Learn About Contra Asset Account

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Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account. 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. 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.

What Is The Importance Of Contra Asset Accounts?

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value.

Contra asset accounts are prepared so that a specific reverse effect on the corresponding asset could be recorded. Accumulated depreciation accounts accumulate the depreciation expense provided so far about the corresponding asset. It is shown as a reduction to the asset account and is reversed when the asset is disposed of. The net of the asset and its related contra asset account is referred to as the asset’s book value or carrying value. Power Manufacturers, Inc. purchases new machinery for a total of $300,000. Therefore, the depreciation of the equipment increases by approximately $50,000 for each year of use. This method uses the initial purchase value and subtracts the accumulated depreciation value for the time period to result in the total value of the equipment after its use.

Reasons To Include Contra Asset Accounts On A Balance Sheet

In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset. A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance.

Every contra asset account on a company’s accounting records will have a pairing account as well. For example, accumulated depreciation will go along with related assets. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. Although contra asset accounts have credit balances, they do not appear in liabilities or equity.

Contra Revenue

This results in compliance with the accrual concept while reflecting on an accurate accounts receivable balance. Accounts receivable result in a cash inflow to an organization when they repay their dues.

Allowance for doubtful debt is a contra account against which bad debts are charged. Therefore, in the allowance method, relevant bad debt expense is recorded and accounts receivable are written off when these are considered not recoverable. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity. For example, the contra asset account Allowance for Doubtful Accounts is related to Accounts Receivable.

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.

What Is A Contra Account?

A contra equity account reduces the total number of outstanding shares listed on a company’s balance sheet. When a company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account. A company may decide to buy back its shares when management feels the stock is undervalued or because it desires to pay stock dividends to its shareholders. Discount on notes receivable refers to a contra asset account that occurs when the current value of a note receivable amounts to less than the face value of the note. The resulting credit balances in these types of accounts may typically be amortized as interest revenue over the course of the note’s viable lifetime. This type of account can equalize balances in the asset account that it is paired with on a business’s balance sheet.

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. This type of account could be called the allowance for doubtful accounts or bad debt reserve.

Free Financial Statements Cheat Sheet

It offsets the balance of the related account, which means when the corresponding account is positive, a contra account will be negative. Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible. Any company that owns intangible assets such as software, patent, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets.

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. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. Contra asset accounts also help companies keep their general ledgers organized.

Types Of Finance And Accounting Jobs

However, they will still appear on the notes to the financial statements with necessary disclosures. DateParticularsDr.Cr.Depreciation$ 10,000Accumulated Depreciation$ 10,000In the above example, depreciation is an expense account.

• A major example of a contra account is the accumulated depreciation.
• There are generally two contra asset accounts used by companies that are an allowance for doubtful debts account and an accumulated depreciation account.
• Debit depreciation expense for $16,875 and credit accumulated depreciation-equipment for $16,875.
• When a contra asset account is first recorded in a journal entry, the offset is to an expense.
• Allowance for doubtful debts accumulates the bad debt expense that has been provided so far.

It is not classified as a liability since it does not represent a future obligation. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value.

The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. Notes receivables are promissory notes that include a promise from a borrower to repay a lender. Sometimes, the current value of a note receivable will fall compared to its face value.

Contra asset accounts help companies to record any reductions to their non-current and current assets. By doing so, they can bring their asset accounts to a more accurate position. After each accounting period, the company records a depreciation expense of the asset. Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount.

For example, GAAP accounting requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for. Contra asset accounts are prepared so that an asset’s gross value and deductions can be shown separately. The accounting rules applicable to contra asset accounts are exactly opposite to asset accounts. Contra asset accounts are credited when these are increased and debited when these are decreased.

They are the current assets of a company expected to be realized within 12 months. Accumulated depreciation is the total amount of depreciation expense allocated to a specific asset since the asset was put into use. The accounting entries for allowance for receivables are as follows. An adjunct account is an account in financial reporting that increases the book value of a liability account. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. A contra account is an account used in a general ledger to reduce the value of a related account. The following information is available from the financial records of X Company.

How Does Depreciation Affect Cash Flow?

The contra asset account has credited balances that can reduce the balance in its paired asset account. 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. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts.

This process will give rise to a contra asset account which is the discount on notes receivables. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are.

Bad debt is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. Investopedia requires writers to use primary sources to support their work.