Contra Account Definition

At the same time, depreciation for the van at the end of the year ended up at $500. When examining the term “contra asset account,” look no further than the root of contra to get a vague grasp of the definition. Because contra means “against,” one could quickly conclude that a contra asset account is going to be an account that goes against the regular asset account on the Balance Sheet. Quite frankly, the actual definition is not far from this estimate. In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset.

Allowance For Doubtful Accounts Calculation

contra asset account definition

Obsolete Inventory Reserves

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. On the balance sheet, the allowance for doubtful accounts can reduce the totals in the business’s accounts receivable.

So, the company’s total value of receivables results in $95,000, and Power Manufacturers may then adjust this calculation in their financial records as they receive more credit sales. $100,000 – $5,000 (the 5% allowance for doubtful accounts) to equal a net receivable amount of $95,000. The purchases account is a general ledger account in which is recorded the inventory purchases of a business. This account is used to calculate the amount of inventory available for sale in a periodic inventory system.

Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance.

Can Someone Explain Contra Accounts To Me?

So, if the company reported receivables amounting to $100,000, the estimated 5% default rate would reduce the amount of accounts receivable by $5,000. The following are several key reasons why it can be important to include contra asset accounts on a balance sheet. Obsolete inventory refers to a company’s products or goods that have become obsolete, or unusable, during routine use and operations. This type of contra asset account may generally small business bookkeeping be debited expenses, followed by a credit to the company’s contra asset account for recording unusable inventory. Similarly, a business may also write off these types of expenses from its financial records if the inventory has been completely phased out. The contra asset account can also be combined with a current inventory account, allowing a financial analyst to determine the current market value of the company’s inventory.

A Little More On What Is A Contra Account

What is an asset account?

Asset accounts represent the different types of economic resources owned or controlled by an entity. Common examples of asset accounts are cash in hand, cash in bank, real estate, inventory, prepaid expenses, goodwill, and accounts receivable.

Therefore, a contra asset can be regarded as a negative asset account. Assume Gem Co.’s Accounts Receivable has debit balance of $100,000 at June 30. Gem anticipates that approximately $2000 will not return to cash, and as a result reports a credit balance of $2000 in Allowance for Doubtful Accounts. Accounting entry to adjust the balance in allowance account will involve the income statement account Bad Debts Expense. When compiling or recording a financial statement, a contra account is recorded immediately before the account or corresponds or relates to.

contra asset account definition

A reserve for doubtful debts can not only help offset the loss you incur from bad debts, but it also can give you valuable insight over time. For example, your ADA could show you how effectively your company is managing credit it extends to customers. bookkeeping Use the accrual accounting method if you extend credit to customers. If a customer purchases from you but does not pay right away, you must increase your Accounts Receivable account to show the money that is owed to your business.

Another way you can calculate ADA is by using the aging of accounts receivable method. QuickBooks For many business owners, it can be difficult to estimate your bad debt reserve.

Is Accounts Receivable A Debit Or Credit Account?

Since we are discussing doubtful accounts, the offset will be against accounts receivables. When determining how much uncollectible customer debt to write off, an associated account called a contra account is used. This helps to keep financial books straight while also allowing the company to see the amount in doubtful accounts.

A debit ticket is an accounting entry that indicates a sum of money that the business owes. A contra account is used in a general ledger to reduce the value of a related account when the two are netted together. A contra account’s natural balance is the opposite of the associated account. If a debit is the natural balance recorded in the related account, the contra account records a credit. Depreciation is the method of accounting used to allocate the cost of a fixed asset over its useful life and is used to account for declines in value. It helps companies avoid major losses in the year it purchases the fixed assets by spreading the cost over several years. Accumulated depreciation is not an asset because balances stored in the account are not something that will produce economic value to the business over multiple reporting periods.

Each contra asset account serves a different specific purpose, but they are have a couple things in common, too. Contra asset accounts are used to reduce the debit balance of its corresponding asset account in order to calculate a net value for each asset. ZipBooks gives you the option to create a contra asset account automatically for any new or existing asset account that you mark as depreciable. Since asset accounts are debit accounts, a contra asset account is a credit account used to offset the balance of the main debit account.

Treasury stock and drawing accounts are examples of contra equity accounts. A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected bookkeeping on the balance sheet. A classic example of human error creating a credit balance on in an asset account is bouncing a check. If you write a check for more than is in your bank account you are going to going to go from a debit balance to a credit balance.

The contra asset account is later reduced when the expense is recorded. Business owners should understand the functions of contra accounts and their importance to maintaining accurate financial records. Taking into account the list of contra asset accounts, how would you calculate the net value of assets? If the example looks difficult, rest assured the solution is very simple.

It is treated as a liability because the revenue has still not been earned and represents products or services owed to a customer. Both are balance sheet accounts, so the transaction does not immediately affect the income statement. It seems that another example of a contra account would be an expense account associated with a security deposit (eg. rental property). The interest owed on a security deposit would show as a debit in the expense account until the tenant moved and the account settled. at that time, cash is debited and the expense account credited for the interest owed/paid.

An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. Unearned revenue is money received from a customer for work that has not yet been performed.

What is a contra equity account?

An owner’s or stockholders’ equity account with a debit balance instead of the normal credit balance. Examples include the owner’s drawing account, a dividend account, and the treasury stock account.

Basically, contra accounts work oppositely from other accounts of the same type. For instance, assets are things that you expect to generate some future prepaid expenses benefit, like cash or equipment. Therefore, accumulated depreciation carries a credit balance whereas asset accounts normally carry a debit balance.

  • Other examples include the allowance for doubtful accounts, discount on bonds payable, sales returns and allowances, and sales discounts.
  • This is an owner’s equity account and as such you would expect a credit balance.
  • An account with a balance that is the opposite of the normal balance.
  • The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts.
  • For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account.
  • For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts.

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. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.

Differences among methods of accounting for inventory will effect the _____ of when the expense is to be recognized, but will not effect the ___________. A contra account is an account whose balance is the opposite of a corresponding account. In finance, a contra account reduces the value of related or corresponding account. It offsets the balance of the related account, which means when the corresponding account is positive, a contra account will be negative. There are many situations where one account is used to offset another account.

contra asset account definition

The situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below. The balances in contra accounts are reduced when the assets or liabilities with which they are paired are disposed of. Thus, when a fixed asset is sold, the accumulated depreciation associated with it is reversed. Otherwise, the balances in the various contra asset accounts would continue to increase over time. Because of the oppositional nature of these asset accounts, the contra account acts as a ‘contrary’ element to the debit balances of regular asset accounts.

And, having a lot of bad debts drives down the amount of revenue your business should have. By predicting the amount of accounts receivables customers won’t pay, you can anticipate your losses from bad debts.

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