What Is A Contra Asset Account? Definition, Types, Example, And More

Sales Allowances-Sales allowances are also a part of the sales account. Sales allowance reduces the selling price when a customer agrees to accept a defective unit instead of returning it to the seller.

A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.

Contra Equity Accounts

When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. Allowance for Doubtful Accounts contra asset account decreases the value of accounts receivable by an estimate of uncollectible receivables to show their net realizable value on a balance sheet.

This amount may appear on a company’s balance sheet, and it can ultimately result in a reduction in the gross amount of a business’s fixed assets. Above mentioned journal entry shows a stark difference between contra asset and contra revenue account.

Difference Between Contra Asset And Contra Revenue

For example, accumulated depreciation is a contra-asset that reduces the value of a company’s fixed assets, resulting in net assets. Contra asset accounts provide business owners with the true value of certain asset accounts. 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. Again, accumulated depreciation reduced fixed and capital asset balances. Apple breaks out its amount of property, plant, and equipment (PP&E) and then lists its accumulated deprecation that reduces the PP&E figure.

Assets are debit balances that include resources with expected positive future economic benefits. You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable. This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. 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 revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances.

What Is A Contra Asset Account? Definition, Types, Example, And More

Instead of debiting the asset account directly, the contra asset account balance will be credited separately. Contra assets may be stated in separate line items on the balance sheet. 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.

While financial information on these accounts might include receivables collected, the company can also choose to include its contra asset accounts as a separate line item on the balance sheet. Balance sheet, users of financial statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life. 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.

Allowance For Doubtful Debts Accounts

In addition, the prior one has a credit balance while the latter one has a debit balance. After having elaborated examples of contra asset and contra revenue account it has become easier to understand the difference. Revenues do not appear on the balance sheet but are listed as part of the income statement. Some accounting professionals use contra revenue accounts to adjust gross receipts and calculate net revenue. Contra revenue carries a debit balance and may be listed as sales discounts, sales returns, or sales allowances. Contra assets are an important bookkeeping concept that helps balance a business’s books.

• However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost.
• Intangible assets include assets that do not have physical substance, but provide future economic benefits.
• Consequently, in the first year, the equipment would reflect a net value of $90,000, which is computed by deducting the accumulated depreciation from the equipment’s historical cost.
• Since liabilities are recorded with credit entries, contra liabilities show a debit balance.
• Allowance for doubtful debts accounts are opposite to accounts receivable accounts.

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. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. The bad debt, or allowance for doubtful accounts has a credit balance to offset the value of accounts receivable. There are different types of Contra Accounts and the most common are contra asset, contra liability, contra equity and contra revenue accounts. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account.

What Is A Contra Asset?

DateParticularsDebitCreditxxxDepreciation$20,000Machinery$20,000In this example, the asset account is reduced by $20,000. So, the chart above clearly displays the difference between contra assets and contra revenue. A classic example of human error creating a credit balance on in an asset account is bouncing a check.

• Contra accounts are needed for determining the book value of assets held by a company.
• An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable.
• These are all examples of contra asset accounts, which are the prevalent type of contra accounts.
• We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R).
• For instance, a contra account that relates to an accounts receivable is called a contra asset account.
• There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.

The reduction in the sale price of a product due to quality defects or mistakes, in an effort to encourage the customer to keep a product with minor defects in exchange for the discount. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. If you stock a limited amount of inventory, Contra Asset Account you could probably do without it. Nora O’Malley covers small business finance and entrepreneurship topics for The Balance. Along with her writing work, Nora is an entrepreneur and consultant who opened an all-tap wine bar in New York’s East Village dubbed Lois and owns a sophisticated snack food business Aida.

Contra Accounts Definition

Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. On the balance sheet, the allowance for doubtful accounts can reduce the totals in the business’s accounts receivable. So, if the company reported receivables amounting to $100,000, the estimated 5% default rate would reduce the number of accounts receivable by $5,000. Now let’s focus our attention on the two most common contra assets – accumulated depreciation and allowance for doubtful accounts. Contrarily, a revenue account is an account that records what we earn. Above all, the contra revenue account is the one that goes in reverse. To sum up, the increase in revenue is credit, and the decrease in revenue is debit.

• A contra liability account is not classified as a liability, since it does not represent a future obligation.
• Sales Discounts –Sales discounts are offered on sales of goods to attract buyers.
• If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.
• A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account.
• These assets are expected to provide future economic benefits for many accounting periods.

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. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. There are many situations where one account is used to offset another account.

What Is A Contra Account

When reporting a contra account in a company’s financial statement, it is reported immediately below the account it relates to or corresponds. Contra accounts have different names depending on the account they correspond. For instance, a contra account that relates to an accounts receivable is called a contra asset account. Allowance for doubtful accounts is a common contra asset listed on a company’s balance sheet under accounts receivable. When a company sells its products or services to customers on credit, the company records the amount sold in its accounts receivable account.

Closing Entries, Sales, Sales Returns & Allowances In Accounting

Consequently, in the first year, the equipment would reflect a net value of $90,000, which is computed by deducting the accumulated depreciation from the equipment’s historical cost. In this method, bad debt expense is estimated for the period and is recorded as an expense while the allowance account is credited. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current https://www.bookstime.com/ accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable. The net value of both these figures is usually reported on a third line. Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation purposes.

Despite being classified as a liability, it functions more like an asset because benefits are provided to the company. While technically classified as an asset, it functions closer to a liability as it reduces the value of the asset it is paired with. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.