Contra Asset Examples, How a Contra Asset Account Works

As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures. 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. However, that $1.4 billion is used to reduce the balance of gross accounts receivable.

In the books, the account of the asset would have a debit value of $100,000, and the CA account would have a credit value of $30,000. If the asset account had a credit balance or the CA account had a debit balance, this would indicate an error in the journal entries. Contra asset accounts are necessary for companies for various reasons. The most prominent of these include allowing companies to present a more accurate picture of their assets. After each accounting period, the company records a depreciation expense of the asset. For example, if an account has a debit balance, a contra account will have a credit balance.

Depreciation Expense Account Vs. Allowance for a Depreciation Account

We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. A contra-account is a permanent account presented in the balance sheet. Depreciation is not directly reduced from the asset so that the historic value/fair value of the
asset could be presented in a balance sheet. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later.

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. Note that in accounting, the term “book value” is also used interchangeably with net value. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances.

Allowance for Doubtful Accounts

There are many situations where one account is used to offset another account. One common example is accumulated amortisation, which is a contra-asset account. This means that it acts in the opposite manner of a regular asset account. This results in compliance with the accrual concept while reflecting on an accurate accounts receivable balance. In this method, bad debt expense is estimated for the period and is recorded as an expense while the allowance account is credited. Allowance for doubtful debts accumulates the bad debt expense (estimated) that has been provided so far.

• Contra asset accounts also help companies keep their general ledgers organized.
• Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
• By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
• Hence, the company will have gross revenue or net sales equal to $9,900.
• Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.
• By doing so, they can bring their asset accounts to a more accurate position.

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.

What Happens to the Balance Sheet When Accounts Receivable Is Collected?

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. 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. 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.

To oppose the revenue made by a company, contra revenue accounts must have a debit balance. As mentioned, CA 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.

What is a Contra Asset?

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As mentioned, a company will usually have debit balances in its asset accounts. A company’s financial accounts will usually have three types of items. Assets are debit balances that include resources with expected positive future economic benefits. This account appears next to the current asset Accounts Receivable. contra asset account 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.

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. Assets are permanent or real accounts which are presented as part of the balance sheet. These ref to the resources owned by the company which arose from the incurrence of a liability or contribution from owners. 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.

Contra equity accounts carry a debit balance reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities include discount on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts.

These assets will have a useful life of more than one year and will be recorded as non-current assets on the balance sheet. Examples of fixed assets include land, building, equipment and vehicles. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount.

They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

Allowance for doubtful accounts

An organization would rather record $100,000 as an asset and would amortize $10,000 depreciation each year for the next 10 years. In a balance sheet, accumulated depreciation would be reflected as a reduction from the asset’s account so that the net balance is evident. 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. Accounts receivable result in a cash inflow to an organization when they repay their dues.

• One common example is accumulated amortisation, which is a contra-asset account.
• A company’s financial accounts will usually have three types of items.
• This process continues each year until the vehicles are fully depreciated.
• Allowance for receivables is an account that companies maintain to record possible bad debts.
• This requirement also comes from the accounting standard for inventories.
• Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired.
• The net amount of accounts receivable is presented in a balance sheet.

The annual amortization of the cost of an asset is referred to as depreciation expense. The corresponding effect is charged to accumulated depreciation accounts. Accumulated depreciation accounts accumulate the depreciation expense charged on the asset.