Contra accounts definition

While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. 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. 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. 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 example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances. A separate account used in such a situation is sometimes called a adjunct account. In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances. A separate account is needed whenever the nature of transactions changes. It is because clubbing together dissimilar transactions impedes any analysis. For example, we need separate accounts to hold the actual cost of property, plant and equipment (PPE) and related accumulated depreciation.

Presentation of Contra Asset Accounts

Contra asset accounts are reported with the related account on the same financial statement. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time.

  • Contra equity reduces the total number of outstanding shares on the balance sheet.
  • Contra asset accounts are hugely beneficial for nearly all types of companies.
  • Asset accounts usually have a positive value which is the same as a debit balance.
  • These accounts might also appear on the balance sheets of the company.

The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. 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 net of these two figures is typically reported on a third line.

A final word about contra asset accounts

Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. Home Depot reports that returns are estimated at the discount on bonds payable time of the sale based on historic returns numbers. The amount is not reported, and the net sales amount is reported on the income statement. Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock.

What is a contra account?

The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Therefore, a contra asset can be regarded as a negative asset account.

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. 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. Sometimes, we have an ancillary balance whose normal balance is the same as that of the parent account.

A less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. By reading these financial statements, an individual will see the full financial picture of the company in question.

Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off. When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account. If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. It could be growing with bad accounts, and cash flow will be affected. 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.

Contra equity and contra revenue

The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. A contra account is a negative account that is netted from the balance of another account on the balance sheet. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.

Offsetting the asset account with its respective contra asset account shows the net balance of that asset. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. In other words, the contra liability account is used to adjust the book value of an asset or liability.

This is an owner’s equity account and as such you would expect a credit balance. Other examples include (1) the allowance for doubtful accounts, (2) discount on bonds payable, (3) sales returns and allowances, and (4) sales discounts. For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

contra account definition

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. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. 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. 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.

Contra Account Definition in Accounting

Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation.

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