A Beginner’s Guide to Using Contra Asset Accounts

Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance.

Accumulated depreciation

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. By reporting contra asset accounts on the balance sheet, users of financial degrees and certificates a business owner needs statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life.

What Is the Benefit of Using a Contra Account?

When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.

Contra revenue account

1. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.
2. 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.
3. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits.
4. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account.

Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business. As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. A debit will be made to the bad debt expense for $4,000 to balance the journal entry.

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. The most common contra equity account is called “treasury stock.” This special account decreases the number of shares outstanding in the market because the company repurchases some of the shares from its buyers. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. 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.

Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. This means that what is capex and opex 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. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased.

This helps the firms to evaluate the book value of their assets and liabilities. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. 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). 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.

Click here to read our full review for free and apply in just 2 minutes. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

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. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts.

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. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, https://www.quick-bookkeeping.net/ and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.

Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.

Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders.

Contra revenue accounts typically offset revenue accounts in a firm’s income statement. However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. When a contra https://www.quick-bookkeeping.net/accrual-accounting-vs-cash-basis-accounting/ asset account is first recorded in a journal entry, the offset is to an expense. 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. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.