the relationship between a contra asset balance and the book value.

contra asset account definition

Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. The allowance for doubtful accounts is a general ledger account that is used to estimate the amount of accounts receivable that will not be collected. A company uses this account to record how many accounts receivable it thinks will be lost. Companies that issue bonds are likely to use contra liability accounts.

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. Contra asset accounts are useful tools in double-entry accounting. 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. Put that contra asset accounts are accounts presented as deductions from the overall value of a particular asset.

The second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount. Companies technically don’t need to have an allowance for doubtful account. If it does not issue credit sales, requires collateral, or only uses the highest credit customers, the company may not need to estimate uncollectability.

For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. The natural balance of a contra asset account, in this case, is exactly the opposite of the balance of the related account. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective. Contra liability accounts are special accounts in the liabilities section of the balance sheet.