What Is a Contra Asset?

You debit the contra revenue accounts and credit the corresponding revenue accounts. For example, when you debit the balance in sales returns account, make sure that you offset the sales revenue account with a credit balance. The two most common contra accounts on a balance are accumulated depreciation and the allowance for doubtful debts. Accumulated depreciation tallies the depreciation to date of a fixed asset, such as a car or a building. The Depreciation Expense account will show up on the income statement and will reduce the net income for the year by $1,000. The Accumulated Depreciation account is a contra asset account on the balance sheet that accumulates the total depreciation of the equipment over time.

A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.

  1. A contra revenue represents any deductions or offsets that need to be removed from gross revenue to provide a clearer understanding of actual income  —  such as in the example just provided.
  2. By recording reductions in a separate account, companies can get better insights into their actual accounts.
  3. In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account.
  4. If the company is certain that they will not receive this money, they can reduce the value of the relevant asset.

Note that in accounting, the term “book value” is also used interchangeably with net value. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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. Allowance for doubtful accounts (ADA) is a https://accounting-services.net/ used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services.

What are the types of Contra Asset Accounts?

QB itself isn’t set up to handle something like this on its own, so manual entries is the only way I know of to take care of it. I strongly suggest having a trained Accountant do this (or something in a similar vein) if you need it done for your business. In the financial statements the asset a/c would be offset against the contra asset a/c to show the net balance. 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 help companies record any reductions to their non-current and current assets.

AccountingTools

A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines. For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand. However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. By a miracle, it turns out the company ended up being rewarded a portion of their outstanding receivable balance they’d written off as part of the bankruptcy proceedings. Of the $50,000 balance that was written off, the company is notified that they will receive $35,000.

Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. Contra accounts help maintain the accuracy of financial records, provide transparency in reporting, and allow for proper tracking and analysis of specific transactions or events. The accounting entries for a discount on notes receivables are as follows.

Contra Account

The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. 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.

For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding. Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible. The second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group.

For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism. 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 allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount.

Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

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. Contra accounts allow you to show the amounts that offset a paired related contra asset account account. As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired.

Writing Off Account

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. Contra revenue accounts reduce revenue accounts and have a debit balance.

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. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. 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.

This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. 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. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet.