What are Contra Accounts?

Therefore, an example of a contra asset account involved with a depreciation situation seems reasonable to observe. Nova Incorporated is attempting to finalize their balance sheet in terms of the net value of their assets. At the end of the year, their assets are as follows… Nova Company https://simple-accounting.org/ valued a van at $30,000, an office building at $500,000 and office equipment at $20,000. At the same time, depreciation for the van at the end of the year ended up at $500. The following are several key reasons why it can be important to include contra asset accounts on a balance sheet.

• For freelancers and SMEs in the UK & Ireland, Debitoor adheres to all UK & Irish invoicing and accounting requirements and is approved by UK & Irish accountants.
• Consequently, in the first year, the equipment would reflect a net value of $90,000, which is computed by deducting the accumulated depreciation from the equipment’s historical cost.
• This type of asset account is referred to as “contra” because normal asset accounts might include a debit, or positive, balance, and contra asset accounts can include a credit, or negative, balance.
• Allowance for doubtful accounts offsets a company’s accounts receivable account.
• For better understanding, let me take 2 examples from above – Accumulated Amortization & Reserve/Provision for Doubtful Debts, & demonstrate the presence of the same in the extract of the balance sheet.

Contra assets are an important bookkeeping concept that helps balance a business’s books. In this article, we look closely at contra assets and the different types of contra accounts you may see on financial statements. 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. Therefore, contra asset accounts differ from other accounts that have a credit balance. An accumulated depreciation account is a type of contra asset account that is used for recording the amount of depreciation a fixed asset evolves through. For instance, a fixed asset such as machinery, a company building, office equipment, vehicles or even office furniture would be highlighted in an accumulated depreciation account.

Types of Contra Account

Debit depreciation expense for $18,625 and credit accumulated depreciation-equipment for $18,625. Allowance for doubtful accounts is shown as a reduction from the gross accounts receivable. The net amount of accounts receivable is presented in a balance sheet. Contra asset accounts are prepared so that a specific reverse effect on the corresponding asset could be recorded. Credit BalanceCredit Balance is the capital amount that a company owes to its customers & it is reflected on the right side of the General Ledger Account.

• Contra asset accounts are credited when these are increased and debited when these are decreased.
• Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
• In the direct write-off method, bad debt expense is charged when these are incurred.
• For stakeholders, looking at both accounts is also crucial in their decision-making process.
• Taking into account the list of contra asset accounts, how would you calculate the net value of assets?
• Debit BalanceIn a General Ledger, when the total credit entries are less than the total number of debit entries, it refers to a debit balance.
• If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

Allowance for doubtful accounts offsets a company’s accounts receivable account. Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery. Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset. So far, we’ve discussed contra asset accounts, which offset the value of asset account balances. Contra accounts can be used for all of the financial components on the balance sheet including assets, liabilities, and equity.

What is a Contra Account? Definition

To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. Sometimes, the current value of a note receivable will fall compared to its face value. This process will give rise to a contra asset account which is the discount on notes receivables.

This is especially true in cases where the contra account has a debit balance, as this will reduce the total amount of the corresponding account. The amount in the accumulated depreciation account is deducted from the assets of a company, such as buildings, vehicles and equipment. This can help anyone viewing the financial information to find the historical cost of the asset.

Understanding contra accounts

Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for.

This amount is typically paired with the company’s current assets on the balance sheet. Balance sheet, users of financial statements can learn more about the What is a contra asset account? 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.

Obsolete inventory reserves

Assets Due To RevaluationAssets revaluation is an adjustment made in the carrying value of the fixed asset, either upwards or downwards, depending upon the fair market value of the fixed asset. Its purpose includes selling the asset to another business unit, merger and acquisition.

In the direct write-off method, bad debt expense is charged when these are incurred. The accounting entry for this is debit, bad debt expense and credit to accounts receivable. Here, accounts receivable are decreased in the period when bad debt expense is incurred. However, bad debt expense can arise to the sales made in earlier periods.

If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. 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. Allowance for receivables is an account that companies maintain to record possible bad debts. Contra assets allow for more granular visibility on the balance sheet by maintaining historical costs and independent values rather than reducing the original account directly.

In the balance sheet, the accounts receivable would be reflected after adjusting this allowance account. If it is the first year of operation, there is no outstanding balance in the allowance account. There are many situations where one account is used to offset another account.

The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers. If actual experience differs, then management adjusts its estimation methodology to bring the reserve more into alignment with actual results. For both contra asset accounts, the entry is a debit to an expense and the credit is to the contra asset account. This type is paired with the asset account, which allows a business to record the original price or value of the asset at time of purchase. The contra asset account then allows recording of the value factoring in depreciation.

Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. The equity section of the balance sheet is where the shareholder’s claims to assets are reported. The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Instead, the existence of contra asset accounts for companies will differ based on a company’s requirements.

Presentation of Contra Asset Accounts

The amount is not reported, and the net sales amount is reported on the income statement. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” Any company that owns intangible assets such as software, patent, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. So, the company’s total value of receivables results in $95,000, and Power Manufacturers may then adjust this calculation in their financial records as they receive more credit sales. Trade accounts receivable refer to an amount that a company bills to its clients when delivering goods or services. These billings may usually be documented on invoices, which are then summarized in an aging report for all the business’s accounts receivable.

Contra asset accounts help companies to record any reductions to their non-current and current assets. By doing so, they can bring their asset accounts to a more accurate position.

• Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances.
• This can help anyone viewing the financial information to find the historical cost of the asset.
• Debit depreciation expense for $18,625 and credit accumulated depreciation-equipment for $18,625.
• The amount is not reported, and the net sales amount is reported on the income statement.
• The obsolete inventory reserve account is the contra account to inventory, another asset listed on the balance sheet.