How to Use Contra Asset Accounts

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Example of a Contra Account

If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance.

As we have seen in the above discussion, how reporting contra assets accounts helps in a better understanding of the financial statements of any organization. So, an organization looking for a robust accounting process must move to this reporting for better understanding. 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.

This is the reason they are categorized as a contra account as the normal asset accounts have positive or debit balance. These contra assets in the balance sheet are reflected with the asset accounts they are paired with to equalize the balance. 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. It is prepared when there is a reduction in the value of assets due to wear and tear continuous use or when we expect that a certain percentage of accounts receivable will not be received.

For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. 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.

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. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the 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.

A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to. Contra equity reduces the total number of outstanding shares on the balance sheet.

By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. 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 allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.

Definition and Examples of Contra Assets

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. The contra asset account, accumulated depreciation, is always a credit balance. 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. When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance.

What Is a Contra Account?

1. If we show $60,000 as an asset in the third year, it will be challenging to understand whether $60,000 is all new purchases or the remaining value of an asset.
2. In the financial statements the asset account would be offset against the contra asset account to show the net balance.
3. 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.
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5. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a do i need to file a tax return for an llc with no activity certain asset over time. The difference between an asset’s account balance and the contra account balance is known as the book value. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.

It is a standard business practice to prepare an estimate for the amount likely to go bad. The provision for doubtful debts is a contra asset account related to debtors. 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.

Overview: What is a contra asset account?

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 accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. 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.

However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they cash flow statement template for excel are used to reduce the balance of another account. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.

Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. It is not classified as a liability since it does not represent a future obligation.

The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. It is only prudent to show the reduction or reserve in a separate account, and at any point, it gives us the netbook value explaining what the actual cost was and how much of that has been depreciated. It also helps create reserves, and later any change in the expected number can be adjusted through allowances and reserves.