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. A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts.
What Is the Benefit of Using a Contra Account?
The Allowance for Doubtful Accounts carries a credit balance that reduces the total amount of accounts receivable to show the amount that the company expects to collect. Overall, contra accounts are offsetting balances that are the opposite of specific accounts. There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra-asset accounts, which are the prevalent type of contra accounts. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account.
How Does a Contra Account Work in Accounting?
Similarly, these accounts can also be essential in various calculations. For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation https://www.quick-bookkeeping.net/invoices/ of $60,000, offsetting that cost. However, a contra-asset account usually has a credit or nil balance. This account offsets the balance in the respective asset account that they pair with on the balance sheet.
- 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.
- Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
- The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
- Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.
Definition and Examples of Contra Assets
The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate 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. When a contra asset account is first recorded in a journal entry, the https://www.quick-bookkeeping.net/ offset is to an expense. 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. However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset.
Is Treasury Stock a Contra Account?
Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts. Any company that owns intangible assets such as software, patents, etc., will maintain an accumulated amortization account.
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. Therefore, the asset’s net value (or the book value) will be $70,000. Contra asset accounts also help companies keep their general ledgers organized. By recording reductions in a separate account, companies can get better insights into their actual accounts. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets.
The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect tax deductions guide 20 popular breaks in 2021 accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. how to get an ein business tax identification number A contra account carries a balance that is opposite to the normal balance of its related main account. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account. This requirement also comes from the accounting standard for inventories.
Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. On the other hand, accumulated depreciation is a contra-asset account. After each accounting period, the company records a depreciation expense of the asset. However, there are some prevalent contra-asset accounts that may exist for all companies. A contra account is an account that companies use to reduce the value of a related account.