This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances. This account helps companies present a more accurate accounts receivable balance on the financial statements. Accumulated depreciation is the most prevalent type of contra-asset account.
In fact, this card is so good that our experts even use it personally. Click here to read our full review for free and apply in just 2 minutes. This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated. The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. The money left over after a company supports operations can be a snapshot of its financial health.
Then, it aggregates all receivables in each grouping, calculates each group by the percentage, and records an allowance equal to the aggregate of all products. Companies technically don’t need to have an allowance for doubtful account. If it does not issue credit sales, requires collateral, or only uses the highest credit customers, the company may not need to estimate uncollectability. You can estimate the total to record in the top 15 financial modeling courses allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount. Rather, it is an adjunct account or a valuation account that is added to the face value of the bonds to arrive at the carrying value (or book value) of the bonds on the balance sheet. Similarly, it allows companies to retrieve original account balances without complicated calculations.
- There are three contra asset accounts that commonly appear in an organization’s chart of accounts.
- Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account.
- A contra-asset account is an account that opposes the balances of other asset accounts.
- Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance.
Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. 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.
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. Companies are recommended to use contra asset accounts for their fixed assets. It’s highly likely that your books will benefit from this process in terms of clarity, transparency, and the amount of time it takes to do accounting. 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.
The Contra Revenue Account
By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. 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.
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- The accumulated depreciation account is perhaps the most common contra asset account used by business owners.
- Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock.
- In this scenario, a write-down is recorded to the reserve for obsolete inventory.
- In this example, the company often assigns a percentage to each classification of debt.
- Of the $50,000 balance that was written off, the company is notified that they will receive $35,000.
There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance and reduce equity accounts.
What Is a Contra Account?
Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. 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. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000.
The company must be aware of outliers or special circumstances that may have unfairly impacted that 2.4% calculation. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account.
Contra revenue accounts reduce revenue accounts and have a debit balance. A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly below their paired accounts.
The Contra Equity Account
Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.
Example of a Contra Account
Both of these accounts offset each other to represent a net balance on a company’s balance sheet. The second entry will be accumulated depreciation, which will be in credit. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold.
This means that 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. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. Contra liability accounts are special accounts in the liabilities section of the balance sheet.
Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. 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. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.
Contra liability, equity, and revenue accounts have natural debit balances. 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. Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance.