When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account. At the end of year 20, the car and the accumulated depreciation accounts balance sheet reserves: definition types and example 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.
When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts).
The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns.
How Contra Asset Accounts Work
If this occurs, the company will debit the allowance for doubtful accounts and credit the corresponding receivables account. The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount. This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
- The difference between an asset’s account balance and the contra account balance is known as the book value.
- When a contra asset account is first recorded in a journal entry, the offset is to an expense.
- Contra revenue accounts reduce revenue accounts and have a debit balance.
- By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
In bookkeeping terms, a contra asset account refers to an account which is offset against an asset account. The net of the asset and its related contra asset account is referred to as the asset’s book value or carrying value. 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. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.
Cash Flow Statement
Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. 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. Contra asset accounts are, as the name implies, accounts that are contrary to popular belief. Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have.
How to Use Contra Asset Accounts
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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. A bit more work will be required on the accountant’s or account analyst’s behalf if books are done manually without any software. The company’s contra asset account will record unusable or obsolete assets.
Let’s go over how they work and what the main types are, and then finish with an example. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.
Contra asset accounts are asset accounts where the balance is a credit balance. They are called “contra” asset accounts because these accounts are contrary to normal accounts. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.
What is a Contra Account?
On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead. In accounting lingo, a dual entry account system includes the concept of a contra entry. It’s an entry that’s the offset or reverse of an entry that’s on the other side of the account.
Why are contra asset accounts important for businesses?
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. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. The two most common examples of contra asset accounts are the accumulated depreciation contra account, and the allowance for doubtful debts contra account. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.
Allowance for doubtful accounts
The natural balance of a contra asset account, in this case, is exactly the opposite of the balance of the related account. 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.
The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining. A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. 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.