Define Contra Asset Account

The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. A contra asset is a negative asset account that offsets the asset account with which it is paired. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. 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 Contra Liability Account

That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900. As mentioned, contra asset accounts usually have a negative value which is the same as a credit balance. That is to completely or partially offset the balance of their related asset accounts. Asset accounts usually have a positive value which is the same as a debit balance.

Everything You Need To Build Your Accounting Skills

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. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers.

Is Premium on Bonds Payable a Contra account?

Define Contra Asset Account

Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. 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. Overall, contra accounts are offsetting balances that are the opposite of specific accounts.

Define Contra Asset Account

  • The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet.
  • Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
  • This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
  • 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.
  • A less common example of a contra asset account is Discount on Notes Receivable.
  • The amount of this reserve is typically based on the company’s historical loss experience for each reserve.

Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. Contra liabilities are common in companies that sell bonds to raise capital.

Types of Contra Asset 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. In response, the firm should decrease its accounts receivable and revenue balances.

  • 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.
  • Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.
  • Allowance for receivables is an account that companies maintain to record possible bad debts.
  • These accounts are used to lower the balance of asset accounts and reflect the net book value of assets.
  • (A debit balance in a contra asset account will violate the cost principle.) Learn more about contra asset accounts.
  • Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable.

For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.

Case Studies of Contra Asset Use

The connection between contra-assets and the income statement is primarily through the periodic expense recognized, such as depreciation or amortization, which affects net income. For example, the depreciation expense recorded is a result of reducing the book value of fixed assets, and it is reported as an expense in the income statement every accounting period. This creates a direct link between the reduction of fixed asset value on the balance sheet and the recognition of expenses on the income statement. The alignment of the cost principle with expense recognition helps ensure that the income statement reflects accurate and periodic matching of revenues with expenses. The purpose of these accounts is to ensure that the financial statements accurately reflect the assets’ net value.

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