This helps the firms to evaluate the book value of their assets and liabilities. 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. 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.
Benefits of Contra Accounts
Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company’s income statement. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet. When a listed company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account. A company may take the decision to buy back its shares when management feels the stock is undervalued or because it desires to pay stock dividends to its shareholders.
Presentation of Contra Asset Accounts
And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business. Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes. A contra account is a negative account that is netted from the balance of another account on the balance sheet. The two most common contra accounts are the allowance for doubtful accounts/bad debt reserve, which is subtracted from accounts receivable, and accumulated depreciation, which is subtracted from 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.
Importance of Contra Accounts
A contra account is a ledger account related to another specificledger account. In fact, as the name “contra” suggests, it is the opposite of aspecific class of account. Contra accounts are a little tricky to think about when you are first starting out.
- Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.
- An important function of contra accounts is to preserve the historical value in the main account while presenting a reduction in the net value.
- The net quantity of fixed assets still in existence is revealed when the asset account and contra asset account are combined.
- Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
- The equity section of the balance sheet is where the shareholder’s claims to assets are reported.
How are Contra Accounts Used and Reported?
As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss. In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account. There is almost always a story behind data; a clarification or historical insight that changes the meaning behind raw figures.
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. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. 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. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability.
- If the values are reported at net value, the users may not able to see how each of the elements has performed over the years.
- In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account.
- This helps the reader to know how many sales were actually made and how many customers had problems with the goods sold.
- A key example of contra liabilities includes discounts on notes or bonds payable.
- A separate account is needed whenever the nature of transactions changes.
Contra assets
For you to show the deprecation in the balance sheet, you need a contra account which will hold the accumulated value of depreciation and latter, offset with machinery account. Here ‘Accumulated Depreciation’ is a contra account and following are the journal entries to be recorded in the books of accounts for first year to account depreciation. Allowance for doubtful debt is a provision created for invoices that are expected to be uncollectible at some point in future years. It is a contra asset account and is directly related to the accounts receivable (asset).
Example #1: Revenue Contra Account
In other words, a contra asset account maintains a credit balance instead of a debit balance. 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. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
- It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers.
- Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.
- Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.
- For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
- The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable.
This way the company can report an item on the balance sheet at itsoriginal amount and show a reduction in value separately in order to report itsnet realizable value. Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing. Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings. Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors.
What is asset? Definition, Explanation, Types, Classification, Formula, and Measurement
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). The difference between an asset’s account balance and the contra account balance is known as the book value. Discount on sales account represents the discount amount a company gives to customers as an incentive to purchase its products or services.
