Contra Account Definition, Types, and Example

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. Typically, a company fails to collect all of the money owed by customers making purchases on credit.

The provision for doubtful debts is a contra asset account related to debtors. Contra Asset AccountA contra asset account is an asset account with a credit balance related to one of the assets with a debit balance. When we add the balances of these two assets, we will get the net book value or carrying value of the assets having a debit balance.

Valuing Notes Receivable

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 revenue accounts reduce revenue https://www.good-name.org/how-accounting-services-can-help-real-estate-companies-optimize-their-finances/ accounts and have a debit balance. Just like contra asset accounts offset the positive values of assets on the balance sheet, contra liabilities offset the negative value of liabilities on the balance sheet. Since liabilities are recorded with credit entries, contra liabilities show a debit balance.

Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser. The percentage of sales method assumes that a fixed percentage of goods or services sold by a company cannot be received. construction bookkeeping Are prepared for various parties; some of them might not be accounting versed; they help identify the reduction in total value. Provision for a discount from creditors and discount on bills receivable are other widely used examples.

Contra liability accounts

Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account.

However, there are some prevalent contra asset accounts that may exist for all companies. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet.

Understanding a Contra Account

Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. Contra assets allow for more granular visibility on the balance sheet by maintaining historical costs and independent values rather than reducing the original account directly. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.

The increase in the accumulated depreciation account reduces the asset to its current book value . Increases in value in excess of prior impairment loss is debited directly to the asset and credited to a revaluation reserve account in the equity section of the balance sheet. Increases in value in excess of prior impairment loss are debited directly to the asset and credited to a revaluation reserve account in the equity section of the balance sheet. In accounting, notes receivables are accounts to keep track of accrued assets that have been earned but not yet received. An impairment cost must be included under expenses when the carrying value of a non-current asset on the balance sheet exceeds the asset’s market value subtracted by any transaction costs .

Why are contra asset accounts important for businesses?

The Johnson family’s purchase of furniture illustrated the effect on the financial statements for two kinds of contra accounts, revenue, and asset. Contra accounts are also used in other areas of the financial statements, such as an estimate on an uncontrollable percentage of credit sales in which the amounts listed must be estimable and probable. When this happens, the debit will be added to the expense account Bad Debt Expense and the credit will be added to the asset account, Allowance for Doubtful Accounts. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.

The entry to remove the asset and its contra account off the balance sheet involves decreasing the asset’s account by its cost and decreasing the accumulated depreciation account by its account balance. The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable. Another reason to include contra accounts on a balance sheet is to preserve the historical value of the main account. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. If a listed company purchases its own shares from the open market, it will have to debit the treasury stock account in order to record the transaction.

Understanding Contra Accounts

It is prepared when there is a reduction in the value of assets due to wear and tear continuous use or when we expect that a certain percentage of accounts receivable will not be received. DepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. This account is not classified as an asset since it does not represent a long-term value.